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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended June 30, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
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Commission file number: 333-31282
O'SULLIVAN INDUSTRIES, INC.
(Exact name of registrant as specified in its charter)
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Delaware 43-0923022
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)
1900 Gulf Street, Lamar, Missouri 64759-1899
(Address of principal executive offices) (Zip Code)
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Registrant's telephone number, including area code: (417) 682-3322
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
None
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
As of September 15, 2000, 100 shares of common stock of O'Sullivan
Industries, Inc. were outstanding and held by O'Sullivan Industries Holdings,
Inc., an affiliate.
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The Index to Exhibits begins on page 59
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PART I
ITEM 1. BUSINESS.
HISTORY AND OVERVIEW
O'Sullivan Industries, Inc., a Delaware corporation incorporated in
1969, is a leading designer, manufacturer and distributer of ready-to-assemble
furniture in the United States. Our 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 to its subsidiary TE Electronics Inc. In February 1994,
TE transferred O'Sullivan to O'Sullivan Industries Holdings, Inc. in exchange
for O'Sullivan Holdings common stock. TE then sold its shares of O'Sullivan
Holdings stock in a public offering. Subsequent to the public offering, neither
Tandy nor TE has had any continuing ownership interest in O'Sullivan or
O'Sullivan Holdings. O'Sullivan Holdings is a holding company with no material
operations. It owns all of the capital stock of O'Sullivan. O'Sullivan owns all
of the capital stock of O'Sullivan Industries - Virginia, Inc., a Virginia
corporation. O'Sullivan Holdings is dependent on O'Sullivan to fund the interest
cost on $15.0 million of debt and dividends on mandatorily redeemable senior
preferred stock (liquidation value plus accumulated dividends of $26.4 million
at June 30, 2000).
References to the words "O'Sullivan," "we," "our," and "us" refer to
O'Sullivan Industries, Inc., and its subsidiaries. References to "O'Sullivan
Holdings" refer to O'Sullivan Industries Holdings, Inc. References to O'Sullivan
Industries - Virginia refer to O'Sullivan Industries - Virginia, Inc.
O'Sullivan owns manufacturing, warehouse and distribution facilities in
Lamar, Missouri, South Boston, Virginia and Cedar City, Utah. O'Sullivan
commenced operations at the Lamar, Missouri plant in 1965, and the South Boston,
Virginia facility became operational in 1989. O'Sullivan phased in production at
the Cedar City, Utah facility in the spring of 1995.
O'Sullivan engages in one industry segment: the design, manufacture and
sale of RTA furniture.
The Recent Recapitalization and Merger
On May 17, 1999, O'Sullivan Holdings entered into an agreement and plan
of merger with OSI Acquisition, Inc., a company formed by principals of
Bruckmann, Rosser, Sherrill & Co., LLC ("BRS"), a private equity firm. Under the
merger agreement, as amended, OSI was merged with and into O'Sullivan Holdings
on November 30, 1999, with O'Sullivan Holdings as the surviving corporation. OSI
did not survive the merger. Thirty-four members of our management and an
affiliate of a former director participated with BRS in the recapitalization and
merger of O'Sullivan Holdings. Management and the affiliate of a former director
owned a total of 27.1% of the outstanding common stock of O'Sullivan Holdings at
June 30, 2000. Affiliates of BRS own the balance.
Each share of outstanding common stock of O'Sullivan Holdings was
exchanged for $16.75 in cash and one share of senior preferred stock with an
initial liquidation value of $1.50 per share. Some of the shares of O'Sullivan
common stock, options and cash held by the management participants in the
recapitalization and merger were exchanged for 371,400 shares of common stock,
72,748 shares of Series B junior preferred stock and options to acquire 60,319
shares of Series A junior preferred stock of the surviving company.
The total amount of funds necessary to fund the recapitalization and
merger and related transactions was approximately $357.0 million. These funds
came primarily from the following sources:
- an equity investment by an affiliate of BRS of approximately $45.3
million in cash in the common stock and Series B junior preferred
stock of O'Sullivan Holdings;
- an equity investment in O'Sullivan Holdings by the management
participants in the recapitalization and merger in the amount of
approximately $13.7 million. This investment consisted of the
exchange by the management participants of common stock of
O'Sullivan Holdings with a value of $6.9 million, options to
acquire common stock of O'Sullivan Holdings with an intrinsic
value of $6.1 million and cash of $0.7 million for shares of
common stock, shares of Series B junior preferred stock and
options to acquire shares of Series A junior preferred stock, each
of O'Sullivan Holdings;
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- the issuance by O'Sullivan Holdings of senior preferred stock with
a total liquidation value of $24.6 million to the existing
stockholders of O'Sullivan Holdings;
- the issuance by O'Sullivan Holdings of a $15.0 million senior note
and warrants exercisable in aggregate into 6.0% of O'Sullivan
Holdings' common stock and 6.0% of O'Sullivan Holdings' junior
preferred stock on a fully diluted basis as of the date of the
issuance of the warrants;
- the issuance by O'Sullivan of $100.0 million of senior
subordinated notes together with warrants issued by O'Sullivan
Holdings exercisable in aggregate into 6.0% of O'Sullivan Holdings
common stock and 6.0% of O'Sullivan Holdings junior preferred
stock on a fully diluted basis as of the date of issuance of the
warrants;
- borrowings by O'Sullivan totaling approximately $139.0 million
under the senior credit facilities; and
- $9.4 million of cash from O'Sullivan.
In addition, $10.0 million of variable rate industrial revenue bonds
remain outstanding following the recapitalization transactions.
The recapitalization and merger was approved by the board of directors
of O'Sullivan Holdings, the board of directors of OSI Acquisition, Inc. and a
majority of the stockholders of O'Sullivan Holdings. We have accounted for the
merger under recapitalization accounting. Under this method, the historical
basis of our assets and liabilities were not affected.
THE RTA FURNITURE SEGMENT
We are a leading designer, manufacturer and distributer of
ready-to-assemble furniture products, with over 45 years of experience. We sell
primarily to the rapidly growing home office and home entertainment markets. We
manufacture approximately 450 stock keeping units of ready-to-assemble furniture
at retail price points from $20 to $999. Our product offerings include
ready-to-assemble desks, computer workcenters, home entertainment centers, audio
equipment racks, pantries and microwave oven carts. We also manufacture a
variety of other ready-to-assemble furniture for home office, home
entertainment, bedroom and other home uses. We design our products to provide
high quality, value and ease of assembly by the consumer using straight-forward,
diagramed instructions. For the fiscal year ended June 30, 2000, we had net
sales of $423.4 million, EBITDA of $36.2 million and a net loss of $3.2 million.
At June 30, 2000, our assets totaled $296.1 million. For additional information
regarding our sales, operating profits and assets, see the financial statements
included in Part II, Item 8 of this report, "Financial Statements and
Supplementary Data."
We distribute our products primarily through office superstores,
including OfficeMax, Office Depot and Staples, discount mass merchants,
including Wal-Mart, Target and Kmart and home centers such as Lowe's, as well as
through other retail channels. We own three modern manufacturing facilities
totaling over 2.1 million square feet that are strategically located across the
United States. This network of manufacturing facilities positions us closer to
our customers and reduces freight costs. Freight costs represent a significant
portion of total product cost.
The $3.6 billion (at retail) ready-to-assemble segment of the North
American furniture market grew at a compound annual growth rate of about 8.75%
from 1992 through 1999, according to Furniture Today. This was significantly
faster than the compound annual growth rate of the roughly $61 billion domestic
residential furniture market from 1992 to 1999. The market for residential
furniture, which includes upholstered furniture and wood furniture shipped fully
assembled by the manufacturer, is influenced by a variety of factors, including
home sales, housing starts and general economic conditions. We believe the
faster growth of ready-to-assemble furniture products is the result of changes
in the needs of consumers, changes in retail distribution channels and
improvements in product quality.
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- CHANGES IN THE NEEDS OF CONSUMERS. Consumer demand for personal
computers, which has been strong in part due to the rapid growth of the
Internet, and for larger screen televisions and related equipment has
driven the demand for more sophisticated ready-to-assemble home office
and home entertainment furniture. We expect the demand for these
product to continue as the number of households owning personal
computers, home theaters and other audio and video equipment expands.
- CHANGES IN RETAIL DISTRIBUTION CHANNELS. Office superstores and
discount mass merchants have altered the way many products are sold in
the United States. The ready-to-assemble furniture segment has been
positively impacted by the rapid growth and increased market share of
these retailers. These distribution channels accounted for over 50% of
the domestic sales of ready-to-assemble furniture in 1999.
- IMPROVEMENTS IN PRODUCT QUALITY. Improvements in equipment, software
and manufacturing processes have enabled the ready-to-assemble
furniture industry to produce higher quality, more durable products. As
a result of these improvements, ready-to-assemble furniture has become
more comparable in quality and durability to wood furniture shipped
fully assembled by the manufacturer but remains relatively less
expensive.
We believe that these trends will continue to drive the growth of the
ready-to-assemble segment of the retail furniture market.
COMPETITIVE STRENGTHS
We believe that we are able to compete effectively due to the following
strengths:
Leading market share position. We believe we are the second largest
North American ready-to-assemble furniture manufacturer in terms of domestic
sales. We estimate our share of the ready-to-assemble furniture market in
calendar 1999 was approximately 16%. Many of our largest customers, including
office superstores and discount mass merchants, have substantial purchasing
requirements across the country. We are able to satisfy these requirements
because of our large manufacturing capacity and our innovative, high quality
products.
Leader in product quality, innovation and design. We believe that we
are recognized as a leader in product quality, innovation and design in the
ready-to-assemble furniture industry. Our computer-aided design software and our
modern manufacturing processes enable us to develop more than 150 new products
per year. Consequently, about one-third of our products are new each year. Our
ability to innovate allows us to keep pace with changes in retailer and consumer
tastes and demands.
Well-established customer relationships. We have well established
relationships with many of the largest retailers of ready-to-assemble furniture
in the United States. These include office superstores like OfficeMax, Office
Depot and Staples. They also include national discount mass merchants, like
Wal-Mart, Target and Kmart. We have also established relationships with leading
electronic superstores like Best Buy and Circuit City and with home centers such
as Lowe's. We believe we have a long history as a trusted vendor and have earned
a reputation for product quality and innovation, customer responsiveness and
manufacturing flexibility.
Recent capacity expansion and system upgrades position us for growth.
In 1998, we completed a $20 million capacity expansion program in our Virginia
plant. This expansion increased our total manufacturing capacity by
approximately 15%. Another plant expansion is under construction in Virginia. We
also recently completed a $13 million manufacturing equipment upgrade in our
Missouri plant. In addition, we have upgraded our management information
systems. This upgrade included a corporate-wide conversion to JD Edwards
software. We also installed new point-of-sale analytical software that allows
our sales force to better analyze sales trends and consumer preferences. In
addition, we installed Pro-engineering, a computer-aided design software
package. This software enhances our product design capabilities and reduces the
time before newly conceived products reach the market.
Low cost, geographically diversified manufacturing operations. We
believe that we are a low-cost ready-to-assemble furniture producer due to our
large scale, modern facilities and efficient manufacturing processes.
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We are the only major ready-to-assemble furniture manufacturer with a plant in
each of the eastern, central and western regions of the United States. Further,
we are the only major manufacturer with a manufacturing facility in the western
United States. This allows our plants to receive particleboard and fiberboard
from the manufacturers located nearest to them. Our network of manufacturing
facilities positions us closer to our customers. It also reduces shipping costs,
which represent a significant proportion of product cost.
Experienced management team with significant equity ownership. Our
senior management team has extensive experience in the ready-to-assemble segment
of the furniture industry. Our ten officers have been with us for an average of
over 16 years. In addition, we have broadened our management's expertise by
hiring executives from other leading manufacturers. Management participants in
the recapitalization invested a total of $13.2 million. This retained equity
includes an interest of approximately 27.1% in the outstanding common stock of
O'Sullivan Holdings. As a result of their substantial equity interest, we
believe the management participants in the recapitalization have a significant
incentive to continue to increase our sales and profitability.
GROWTH STRATEGY
Sales of ready-to-assemble furniture, although expanding more rapidly
than sales of traditional casegood furniture, still represent only about 6% of
the overall domestic residential furniture market. As the quality of
ready-to-assemble furniture continues to improve, and office superstores and
discount mass merchants continue to expand, we expect ready-to-assemble
furniture to gain additional market share. The key elements of our growth
strategy are as follows:
Continue to develop a broad range of innovative, high quality products.
We are dedicated to offering a broad range of high quality products at a variety
of retail prices. We believe that by maintaining a broad product line we can
appeal to a greater number of consumers and penetrate a larger number of
distribution channels. We seek to drive demand for our products and maintain
profitability in an otherwise price-rigid environment by providing a steady
supply of high quality product introductions. In fiscal year 2000, we introduced
approximately 230 new products.
Further penetrate existing and new, growing distribution channels.
Sales to office superstores and discount mass merchants, our core distribution
channels, have grown at a compound annual growth rate of 16% since fiscal year
1995 to over $300 million in fiscal year 2000. To increase sales to our existing
customer base, we have developed several initiatives. These initiatives include
dedicated product lines, enhanced customer service and tailored marketing
programs. We have also focused on increasing sales to other growing distribution
channels. These channels include electronic specialty retailers and home
improvement centers.
Lower production costs. Producing ready-to-assemble furniture cost
effectively is vital to our competitive position. This belief was the premise
for our recently completed capital expansion and management information systems
upgrade. Our capital investments have increased our total manufacturing
capacity. New equipment and employee training have also improved our inventory
management, order fulfillment rates and production efficiency. In addition, our
JD Edwards and Pro-engineering software implementations have improved our
customer responsiveness and product design capability.
Remain committed to customer service. We are committed to providing
superior customer service to maintain strong relationships with our customers.
We strive to develop marketing strategies that are consistent with our
customers' needs and their position in the marketplace. The recent investments
we have made to improve our management information systems and increase our
manufacturing capacity should enable us to provide a higher level of customer
responsiveness, improve the look and quality of our products and enhance our
ability to forecast orders.
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PRODUCT OVERVIEW
We group our product offerings into three distinct categories:
- furniture for the home office, including desks, computer work centers,
bookcases, filing cabinets and computer storage racks;
- electronics display furniture, including home entertainment centers,
home theater systems, television and stereo tables and cabinets, and
audio and video storage racks; and
- home decor furniture, including microwave oven carts, pantries, living
room and recreation room furniture and bedroom pieces, including
dressers, night stands and wardrobes.
The following is a description of some of our products.
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PRODUCT DESCRIPTION KEY CUSTOMERS
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Living Dimensions................... Contemporary small office/home OfficeMax, Office Depot, Best Buy,
office and entertainment Office World, Circuit City
furniture. Upscale features
include Armortop(R) laminates and
Quickfit(TM) fastener system.
Xpressions(TM)......................... Generation X targeted home office Wal-Mart, Circuit City, Meijer,
and entertainment furniture Ames, Staples, Montgomery Ward
collection. Features include
mini-stereo system compatibility,
lavish media storage and youthful
high contrast, two-tone finish.
French Gardens...................... Country French style collection OfficeMax, Shopko, Montgomery Ward
with antique Odessa Pine finish.
Both home office and entertainment
products.
Transitions......................... Contemporary small office/home Best Buy, Lowe's, Montgomery Ward
office and entertainment furniture
collection in a medium alder finish.
Diplomat............................ Modular home office/small office Staples
collection in snow maple and vivid
beech finishes.
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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 market,
we believe we are recognized as one of the industry's premier producers of
contemporary home office ready-to-assemble furniture. As evidence of our
commitment to quality and innovation, in the past three years we introduced an
average of over 150 products per year. In the ready-to-assemble furniture
industry, a new product can be a variation in color or styling of an existing
product. By providing a continuous supply of new product introductions, we are
able to drive demand for our products, which we believe will allow us to
maintain our profit margins in an otherwise price-rigid environment.
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We maintain an in-house product design staff that collaborates with our
marketing personnel and customers to develop new products based on demographic
and consumer information. The product design professionals then work with our
engineering division to produce full-scale prototypes. The engineering staff
uses computer-aided design Pro-engineering software, which provides the latest
three-dimensional graphics capabilities. Pro-engineering software allows a
design engineer to accelerate the time-to-completion for a new product design.
This allows us to reduce the time for newly conceived products to reach the
market. We then show our prototypes to our customers to gauge interest. If
initial indications of product appeal are favorable, we usually can commence
production within twelve weeks. We spent approximately $1,000,000, $800,000 and
$900,000 on product design and development in fiscal years 2000, 1999 and 1998,
respectively.
CUSTOMERS
Ready-to-assemble furniture is sold through a broad array of
distribution channels, including discount mass merchants, office superstores,
electronic superstores, national department stores and home centers. While the
ready-to-assemble segment historically has been dominated by discount mass
merchants like Wal-Mart, Target and Kmart, office superstores have quickly
become the second largest distribution channel. The office superstores are the
fastest growing channel.
We have a large market share position in both of the two major
distribution channels and longstanding relationships with key customers. In
fiscal year 2000, over 60% of our sales were made through the office superstore
and discount mass merchant channels. In that same period, sales to OfficeMax
accounted for about 22% of our gross sales, Office Depot accounted for about 18%
of our gross sales and Wal-Mart accounted for 11% of our gross sales. Similar to
other large ready-to-assemble furniture manufacturers, our sales are fairly
concentrated.
SALES AND MARKETING
We manage our customer relationships both through our in-house sales
force and a network of independent sales representatives. Key accounts like
OfficeMax and Office Depot are called on jointly by our sales force and
independent sales representatives. Smaller customers are serviced mainly by
independent sales representatives, whose activities are reviewed by our in-house
sales force.
We work extensively with our customers to meet their specific
merchandising needs. Through customer presentations and other direct feedback
from the customer and consumers, we identify the consumer tastes and profiles of
a particular retailer. With this information, we make product recommendations to
our customers. We maintain a close dialogue with customers to ensure that the
design and functional requirements of our products are fulfilled.
Our products are promoted by our customers to the public under
cooperative and other advertising agreements. Under these agreements, our
products are advertised in newspaper inserts and catalogs, among other
publications. We generally cover a portion of the customer's advertising
expenses if the customer places approved advertisements mentioning us and our
products by name. We may also provide support to some customers' advertising
programs. We generally do not advertise directly to consumers. We do, however,
advertise in trade publications to promote O'Sullivan as a producer of high
quality ready-to-assemble furniture.
We provide extensive service support to our customers. This support
includes designing and installing in-store displays, educating retailers' sales
forces and maintaining floor displays. We have been recognized for our
commitment to our retail partners and have earned several awards in recent
years.
We participate in the eight-day furniture markets held in High Point,
North Carolina in April and October of each year. High Point is the principal
international market in the furniture industry. It attracts buyers from the
United States and abroad. We maintain over 16,000 square feet of leased showroom
space at High Point. We also maintain two other showrooms to market our product
lines. In addition, we participate in other trade shows, including the
international furniture show in Cologne, Germany.
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We sell our products throughout the United States and in Canada,
Mexico, the United Kingdom and other countries. Export sales were $25.0 million,
$26.5 million and $27.1 million in fiscal 2000, 1999 and 1998, respectively. In
fiscal 2000 and 1998, international sales declined largely due to the strength
of the dollar against the pound and lower sales to the Middle East. In fiscal
1999, international sales increased because of increased sales to the United
Kingdom and the growth of international office superstores.
MANUFACTURING
We operate three modern manufacturing facilities, which are described
more fully below. They are located in Lamar, Missouri, South Boston, Virginia
and Cedar City, Utah. In total, these facilities have over 2.1 million square
feet.
- Lamar, Missouri: Opened in 1965, this facility has about 1.1 million
square feet. It is the largest of our three facilities and has the
capability to produce our entire product offering. This facility also
serves as our corporate headquarters.
- South Boston, Virginia: Opened in 1989, our South Boston facility has
been expanded to approximately 480,000 square feet. This includes a
100,000 square foot expansion in 1993 and an additional 30,000 square
foot expansion in 1998. The South Boston facility has the capability to
manufacture substantially all of our products. As a part of our
expansion in 1998, we added a strip line, a laminator, a combi-former
machine and a new wrap line to the facility. This facility is
undergoing further expansion to increase its capacity.
- Cedar City, Utah: This facility was opened in the spring of 1995. Our
newest plant encompasses about 530,000 square feet. It has about 25% of
the production capacity of our Lamar facility. We opened this facility
in Utah to be closer to western customers and particleboard suppliers
in order to reduce transportation costs.
We have invested approximately $60.7 million in capital improvements to
expand production capacity, increase manufacturing efficiency and install a new
corporate-wide JD Edwards management information system since the beginning of
fiscal year 1998. These efforts have provided significant production
improvements, including:
- Improved product styling and efficiency: We were one of the first
ready-to-assemble furniture manufacturers to utilize combi-former
machines. We installed our fourth combi-former machine in fiscal 2000.
These machines provide a significant advantage in product styling by
creating rounded and other curved edges on furniture parts.
- Improved manufacturing efficiency: Our new equipment is highly
automated and efficient. However, it is also complex and requires
extensive training. As our employees have become more familiar with the
new equipment, their productivity has improved.
- Increased manufacturing flexibility: The new equipment installed at our
South Boston, Virginia plant has provided expanded capacity and
manufacturing flexibility. As a result, the South Boston facility is
now capable of manufacturing a broader spectrum of parts. Some of these
parts were formerly manufactured only in our Lamar plant. We believe
that our expanded manufacturing capacity will increase manufacturing
flexibility, reduce freight costs and allow us to better serve East
Coast markets.
RAW MATERIALS
The materials used in our manufacturing operations include
particleboard, fiberboard, coated paper laminates, glass, furniture hardware and
packaging materials. Our largest raw material cost is particleboard. We purchase
all of our raw material needs from outside suppliers. We buy our particleboard
and fiberboard at market-based prices from several independent wood product
suppliers. We purchase other raw materials from a
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limited number of vendors. These raw materials are generally available from
other suppliers, although the cost from alternate suppliers might be higher.
As is customary in the ready-to-assemble furniture industry, we do not
maintain long-term supply contracts with our suppliers. We do, however, have
long standing relationships with all of our key suppliers and encourage supplier
partnerships. Our supplier base is sufficiently diversified so that the loss of
any one supplier in any given commodity should not have a material adverse
effect on our operations. We have never been unable to secure needed raw
materials. However, there could be adverse effects on our operations and
financial condition if we are unable to secure necessary raw materials like
particleboard and fiberboard.
Because we purchase all of our raw materials from outside suppliers, we
are subject to fluctuations in prices of raw materials. For example, our results
of operations were significantly affected in fiscal year 2000 by higher
particleboard, fiberboard and cartoning costs. Future increases in the price of
raw materials could again affect our results of operations. See "Cautionary
Statement Regarding Forward Looking Information and Risk Factors" in Item 7 of
Part II of this report.
COMPETITION
The residential furniture market is very competitive and includes a
large number of both domestic and foreign manufacturers. Our competitors include
manufacturers of both ready-to-assemble and assembled furniture. Although a
large number of companies manufacture ready-to-assemble furniture, the top five
ready-to-assemble furniture manufacturers accounted for an estimated 76% of the
domestic ready-to-assemble furniture market in 1999. Our top five competitors in
terms of market share of the ready-to-assemble segment are Sauder Woodworking,
Inc., Bush Industries, Inc., Dorel Industries, Inc., Mills Pride and Creative
Interiors. Some of our competitors have greater sales volume and financial
resources.
We, along with some of our competitors, have continued to increase
production capacity significantly as the market for ready-to-assemble furniture
has grown. The current increases in production capacity could cause excess
capacity and increased competition if anticipated sales increases do not
materialize. This could adversely affect our margins and results of operations.
PATENTS AND TRADEMARKS
We have a United States trademark registration and international
trademark registrations or applications for the use of the O'Sullivan(R) name on
furniture. We believe that the O'Sullivan name and trademark are well-recognized
and associated with high quality by both our customers and consumers and are
important to the success of our business. Our products are sold under a variety
of trademarks in addition to O'Sullivan. Some of these names are registered
trademarks. We do not believe that the other trademarks we own enjoy the same
level of recognition as the O'Sullivan trademark. We also do not believe that
the loss of the right to use any one of these other trademarks would be material
to our business. We hold a number of patents and licenses. None of these patents
and licenses are individually considered by us 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.
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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, 2000, we had approximately 2,700 employees. Sixty-three
percent of these employees are located in Lamar. None of our employees are
represented by a labor union. We believe that we have good relations with our
employees.
ENVIRONMENTAL AND SAFETY REGULATIONS
Our operations are subject to extensive federal, state and local
environmental laws, regulations and ordinances. Some of our operations require
permits. These permits are subject to revocation, modification and renewal by
governmental authorities.
Governmental authorities have the power to enforce compliance with
their regulations. Violators may be subject to fines, injunction or both.
Compliance with these regulations has not in the past had a significant effect
on our earnings, capital expenditures or competitive position. We anticipate
increased federal and state environmental regulations affecting us as a
manufacturer, particularly regarding emissions and the use of various materials
in our production process. In particular, regulations to be issued under the
Clean Air Act Amendments of 1990 could subject us to new standards regulating
emissions of some air pollutants from our wood furniture manufacturing
operations. We cannot at this time estimate the impact of these new standards on
our operations, future capital expenditure requirements or the cost of
compliance. We have applied for air emission permits under Title V of the Clean
Air Act Amendments of 1990, and a draft of the permit is under review.
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 a recycler and off-site disposal sites. Wood by-products generated
at the Cedar City facility are shipped to a local landfill. Our by-product
disposal costs were approximately $1.9 million for fiscal 2000, $1.8 million for
fiscal 1999 and $1.2 million for fiscal 1998.
Our manufacturing facilities ship waste products to various disposal
sites. If our waste products include hazardous substances and are discharged
into the environment, we are potentially liable under various laws. These laws
may impose liability for releases of hazardous substances into the environment.
These laws may also provide for liability for damage to natural resources. One
example of these laws is the federal Comprehensive Environmental Response,
Compensation and Liability Act. Generally, liability under this act is joint and
several and is determined without regard to fault. In addition to the
Comprehensive Environmental Response, Compensation and Liability Act, similar
state or other laws and regulations may impose the same or even broader
liability for releases of hazardous substances.
We have been designated as a potentially responsible party under the
Arkansas Remedial Action Trust Fund Act for the cost of cleaning up a disposal
site in Diaz, Arkansas. We entered into a de minimis buyout 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 should not require the potentially responsible parties to
make additional
9
<PAGE> 11
payments. We believe that the amounts we may be required to pay in the future,
if any, relating to this site will be immaterial.
Our operations also are governed by laws and regulations relating to
workplace safety and worker health, principally the Occupational Safety and
Health Act and related regulations. Additionally, some of our products must
comply with the requirements and standards of the United States Consumer
Products Safety Commission. We believe that we are in substantial compliance
with all of these laws and regulations.
ITEM 2. PROPERTIES.
O'Sullivan owns three manufacturing, warehouse and distribution
facilities. The Lamar, Missouri facility, which also serves as O'Sullivan's
headquarters, consists of approximately 1,094,000 square feet. The South Boston,
Virginia facility has approximately 480,000 square feet, and the Cedar City,
Utah facility has approximately 530,000 square feet.
O'Sullivan has minimal unused land at Lamar on which it could build new
production or warehouse facilities. It does have excess land at South Boston and
Cedar City which may be used for expansion.
O'Sullivan also leases space for showrooms in High Point, North
Carolina and Bentonville, Arkansas. It leases warehouse space in Lamar and
Neosho, Missouri and South Boston, Virginia.
O'Sullivan's Canadian operations are in a leased facility in Markham,
Ontario. O'Sullivan's United Kingdom operations are in a leased facility in
Oxfordshire.
O'Sullivan considers its owned and leased facilities to be adequate for
the needs of O'Sullivan and believes that all of its owned and leased properties
are well maintained and in good condition.
ITEM 3. LEGAL PROCEEDINGS.
Prior to O'Sullivan Holdings' initial public offering in 1994, we were
owned by Tandy Corporation. As part of the initial public offering, O'Sullivan
Holdings entered into a tax sharing and tax benefit reimbursement agreement with
Tandy. The structure of the public offering increased the basis in our assets
for tax purposes. This basis increase reduces the amount of gain we recognize
upon sales of our assets and increases our annual tax deductions for
depreciation and amortization. This increase in deductions reduces the amount of
income taxes that we pay. Under the tax sharing agreement, O'Sullivan Holdings
agreed to pay Tandy nearly all of any benefit we receive from this reduction in
our taxable income. Our taxable income is determined after taking into account
all of our other deductible expenses. The annual payment to Tandy under the tax
sharing agreement was $4.3 million for fiscal 2000, $9.7 million for fiscal 1999
and $11.7 million for fiscal 1998. This agreement will remain in effect until
2033. However, under the terms of the tax sharing agreement, O'Sullivan Holdings
and Tandy are expected to negotiate a final payment and termination date of the
agreement in 2009.
Since the initial public offering, in determining the benefit payment
to Tandy under the tax sharing agreement, we have deducted our interest expense.
We are incurring a significant increase in interest expense associated with our
higher debt levels in connection with the financing of the recapitalization and
merger. We believe that this increased interest expense, and certain expenses
incurred to consummate the recapitalization and merger, should be taken into
account in determining the payments O'Sullivan Holdings is required to make to
Tandy under the tax sharing agreement, and Tandy does not. Under the tax sharing
agreement, disputes between the parties must be referred to the chief executive
officers. If they are unable to resolve the dispute, it is to be resolved by a
public accounting firm or a law firm reasonably satisfactory to Tandy and
O'Sullivan Holdings.
On June 29, 1999, Tandy filed a complaint against O'Sullivan Holdings
in the District Court of Texas in Tarrant County. Tandy's complaint sought a
court order compelling O'Sullivan Holdings to submit to a dispute resolution
process. Alternatively, the complaint sought a declaratory judgment that after
the merger O'Sullivan Holdings must continue to make tax-sharing payments to
Tandy as if the merger had not occurred. On September 9, 1999, Tandy filed a
motion for summary judgment in its lawsuit against O'Sullivan Holdings. On
October 8,
10
<PAGE> 12
1999, Tandy's motion was denied, as was all other relief sought by Tandy, except
that O'Sullivan Holdings was directed to commence dispute resolution procedures
before an arbitrator, according to the terms of the tax sharing agreement.
Arbitrators have been selected to hear the dispute, and discovery is in process.
To support its motion for summary judgment, Tandy referred to a letter it
received from its independent outside auditors, PricewaterhouseCoopers LLP.
PricewaterhouseCoopers audits both Tandy's financial statements and our
financial statements. The PricewaterhouseCoopers letter advised Tandy on how
PricewaterhouseCoopers expected the tax sharing agreement would operate, if
certain assumptions were valid. On its face, the letter made clear that it was
not expressing an "opinion" on how the actual dispute between Tandy and
O'Sullivan Holdings would in fact be resolved, and the letter addressed
assumptions that PricewaterhouseCoopers had been given by Tandy.
O'Sullivan Holdings' annual report to stockholders on SEC Form 10-K for
fiscal 1999 disclosed these facts, and expressed management's view, based on an
opinion of our outside counsel, that Tandy's position in its suit was without
merit. Because PricewaterhouseCoopers both wrote its letter to Tandy but did not
object to the inclusion of our management's view in the Form 10-K on the merits
of Tandy's lawsuit, the SEC Staff asked O'Sullivan Holdings to clarify "whether
PricewaterhouseCoopers has a reasonable basis to doubt management's view that
Tandy's lawsuit has no merit." In our view, PricewaterhouseCoopers had a
reasonable basis for its acquiescence in the footnote disclosure in the Form
10-K that Tandy's position was without merit. First, O'Sullivan Holdings
received an opinion from our outside counsel that supports our view that Tandy's
position in the litigation was without merit. That opinion was made available to
PricewaterhouseCoopers in connection with its annual audit, and clearly supports
the decision not to object to the inclusion of that footnote in O'Sullivan
Holdings' financial statements. Second, PricewaterhouseCoopers also has advised
O'Sullivan Holdings that its letter was predicated on assumptions it now
understands are not relevant to the merger as presently structured, and
therefore, PricewaterhouseCoopers has reaffirmed that its original letter did
not attempt to offer an expert opinion to Tandy on the merger or predict the
actual outcome of the litigation between Tandy and us. Neither
PricewaterhouseCoopers nor we believe there is any inconsistency between
PricewaterhouseCoopers' original letter and its non-objection to the inclusion
of that footnote disclosure in the Form 10-K. In light of
PricewaterhouseCoopers' response, the PricewaterhouseCoopers letter had no
relevance to the merger. However, we have included this discussion of the
PricewaterhouseCoopers letter because the SEC requested that it be included in
the proxy statement relating to the merger.
Finally, the Staff suggested that its concerns about this situation
could be eliminated if PricewaterhouseCoopers were to withdraw the letter to
Tandy. But, since the letter is not an expert opinion on any pending matter, a
position PricewaterhouseCoopers has since reaffirmed to us, we do not believe
there is any reason for PricewaterhouseCoopers formally to withdraw its letter.
O'Sullivan Holdings believes it is now, and expects to continue to be,
in full compliance with the tax sharing agreement. O'Sullivan Holdings believes
that Tandy's position is without merit and intends to defend itself vigorously.
However, if Tandy's interpretation prevails over ours and our increased interest
and other merger-related expenses are not allowable in determining our payment
to Tandy, payments to Tandy may exceed $6.8 million more than we currently
anticipate for fiscal years 2000 and 2001 combined. See "Cautionary Statement
Regarding Forward Looking Statements and Risk Factors" in Item 7 of Part II of
this report.
Litigation Challenging the Merger. On May 18, 1999, five lawsuits were
filed as class actions by stockholders in the Delaware Court of Chancery seeking
to enjoin the recapitalization and merger or, in the alternative, to rescind the
recapitalization and merger and recover monetary damages. The complaints named
as defendants O'Sullivan, all of its directors and, in some cases, BRS. The
complaints allege that our directors breached their fiduciary duties by
approving the recapitalization and merger. The complaints also alleged that the
price terms of the merger were inadequate and unfair to O'Sullivan's
stockholders. In addition, the complaints alleged that the management
participants in the recapitalization and merger had conflicts of interest that
prevented them from acting in the best interests of O'Sullivan's stockholders
and that made it inherently unfair for BRS and the management participants in
the buyout to acquire 100% of the O'Sullivan stock. In the cases naming BRS as a
defendant, BRS was alleged to have aided and abetted the alleged breaches of
fiduciary duties. These lawsuits were dismissed without prejudice in March 2000.
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<PAGE> 13
Other Litigation and Claims. In addition, we are a party to various
pending legal actions arising in the ordinary operation of our business. These
include product liability claims, employment disputes and general business
disputes. We believe that these actions will not have a significant negative
effect on our operating results and financial condition.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matters were submitted to a vote of security holders of O'Sullivan
during the quarter ended June 30, 2000.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER
MATTERS.
Our common stock is owned by O'Sullivan Holdings, so there is no
established public market for our common equity.
In connection with the recapitalization and merger, O'Sullivan
Industries issued 100,000 units, each consisting of $1,000 principal amount of
its 13_% senior subordinated notes due 2009 and one warrant to purchase shares
of O'Sullivan Holdings common stock and one warrant to purchase shares of
O'Sullivan Holdings Series B junior preferred stock. The offering was exempt
under Section 4 of the Securities Act of 1933, as amended, since the units were
offered only to a limited number of highly sophisticated institutional
investors. We sold the units to Lehman Brothers as underwriter. The offering
price, before expenses, was $980.46 per unit. In connection with the placement
of the units, we paid Lehman Brothers $3.4 million in fees and expenses.
The warrants to purchase shares of O'Sullivan Holdings common stock are
for an aggregate of 93,273 shares. The exercise price for the warrants is $0.01
per share. The warrants to purchase shares of O'Sullivan Holdings Series B
junior preferred stock are for an aggregate of 39,273 shares at an exercise
price of $0.01 per share. The warrants expire on October 15, 2009 if not sooner
exercised.
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<PAGE> 14
ITEM 6. SELECTED CONSOLIDATED HISTORICAL FINANCIAL INFORMATION.
The selected historical consolidated results of operations and balance
sheet data for the five years ended June 30, 2000 are derived from O'Sullivan's
audited financial statements. This selected consolidated financial data should
be read in conjunction with Item 7, "Management's Discussion and Analysis of
Financial Condition and Results of Operations," and Item 8, "Consolidated
Financial Statements and Related Notes," in Part II of this report.
<TABLE>
<CAPTION>
For the year ended June 30,
-----------------------------------------------------------
2000 1999 1998 1997 1996
---------- ---------- ---------- ---------- ---------
(in thousands)
<S> <C> <C> <C> <C> <C>
Earnings Data:
Net sales $ 423,425 $ 379,632 $ 339,407 $ 321,490 $ 291,766
Cost of sales 298,387 267,630 244,086 230,578 229,262
---------- ---------- ---------- ---------- ---------
Gross profit 125,038 112,002 95,321 90,912 62,504
Selling, marketing and administrative 82,244 74,962 69,212 62,137 52,691
Compensation expense associated with stock
options 10,627 - - - -
Loss on settlement of interest rate swap 408 - - - -
Restructuring charges - - - - 5,212
---------- ---------- ---------- ---------- ---------
Operating income 31,759 37,040 26,109 28,775 4,601
Interest expense, net 17,445 2,844 2,468 2,327 3,831
Income before income tax provision and
extraordinary item 14,314 34,196 23,641 26,448 770
Income tax provision 5,153 12,311 8,742 10,050 433
---------- ---------- ---------- ---------- ---------
Net income before extraordinary item 9,161 21,885 14,899 16,398 337
Extraordinary loss from early extinguishment of
debt, net of income tax benefit (305) - - - -
---------- ---------- ---------- ---------- ---------
Net income $ 8,856 $ 21,885 $ 14,899 $ 16,398 $ 337
========== ========== ========== ========== =========
Cash flow provided by operating activities $ 40,161 $ 25,297 $ 27,164 $ 23,512 $ 25,345
Cash flow used for investing activities (16,559) (15,779) (28,359) (15,825) (4,403)
Cash flow used by financing activities (15,475) (7,588) (3,970) (1,218) (21,000)
EBITDA (1) $ 47,175 $ 51,002 $ 37,669 $ 38,735 $ 13,836
Depreciation and amortization 15,416 13,962 11,560 9,960 9,235
Capital expenditures 16,559 15,779 28,359 15,825 4,403
</TABLE>
<TABLE>
<CAPTION>
June 30,
-----------------------------------------------------------
2000 1999 1998 1997 1996
---------- ---------- ---------- ---------- ---------
(in thousands)
<S> <C> <C> <C> <C> <C>
Balance Sheet Data:
------------------
Working capital $ 93,534 $ 85,262 $ 72,893 $ 82,045 $ 71,136
Total assets 296,289 266,967 250,314 232,607 212,317
Long-term debt 235,708 22,000 30,000 30,000 30,000
Stockholders' equity (deficit) (7,857) 157,103 135,225 120,375 103,982
</TABLE>
----------------------------------
(1) EBITDA means earnings before interest expense and interest income,
income taxes, depreciation and amortization. EBITDA is presented here to provide
additional information about our operations. This item should be considered in
addition to, but not as a substitute for or superior to, operating income, net
income, cash flow and other measures of financial performance prepared in
accordance with generally accepted accounting principles. EBITDA may differ in
the method of calculation from similarly titled measures used by other
companies.
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<PAGE> 15
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.
The domestic ready-to-assemble furniture market has experienced
significant growth over the past several years and has emerged as a key
component of the overall U.S. home and office furnishings industry. Our company
is the second largest ready-to-assemble furniture manufacturer in the United
States in terms of domestic sales with over 45 years of experience. We design,
manufacture and distribute a broad range of RTA furniture products--bookcases,
cabinets, computer workcenters, desks, entertainment centers and stereo
racks--with retail prices ranging from $20 to $999. In recent years, we have
committed substantial resources to the development and implementation of a
diversified sales, marketing and product strategy in order to capitalize on
growth opportunities presented by emerging retail channels of distribution and
changes in consumer demographics and preferences. We have structured our
business to offer a wide variety of RTA furniture products through increasingly
popular retail distribution channels, including office superstores, discount
mass merchants, electronic superstores, department stores, home improvement
centers and home furnishings retailers. We continue to strive towards building
long-term relationships with quality retailers in existing and emerging high
growth distribution channels to develop and sustain our future growth.
We purchase large quantities of raw materials including particleboard
and fiberboard. We are dependent on our outside suppliers for all of these raw
materials. Therefore, we are subject to changes in the prices charged by our
suppliers. In fiscal 2000, our profits were reduced by price increases of these
commodities.
In fiscal 1999 and 2000, our net sales increased in excess of 10% per
year, reflecting the strong growth for the RTA furniture market and the strong
U.S. economy generally. In the first quarter of fiscal 2001, however, this
growth stalled, reflecting an industry slowdown and caution about the U.S.
economy generally. We currently expect that our sales for the first quarter of
fiscal 2001 will be down mid-single digits from the prior year due primarily to
Service Merchandise who is no longer selling home office or entertainment
furniture.
While we have confidence in the future of the RTA furniture industry,
we cannot yet predict when our sales will return to their historical growth
rates. The sales decline will also reduce our first quarter gross profit and
operating income, EBITDA and net income.
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<PAGE> 16
RESULTS OF OPERATIONS.
The following table sets forth the approximate percentage of items
included in the Consolidated Statement of Operations relative to net sales for
the three-year period ended June 30, 2000:
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
----------------------------------
2000 1999 1998
<S> <C> <C> <C>
Net sales 100.0% 100.0% 100.0%
Cost of sales 70.5% 70.5% 71.9%
Gross margin 29.5% 29.5% 28.1%
Selling, marketing and administrative expenses 19.4% 19.7% 20.4%
Compensation expense associated with stock options 2.5% -- --
Loss on settlement of interest rate swap 0.1% -- --
Operating income 7.5% 9.8% 7.7%
Interest expense, net 4.1% 0.7% 0.7%
Income tax expense 1.2% 3.2% 2.6%
Extraordinary loss from early extinguishment of debt, net of income
tax benefit of $171 0.1% -- --
Net income 2.1% 5.8% 4.4%
Depreciation and amortization 3.6% 3.7% 3.4%
</TABLE>
YEAR ENDED JUNE 30, 2000 COMPARED TO THE YEAR ENDED JUNE 30, 1999.
Net sales. Net sales increased by $43.8 million, or 11.5%, to $423.4
million in fiscal 2000, up from $379.6 million in fiscal 1999. The increase in
net sales was primarily driven by a 10.1% increase in the number of units sold
and, to a lesser extent, a 2.5% increase in the average selling price. Strong
sales increases to the office superstore, home improvement and electronic
specialty retailer channels accounted for the sales increase, partially offset
by a decline in sales to the department store/catalog showroom, regional mass
merchant, OEM and export channels. Consumer demand for our product was driven by
the increase of multi-computer households, the continued growth of small
businesses, especially home-based businesses, aggressive promotional efforts of
certain retailers, additional floor space allotted to our category by certain
retailers in the home improvement channel and new store openings.
In March 1999, Service Merchandise Co., one of our largest customers,
filed for bankruptcy protection under Chapter 11. We are currently shipping to
Service Merchandise while it operates under Chapter 11 bankruptcy protection,
which gives certain priority claims to vendors in the event of liquidation. On
February 22, 2000, Service Merchandise announced that as part of its bankruptcy
reorganization plan, it would no longer sell a number of product lines,
including home office and entertainment furniture. Service Merchandise, however
does plan to continue selling kitchen furniture. This decision substantially
reduced our sales to Service Merchandise in fiscal 2000. We expect that our
sales will be further reduced or eliminated in fiscal 2001 and thereafter. Gross
sales to Service Merchandise declined from approximately 7% of our gross sales
in fiscal 1999 to approximately 4% of our gross sales in fiscal 2000.
Sales declines in the other channels were due to the bankruptcy of
certain regional mass merchants, the discontinuance of our category or our
product line in certain department stores, and the replacement of an overseas
distributor.
Slower economic growth and weaker retail sales have softened the sales
impact that we expected in the first quarter of fiscal 2001, and we now expect
sales in the first quarter of fiscal 2001 to be down mid-single digits from net
sales for the first quarter of fiscal 2000 due primarily to a major customer who
is no longer selling home office or entertainment furniture.
15
<PAGE> 17
Gross profit. Our gross profit for fiscal 2000 was $125.0 million, an
increase of $13.0 million, or 11.6%, from $112.0 million in fiscal 1999. The
gross profit margin was virtually unchanged at 29.5%. The increase in gross
profit dollars was primarily from increased sales volume, increased productivity
and our value analysis program offset by higher material costs. During fiscal
1999, we incurred higher labor and overhead costs associated with the
implementation of new manufacturing equipment and related adaptation of
manufacturing processes.
In the fourth quarter of fiscal 1999, certain key commodity suppliers
announced price increases that were followed by additional price increases
throughout the fiscal year. We estimate that higher prices increased our cost
of sales by approximately $5.0 million during fiscal 2000. We were able to
minimize the effect of these increases through our value analysis program and
productivity gains in manufacturing and decreased overhead on a per unit basis
due to increased volume and capacity utilization rates. We believe that we can
continue to partially offset the effect of such increases through the programs
mentioned above and through the eventual inclusion of the higher costs in the
selling price of our products. We do not expect further price increases, and in
fact, anticipate a softening in the demand and pricing for certain commodities.
However, there can be no assurance that commodity prices will remain constant
or decline in the future, or that we will be successful in offsetting any
future potential price increases.
Selling, Marketing and Administrative Expenses. Selling, marketing and
administrative expenses increased to $82.2 million, or 19.4%, of sales from
$75.0 million or 19.7% of sales in fiscal 1999. The majority of the dollar
increase in selling, marketing and administrative expenses was due to higher
promotional, freight and commission expenses associated with increased sales
activity. Salaries, wages and associated taxes and benefits also increased as
additional resources were allocated to in-house training. Legal expenses
associated with the exchange offering for the senior subordinated notes and
arbitration proceedings with Tandy and BRS management fees subsequent to the
recapitalization also contributed to the increase in selling, marketing and
administrative expenses.
Merger related and other special charges. For fiscal 2000, O'Sullivan
incurred compensation expense in connection with stock options related to the
merger of $10.6 million. Additionally, we incurred a charge of $408,000 for the
settlement of an interest rate swap agreement entered into in fiscal 1997. Both
the compensation expense from stock options and the loss on the settlement of
the interest rate swap have been included as separate line items in the
accompanying consolidated statement of operations.
Depreciation and amortization. Our depreciation and amortization
expenses increased $1.4 million to $15.4 million in fiscal 2000 from $14.0
million in fiscal 1999. The increase in depreciation and amortization expense
was due to capital additions of $16.6 million in fiscal 2000 and $15.8 million
in fiscal 1999. The expenditures were primarily for completion of the capacity
expansion program at our Virginia plant, capacity expansion at our Utah plant
and upgrading manufacturing equipment at our Missouri plant.
Operating Income. Operating income, including merger related expenses
and other special charges, decreased $5.2 million to $31.8 million in fiscal
2000 from $37.0 million in fiscal 1999. The decrease was due to the merger
related and other special charges which totaled $11.0 million.
Excluding merger related and other special charges, operating income
increased $5.8 million, or 15.7%, to $42.8 million in fiscal 2000 from $37.0
million in fiscal 1999. The increase in operating income was primarily due to
increased sales volume and increased productivity offset by higher material
costs, higher selling, marketing and administrative costs associated with
increased sales volume and additional depreciation expense.
Net interest expense. Net interest expense increased from $2.8 million
in fiscal 1999 to $17.4 million in fiscal 2000. The interest expense increased
due to the higher level of borrowings associated with the financing of the
merger. The merger closed on November 30, 1999, so only seven months of
increased expense associated with the new debt is reflected in the fiscal year
results.
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<PAGE> 18
Extraordinary item. O'Sullivan repaid private placement notes with a
principal amount of $16.0 million for $16.5 million on November 30, 1999. The
$476,000 prepayment fee has been recognized as an extraordinary loss of
$305,000, net of the related tax benefit.
Income tax expense. Income tax expense decreased by $7.2 million, or
58.5%, to $5.2 million in fiscal 2000 from $12.3 million in fiscal 1999. The
effective tax rate in both fiscal 1999 and fiscal 2000 was 36.0%.
Net income. As a result of the above factors, net income decreased by
$13.0 million from net income of $21.9 million in fiscal 1999 to net income of
$8.9 million in fiscal 2000.
EBITDA. EBITDA, which we define as earnings before interest income and
interest expense, income taxes, depreciation and amortization, decreased $3.8
million to $47.2 million in fiscal 2000 from $51.0 million in fiscal 1999.
EBITDA decreased primarily due to the merger related costs and other special
charges associated with the merger offset to some degree by increased earnings
due to increased sales volume and productivity. Excluding merger related and
other special charges, EBITDA would have increased $7.2 million to $58.2 million
in fiscal 2000 from $51.0 million in fiscal 1999.
EBITDA is presented to provide additional information about our
operations. This item should be considered in addition to, but not as a
substitute for or superior to, operating income, net income, operating cash flow
and other measures of financial performance prepared in accordance with
generally accepted accounting principles. EBITDA may differ in the method of
calculation from similarity titled measures used by other companies.
YEAR ENDED JUNE 30, 1999 COMPARED TO THE YEAR ENDED JUNE 30, 1998.
Net sales. Net sales increased by $40.2 million, or 11.9%, to $379.6
million in fiscal 1999, up from $339.4 million in fiscal 1998. The increase in
net sales was primarily driven by a 10.9% increase in the number of units sold
and, to a lesser extent, a 1.0% increase in the average selling price. Strong
increases in net sales to the national discount mass merchant, electronic
specialty retailer and office superstore channels accounted for the sales
increase, offset by a decline in sales to the regional mass merchant, department
store/catalog showroom, home improvement, original equipment manufacturer and
export channels. Consumer demand for our products was driven by market growth
fueled by the robust growth of the sub-$1,000 computer market, sales efforts
targeted toward specific rapidly growing customers, the success of new product
introductions, additional floor space and resources provided by retailers for
ready-to-assemble furniture and new store openings by certain retailers.
In March 1999, Service Merchandise Co., one of our largest customers,
filed for bankruptcy protection under Chapter 11. In addition Montgomery Ward &
Co. exited Chapter 11 on August 2, 1999. If Service Merchandise, Montgomery Ward
or another major customer liquidates or ceases or substantially reduces its
purchase of products from us, we cannot assure you that we will be able to
replace these sales.
Gross profit. Our gross profit for fiscal year 1999 was $112.0 million,
an increase of $16.7 million, or 17.5%, from $95.3 million in fiscal 1998. This
increase was attributable to higher net sales and an improvement in the gross
profit margin, which increased by 140 basis points to 29.5% in fiscal 1999 from
28.1% in fiscal 1998. The increase in gross margin was primarily attributable to
increased unit sales and, to some extent, lower material costs due to our
on-going value-engineering program and improved manufacturing productivity.
These increases were somewhat offset by the increase in net sales to discount
mass merchants which normally has lower gross profit margins.
Selling, marketing and administrative expenses. Selling, marketing and
administrative expenses increased by $5.8 million, or 8.3%, to $75.0 million in
fiscal 1999, from $69.2 million in fiscal 1998. The increase in selling,
marketing and administrative expenses was due primarily to $3.2 million of
higher advertising and out-bound freight expense directly associated with higher
net sales levels and customer mix and $2.3 million in higher profit sharing and
incentive compensation costs resulting from our improved financial results.
These increases were partially offset by lower commission expense resulting from
management's emphasis on reducing
17
<PAGE> 19
costs, and to some extent lower bad debt expense related to the purchase and
initiation of credit insurance during fiscal 1999. As a percentage of sales,
selling, marketing and administrative expenses decreased by 70 basis points to
19.7% of sales in fiscal 1999 from 20.4% of sales in fiscal 1998 primarily from
improved economies of scale.
Depreciation and amortization. Our depreciation and amortization
expenses increased $2.4 million, or 20.7%, to $14.0 million in fiscal 1999 from
$11.6 million in fiscal 1998. The increase in depreciation and amortization
expense was due to capital additions of $15.8 million in fiscal 1999 and $28.4
million in fiscal 1998. The expenditures were primarily for capacity expansion
in our Virginia plant and upgrading manufacturing equipment in our Missouri
plant.
Operating income. Operating income increased by $10.9 million, or
41.9%, to $37.0 million in fiscal 1999 from $26.1 million in fiscal 1998.
Net interest expense. Net interest expense increased by $400,000 to
$2.8 million in fiscal 1999. The increase was due largely to the refinancing of
our $10.0 million of industrial revenue bonds in the second quarter of fiscal
1999, which triggered a one-time charge of $300,000 to pay the call premium.
Income tax expense. Income tax expense increased by $3.6 million, or
41.4%, to $12.3 million in fiscal 1999 from $8.7 million in fiscal 1998. Our
effective tax rate for fiscal 1999 was 36.0%, down slightly from 37.0% in fiscal
1998.
Net income. As a result of the above factors, net income increased by
$7.0 million, or 47.0%, to $21.9 million in fiscal 1999 from $14.9 million in
fiscal 1998.
EBITDA. EBITDA, which we define as earnings before interest income and
interest expense, income taxes and depreciation and amortization, increased by
$13.3 million, or 35.3%, to $51.0 million in fiscal 1999. The increase in EBITDA
for fiscal 1999 was driven by increased sales volumes, productivity gains in our
three manufacturing plants, improved absorption of overhead costs associated
with increased net sales and the success of our value analysis program. These
gains were somewhat offset by increased profit sharing and incentive
compensation costs as well as higher outbound freight and advertising expenses
associated with sales volume increases and customer mix.
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.
LIQUIDITY AND CAPITAL RESOURCES.
Our primary sources of liquidity are cash flow from operations and
borrowings under our senior secured credit facility, which is discussed below.
Our liquidity requirements will be to pay our debt, including interest expense
under the senior credit facilities and the notes, payments to Tandy and to
provide for working capital and capital expenditures.
Working capital. As of June 30, 2000, we had cash and cash equivalents
of $11.9 million compared to $3.7 million at June 30, 1999. Net working capital
was $93.5 million at June 30, 2000 compared to $85.3 million at June 30, 1999.
The $8.2 million increase in net working capital resulted primarily from the
increased cash balance and increased investments in inventory partially offset
by a reduction in trade receivables. Inventory investment increased to support
higher sales volumes and in anticipation of stronger sales during the late
summer and early fall selling seasons. The decline in trade receivables was due
to changes in payment terms with certain customers resulting in quicker cash
receipt.
Operating Activities. Net cash provided by operating activities was
$40.2 million in fiscal 2000 compared to $25.3 million in fiscal 1999. The
increase of $14.9 million in cash flows from operations was due to less cash
needed to finance receivables and inventories plus more cash generated by
increases in accounts payable,
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accrued liabilities and income taxes payable when compared to the prior year,
due primarily to increased accrued interest expense and longer payables terms.
Partially offsetting these items was less cash generated by net income because
of the $10.6 million non-cash charge for compensation expense associated with
stock options.
Investing Activities. We invested $16.6 million for capital
expenditures in fiscal 2000 compared to $15.8 million during the previous fiscal
year. The expenditures increased the capacity of our Virginia and Utah plants
and upgraded equipment at our Missouri location. Our ability to make future
capital expenditures is subject to certain restrictions under our senior credit
facilities.
Financing Activities. On November 30, 1999 we completed our merger and
recapitalization. Our consolidated indebtedness at June 30, 2000 was $244.0
million, consisting of the following.
- $100.0 million in 13-3/8% senior subordinated notes due 2009
issued with warrants to purchase 6.0% of O'Sullivan Holdings
common and Series B junior preferred stock on a fully diluted
basis. These warrants were assigned a value of $3.5 million.
These notes were issued at a price of 98.046% providing $98.0
million in cash proceeds before expenses related to the issuance.
- $134.0 million in senior secured credit facilities consisting of a
sixty-three month $34.0 million term loan, a seven and one-half
year $100.0 million term loan and a $40.0 million revolving line
of credit, currently with no borrowings. The revolving line of
credit has a $15.0 million sub-limit for letters of credit, of
which we are currently utilizing approximately $12.8 million.
- $10.0 million in variable rate industrial revenue bonds.
O'Sullivan paid a dividend of approximately $186.8 million to
O'Sullivan Holdings and repaid an intercompany balance of about $28.5 million
to finance the repurchase of stock.
Expenses related to the issuance of debt financing were approximately
$12.6 million. The credit facilities and notes are subject to certain financial
and operational covenants and other restrictions, including among others, a
requirement to maintain certain financial ratios and restrictions on our ability
to incur additional indebtedness. In addition, the agreements effectively
prohibit the payment of dividends on our stock.
As required under the new senior credit facilities, we hedged one-half
of our term loans with an initial notional amount of $67.5 million with a
costless interest rate collar. The collar is based on three-month LIBOR with a
floor of 6.43% and a ceiling of 8.75%. To terminate this contract at June 30,
2000 we would have been required to pay the counterparty approximately
$144,000.
We repaid our private placement notes with a principal amount of $16.0
million for $16.5 million on November 30, 1999. The $476,000 prepayment fee is
recorded as a $305,000 extraordinary item, net of taxes.
Tax Sharing Agreement. For the year ended June 30, 2000, O'Sullivan
Holdings paid Tandy Corporation $4.3 million pursuant to the Tax Sharing and Tax
Reimbursement Agreement between us. The effect of the merger upon our payments
to Tandy under this agreement is the subject of an arbitration proceeding. See
note 17 to the financial statements in item 8 of Part II of this report and Item
3, "Legal Proceedings," in Part I of this report. If the ruling in the
arbitration proceeding is in Tandy's favor, our payments under the tax sharing
agreement would be substantially higher; the amount would depend on our taxable
income. Based on current estimates, O'Sullivan Holdings' payments to Tandy may
exceed $6.8 million more than we currently anticipate for fiscal years 2000 and
2001 combined if the arbitration ruling were in Tandy's favor.
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
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instruments to reduce the impact of adverse changes in market prices. We do not
hold or issue derivative instruments for trading purposes, and we have no
material sensitivity to changes in market rates and prices on our derivative
financial instrument positions.
We have market risk in interest rate exposure, primarily in the United
States. We manage interest rate exposure through our mix of fixed and floating
rate debt. Interest rate swaps or collars may be used to adjust interest rate
exposures when appropriate based on market conditions. For qualifying hedges,
the interest differential of swaps or collars is included in interest expense.
We believe our foreign exchange risk is not material.
Due to the nature of our product lines, we have material sensitivity to
some commodities, including particleboard, fiberboard, corrugated cardboard and
hardware. We manage commodity price exposures primarily through the duration and
terms of our vendor contracts. A 1.0% change in these commodity prices could
affect our cost of sales by approximately $1.4 million annually.
In the fourth quarter of fiscal 1999, certain particleboard and
fiberboard suppliers announced price increases. We were able to minimize the
effect of initial increases during the first quarter of fiscal 2000 through our
value analysis program and productivity gains in manufacturing. Additional price
increases became effective during the second and third quarters of fiscal 2000.
In the fourth quarter, certain suppliers of cartons increased their prices to
us. We were able to partially offset the effect of these price increases through
the programs mentioned above combined with increased operating leverage from
higher sales levels. We estimate these increased our cost of sales by
approximately $5.0 million during fiscal 2000.
These price increases will continue to increase our cost of sales in
fiscal 2001, although we expect certain of these prices to decline. We believe
that we can continue to partially offset the effect of such increases through
the programs mentioned above and through the eventual inclusion of the higher
costs in the selling price of our products. However, there can be no assurance
that we will be successful in offsetting these or future potential price
increases.
From time to time we may use derivative financial instruments to reduce
interest rate risks. We do not hold or issue derivative financial instruments
for trading purposes. As required under the new senior credit facilities, we
hedged one-half of our term loans with an initial notational amount of $67.5
million with a costless interest rate collar. The collar is based on 3 month
LIBOR with a floor of 6.43% and a ceiling of 8.75%.
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.
INCOME TAXES.
Prior to O'Sullivan Holdings' initial public offering in 1994,
O'Sullivan Industries was owned by Tandy Corporation. As part of the initial
public offering, O'Sullivan Holdings entered into a tax sharing and tax
reimbursement agreement with Tandy. The structure of the public offering
increased our basis in our assets for tax purposes. This basis increase raises
our tax deductions for depreciation and amortization each year. This reduces
the amount of income taxes we pay to the IRS. Under the tax sharing and tax
benefit reimbursement agreement, O'Sullivan Holdings agreed to pay Tandy nearly
all of any benefit we receive from the increased depreciation and amortization
which reduces our taxable income, as determined after taking into account all
of our other deductible expenses, by the increase in these deductions. This
agreement remains in effect after the merger and recapitalization.
Since the initial public offering, in determining the benefit payment
to Tandy under the tax sharing and tax benefit reimbursement agreement, we have
deducted our interest expense. Our interest expense has increased significantly
because of our higher debt levels incurred to finance the merger. We believe
that our increased interest expense should be taken into account in determining
the payments that we are required to make to Tandy.
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Tandy has filed suit in a Texas state court against us claiming that
any reduction in our tax benefit payments resulting from these expenses in
connection with the merger would violate the tax agreement. The court has
ordered the dispute to be submitted to arbitration pursuant to the tax sharing
agreement. Arbitrators have been appointed and discovery is progressing. We
believe we are and expect to continue to be in full compliance with the tax
agreement. We believe Tandy's lawsuit is without merit and intend to defend
ourselves vigorously. Although we believe our interpretation of the tax
agreement will ultimately prevail over Tandy's interpretation, we cannot assure
you of this. If Tandy's interpretation prevails over O'Sullivan Holdings' and
these expenses are not allowable in determining our payment to Tandy, payments
to Tandy may exceed $6.8 million more than we currently anticipate for fiscal
years 2000 and 2001 combined. See "Cautionary Statement Regarding Forward
Looking Information and Risk Factors" and Item 3, "Legal Proceedings," in Part I
of this report.
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 Operation and the
Notes to the Consolidated Financial Statements in Part II of this report, the
portions of Item 1 in Part I captioned "Risk Factors, " "Raw Materials,"
"Competition," "Working Capital--Business and Credit Risk Concentrations" and
"Environmental and Safety Regulations" and Item 3 in Part I contain
forward-looking statements. These include information relating to cost savings,
benefits, revenues and earnings estimated to result from the merger. These
statements can be identified by the use of future tense or dates or terms such
as "believe," "would," "expect," "anticipate" or "plan."
These forward-looking statements involve risks and uncertainties.
Actual results may differ materially from those predicted by the forward-looking
statements. Because these forward-looking statements involve risks and
uncertainties, actual results may differ significantly from those predicted in
these forward-looking statements. You should not place a lot of weight on these
statements. These statements speak only as of the date of this document or, in
the case of any document incorporated by reference, the date of that document.
Factors and possible events which could cause results to differ include:
- OUR SUBSTANTIAL LEVERAGE COULD MAKE IT MORE DIFFICULT TO PAY OUR
DEBTS, DIVERT OUR CASH FLOW FROM OPERATIONS FOR DEBT PAYMENTS, LIMIT OUR ABILITY
TO BORROW FUNDS AND INCREASE OUR VULNERABILITY TO GENERAL ADVERSE ECONOMIC AND
INDUSTRY CONDITIONS. Any of these consequences of our substantial indebtedness
could prevent us from fulfilling our obligations under our indebtedness because
our ability to make required payments on our debt depends on our ability to
generate sufficient cash flow to make these payments. We have a significant
amount of indebtedness as shown in the chart below:
<TABLE>
<CAPTION>
JUNE 30, 2000
(DOLLARS IN MILLIONS)
<S> <C>
Total indebtedness...................................................................$ 244.0
Indebtedness senior to O'Sullivan senior subordinated notes..........................$ 144.0
Stockholder's deficit................................................................$ (7.9)
</TABLE>
Our substantial indebtedness could have important consequences to
holders of our debt and equity. For example, it could:
- make it more difficult for us to satisfy our obligations with
respect to our debt, particularly our subordinated debt;
- increase our vulnerability to general adverse economic and
industry conditions;
- limit our ability to fund future working capital, capital
expenditures, and other general corporate requirements;
- require a substantial portion of our cash flow from operations
for debt payments;
- limit our flexibility to plan for, or react to, changes in our
business and the industry in which we operate;
- place us at a competitive disadvantage compared to our
competitors that are less leveraged;
- limit our ability to borrow additional funds; and
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- expose us to fluctuations in interest rates because some of
our new debt has a variable rate of interest.
- WE MAY NOT HAVE SUFFICIENT CASH FROM CASH FLOW FROM
OPERATIONS, AVAILABLE CASH AND AVAILABLE BORROWINGS UNDER OUR SENIOR BANK
FACILITIES TO SERVICE OUR INDEBTEDNESS, WHICH WILL REQUIRE A SIGNIFICANT AMOUNT
OF CASH. Our business may not generate sufficient cash flow from operations and
we may not realize operating improvements on schedule. Also, 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.
Future borrowings may not be available to us under our senior credit
facilities in an amount sufficient to enable us to service our indebtedness or
to fund our other liquidity needs. We may need to refinance all or a portion of
our indebtedness, including O'Sullivan Industries' senior credit facilities,
O'Sullivan Industries' senior subordinated notes and O'Sullivan Holdings' senior
note, on or before maturity. We probably would not be able to refinance any of
our indebtedness on commercially reasonable terms or at all.
- REDUCTIONS IN RETAIL SALES COULD REDUCE OUR SALES, ESPECIALLY
IF THE REDUCTIONS OCCUR IN THE INDUSTRIES THAT WE BELIEVE ARE CONTRIBUTING TO
THE GROWTH OF THE READY-TO-ASSEMBLE FURNITURE INDUSTRY AND COULD REDUCE OUR
ABILITY TO PAY OUR DEBTS. Most of our sales are to major retail chains. If
there is a reduction in the overall level of retail sales, our sales could also
decline and our ability to pay our debts could be reduced. We believe that
sales of ready-to-assemble furniture increased over the last several years in
part because of an increase in sales of personal computers and home
entertainment electronic equipment. As this market, and our market generally,
is now substantially larger, it is possible that our growth may be adversely
affected by a recession more than in previous periods. If the level of sales of
these types of electronic equipment decreases, our sales could also decrease.
- OUR PROFITS WOULD BE REDUCED IF THE PRICES OUR SUPPLIERS
CHARGE US FOR RAW MATERIALS INCREASE LEADING TO OUR BEING LESS ABLE TO SERVICE
OUR DEBTS. We are dependent on outside suppliers for all of our raw material
needs and are subject to changes in the prices charged by our suppliers. If
these prices were to increase significantly this could lead to our being unable
to service our indebtedness.
In the past, our profits have been reduced by price increases in the
prices of particleboard and fiberboard. The following developments affected our
results of operations in fiscal 2000 and could affect our operations in future
years.
- In fiscal 2000, some of our particleboard and fiberboard
suppliers increased their prices by approximately 6.5%. We
spent approximately $91 million on these products in fiscal
2000.
- Certain corrugated carton suppliers are implementing
additional price increases of about 8% in our fourth quarter
of fiscal 2000. In fiscal year 2000, we spent approximately
$18 million on corrugated cartons.
- Increases in the cost of petroleum products have increased and
may continue to increase the costs we pay for delivery of raw
materials and to ship our products to customers.
- BECAUSE WE SELL PRODUCTS TO A SMALL NUMBER OF CUSTOMERS, OUR
SALES WOULD BE REDUCED IF ONE OF OUR 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. If we were to lose any of our major customers or they were to
significantly reduce the size or number of their orders for any reason at all,
including their bankruptcy or reorganization, mergers or our inability to fill
their orders in a timely fashion. Any loss or reduction may adversely affect our
cash flows and our ability to pay our debts. During fiscal year 2000, our three
largest customers, OfficeMax, Office Depot and Wal-Mart accounted for
approximately 51% of our gross sales. At June 30, 2000, our largest five
customer accounts receivable balances comprised approximately 68% of our trade
receivables balance. 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.
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- 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. The competitive nature of our industry could lead to smaller profit
margins due to competitive pricing policies or excess capacity. If this were to
occur our cash flows and our ability to pay our debts may be reduced. This
competitive pressure could be exacerbated if excess manufacturing capacity
develops in the RTA furniture industry due to over-expansion by manufacturers,
new entrants into the market, reduction in demand or otherwise.
- BECAUSE O'SULLIVAN INDUSTRIES' SENIOR SUBORDINATED NOTES AND
THE SUBSIDIARY GUARANTEES THEREOF, AND O'SULLIVAN HOLDINGS' SENIOR NOTE RANK
BEHIND OUR SENIOR DEBT, HOLDERS OF THESE NOTES MAY RECEIVE PROPORTIONATELY LESS
THAN HOLDERS OF OUR SENIOR DEBT IN A BANKRUPTCY, LIQUIDATION, REORGANIZATION OR
SIMILAR PROCEEDING. In the event of a bankruptcy, liquidation or reorganization
or similar proceeding relating to us, holders of O'Sullivan Industries' senior
subordinated notes and O'Sullivan Holdings' senior 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.
- 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 PROBABLY WOULD NOT HAVE SUFFICIENT CASH TO PAY OUR
ACCELERATED INDEBTEDNESS. We must maintain minimum debt service and maximum
leverage ratios under our senior credit facilities. A failure to comply with the
restrictions contained in our senior credit facilities could lead to an event of
default, which could result in an acceleration of that indebtedness. Were this
to occur, we might not have sufficient cash to pay our accelerated indebtedness
or other debt.
Our senior credit facilities, O'Sullivan Industries senior subordinated
notes and O'Sullivan Holdings' senior note restrict our ability, among others,
to:
- incur additional indebtedness;
- pay dividends and make distributions;
- issue common and preferred stock of subsidiaries;
- make certain investments;
- repurchase stock;
- create liens;
- enter into transactions with affiliates;
- enter into sale and leaseback transactions;
- merge or consolidate; and
- transfer and sell assets other than in the ordinary course of
business.
An acceleration under our senior credit facilities would also
constitute an event of default under the indenture relating to O'Sullivan
Industries' senior subordinated notes and the securities purchase agreement
relating to O'Sullivan Holdings' senior note.
- DESPITE OUR CURRENT LEVELS OF DEBT, WE MAY STILL INCUR MORE
DEBT AND INCREASE THE RISKS DESCRIBED ABOVE. We may be able to incur significant
additional indebtedness in the future. If we or our subsidiaries add new debt to
our current debt levels, the related risks that we and they now face could
intensify making it less likely that we will be able to fulfill our obligations
to holders of O'Sullivan Industries' senior subordinated notes or O'Sullivan
Holdings' senior note. None of the agreements governing our indebtedness
completely prohibits us or our subsidiaries from doing so. The revolving credit
facility of the senior credit facilities permit additional borrowings of up to
$27.2 million at June 30, 2000, including $2.2 million for letters
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of credit. These additional borrowings would be senior to O'Sullivan Industries'
senior subordinated notes and O'Sullivan Holdings' senior note.
- OUR PAYMENTS TO TANDY MAY BE SIGNIFICANTLY HIGHER THAN WE
CURRENTLY ANTICIPATE IF TANDY'S INTERPRETATION OF THE TAX SHARING AND TAX
BENEFIT REIMBURSEMENT AGREEMENT WITH TANDY IS ACCEPTED OVER OUR INTERPRETATION
OF THE AGREEMENT AND CONSEQUENTLY OUR ABILITY TO PAY OUR DEBTS MAY BE ADVERSELY
AFFECTED. If Tandy is successful, our payments to Tandy may be significantly
higher than currently anticipated, which would adversely affect our ability to
pay our debts.
On June 29, 1999, Tandy filed suit in a Texas court against us. The
suit relates to a potential reduction in our tax benefit payments to Tandy
resulting from our increased interest expense following completion of the
merger. Tandy claims that this reduction would violate the tax sharing and tax
benefit reimbursement agreement entered into at the time of our initial public
offering. If Tandy were to prevail, our increased interest expense following the
merger and certain expenses incurred to consummate the merger would not be taken
into account in determining our annual payments to Tandy. For example, based on
current estimates, our payments to Tandy may exceed $6.8 million more than we
currently anticipate for fiscal years 2000 and 2001 combined. However, if our
earnings are significantly less than current estimates, then the difference
between the amount we believe we would owe to Tandy and the amount Tandy
believes we would owe under the tax sharing agreement would be significantly
greater. If necessary, we would fund these increased payment obligations from
cash flow from operations, borrowing under the senior credit facilities, or
other sources of capital, if available. See Item 3, "Legal Proceedings" in Part
I of this report.
- IF WE BECOME BANKRUPT, THE CLAIMS OF HOLDERS OF O'SULLIVAN
INDUSTRIES' SENIOR SUBORDINATED NOTES AGAINST US MAY BE LESS THAN THE FACE VALUE
OF THE NOTES DUE TO ORIGINAL ISSUE DISCOUNT. O'Sullivan Industries' senior
subordinated notes bear a discount from their stated principal amount at
maturity. If a bankruptcy case is commenced by or against O'Sullivan Industries
under the U.S. Bankruptcy Code, the claim of a holder of the notes with respect
to the principal amount thereof would likely be limited to an amount equal to
the sum of (1) the initial offering price and (2) the portion of the original
issue discount, or OID, that is not deemed to constitute "unmatured interest"
for purposes of the U.S. Bankruptcy Code. Any OID that was not accrued as of the
bankruptcy filing would constitute "unmatured interest."
- WE ARE AT RISK THAT USERS OF OUR PRODUCTS WILL SUE US FOR
PRODUCT LIABILITY. IF WE WERE UNABLE TO DEFEND OURSELVES AGAINST SOME PRODUCT
LIABILITY LAWSUITS, OUR SUCCESS AND OUR ABILITY TO PAY OUR DEBTS MAY BE
ADVERSELY AFFECTED. 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 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.
- WE MAY BE LIABLE FOR PENALTIES UNDER ENVIRONMENTAL LAWS, RULES
AND REGULATIONS. THIS COULD NEGATIVELY AFFECT OUR SUCCESS AND OUR ABILITY TO PAY
OUR DEBTS. Our operations are subject to many federal, state and local
environmental laws, regulations and ordinances. Some of our operations require
permits, that are subject to revocation, modification and renewal by
governmental authorities. Governmental authorities have the power to enforce
compliance with their regulations, and violators may be subject to fines,
injunction or both. Our business involves operations which are subject to these
rules and regulations. Compliance with them may require substantial capital
expenditures or increase our operating expense. These costs and expenses may
adversely affect our success and ability to pay our debts.
- THE INTERESTS OF OUR CONTROLLING STOCKHOLDERS MAY BE IN
CONFLICT WITH INTERESTS OR THE HOLDERS OF OUR INDEBTEDNESS. THIS CONFLICT COULD
RESULT IN CORPORATE DECISION MAKING THAT INVOLVES DISPROPORTIONATE RISKS TO THE
HOLDERS OF OUR INDEBTEDNESS, INCLUDING OUR ABILITY TO SERVICE OUR DEBTS OR PAY
THE PRINCIPAL AMOUNT OF INDEBTEDNESS WHEN DUE. Following the recapitalization
and merger, affiliates of BRS own securities representing approximately 72.9% of
the voting power of the outstanding common stock of O'Sullivan Holdings.
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By reason of their ownership, they control our affairs and policies. There may
be circumstances where the interests of BRS and its affiliates could be in
conflict with the interests of the holders of our indebtedness. For example, BRS
and its affiliates may have an interest in pursuing transactions that, in their
judgment, could enhance their equity investment, even though these transactions
might involve risks to the holders of O'Sullivan's debt. See Item 10, "Directors
and Executive Officers of the Registrant," and Item 12, "Security Ownership of
Certain Beneficial Owners and Management," in Part III of this report.
- IF OUR KEY PERSONNEL WERE TO LEAVE OUR SUCCESS COULD BE
NEGATIVELY AFFECTED AND OUR ABILITY TO SERVICE OUR DEBTS COULD BE ADVERSELY
AFFECTED. Our continued success is dependent, to a certain extent, upon our
ability to attract and retain qualified personnel in all areas of our business,
including management positions and key sales positions, especially those
positions servicing our major customers. If any of our key personnel were to
leave it may adversely affect our ability to service our debt. Members of the
O'Sullivan family in particular have been instrumental in the development of our
business and the implementation of our corporate strategy. We do not have
employment agreements with any of our officers or key personnel located in the
United States and we do not carry key person life insurance on any of our
employees. We may not be able to keep existing personnel, including O'Sullivan
family members, or be able to attract qualified new personnel. Our inability to
do so could have a negative effect on us as we may be unable to efficiently and
effectively run our business without these key personnel.
- FEDERAL AND STATE STATUTES ALLOW COURTS, UNDER SPECIFIC
CIRCUMSTANCES, TO VOID GUARANTEES, SUBORDINATE CLAIMS IN RESPECT OF THE OUR
INDEBTEDNESS AND REQUIRE HOLDERS OF OUR DEBT TO RETURN PAYMENTS RECEIVED FROM
GUARANTORS. Under federal bankruptcy law and comparable provisions of state
fraudulent transfer laws, courts may void guarantees or claims related to our
indebtedness, or subordinate any guarantees to all of our other debts or all
other debts of our guarantor if, among other things, at the time our guarantor
incurred the indebtedness connected with its guarantee, we or the guarantor:
- received less than reasonably equivalent value or fair
consideration for the issuance of the guarantee; and
- we were or the guarantor was insolvent or rendered insolvent
by the incurrence; or
- we were or the guarantor was engaged in a business or
transaction for which our or the guarantor's remaining assets
constituted unreasonably small capital; or
- we or the guarantor intended to incur or believed that we or
it would incur debts beyond our or its ability to pay these
debts as they mature.
In addition, a court could void any payment by us or the guarantor
related to its guarantee and require that payment to be returned to us or the
guarantor, or to a fund for the benefit of our creditors or the creditors of the
guarantor.
The measures of insolvency for purposes of these fraudulent transfer
laws will vary depending upon the law applied. Generally, a guarantor would be
considered insolvent if:
- the sum of its debts, including contingent liabilities, were
greater than the fair saleable value of all of its assets; or
- the present fair saleable value of its assets were less than
the amount that would be required to pay its probable
liability on its existing debts, including contingent
liabilities, as they became absolute and mature; or
- it could not pay its debts as they became due.
If a court were to disagree with our conclusions as to the legality of
any subsidiary guarantees it could adversely affect the rights of holders of
O'Sullivan's indebtedness.
- WE MAY NOT HAVE THE ABILITY TO RAISE THE FUNDS NECESSARY TO
FINANCE A CHANGE OF CONTROL OFFER REQUIRED BY OUR DEBT AGREEMENTS. Upon certain
change of control events, we will be required to offer to repurchase all of
O'Sullivan's outstanding senior subordinated notes and O'Sullivan Holdings'
senior note. If we do not have sufficient funds at the time of a change of
control we will not be able to make the required repurchase
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<PAGE> 27
of these notes. This could be because of cash flow difficulties or because of
restrictions in our senior credit facilities and any future credit agreements
that will not allow these repurchases.
In addition, some kinds of corporate events, such as a leveraged
recapitalization, would increase the level of our indebtedness but would not
necessarily constitute a "Change of Control" and would therefore not require us
to repurchase the notes.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The information required by this item is incorporated herein by
reference to the section entitled "Market Risk and Inflation" in Item
7,"Management's Discussion and Analysis of Financial Condition and Results of
Operations," in Part II of this report.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
Immediately following are the report of independent accountants, the
consolidated balance sheets of O'Sullivan and subsidiaries as of June 30, 2000
and 1999, and the related consolidated statements of operations, cash flows and
changes in stockholders' equity for each of the three years in the period ended
June 30, 2000, and the notes thereto.
26
<PAGE> 28
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of
O'Sullivan Industries, 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, Inc. (a wholly-owned subsidiary of
O'Sullivan Industries Holdings, Inc.) and its subsidiaries (the "Company") at
June 30, 2000 and 1999, and the results of their operations and their cash
flows for each of the three years in the period ended June 30, 2000, in
conformity with accounting principles generally accepted in the United States
of America. These financial statements are the responsibility of the Company's
management; our responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits of these statements in
accordance with auditing standards generally accepted in the United States of
America, which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
PricewaterhouseCoopers LLP
Fort Worth, Texas
August 18, 2000
27
<PAGE> 29
O'SULLIVAN INDUSTRIES, INC. AND SUBSIDIARIES
(A wholly owned subsidiary of O'Sullivan Industries Holdings, Inc.)
CONSOLIDATED BALANCE SHEETS
(in thousands, except for share data)
<TABLE>
<CAPTION>
June 30,
----------------------------
Assets 2000 1999
------ ------------ -------------
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 11,867 $ 3,740
Trade receivables, net of allowance for doubtful accounts 58,975 63,268
of $3,095 and $2,416, respectively
Inventories, net 65,256 56,134
Prepaid expenses and other current assets 6,432 3,810
------------ -------------
TOTAL CURRENT ASSETS 142,530 126,952
Property, plant and equipment, net 99,548 96,684
Other assets 13,935 1,909
Goodwill, net of accumulated amortization 39,755 41,422
Receivable from parent 521 -
------------ -------------
TOTAL ASSETS $ 296,289 $ 266,967
============ =============
LIABILITIES AND STOCKHOLDER'S EQUITY (DEFICIT)
----------------------------------------------
Current liabilities:
Accounts payable $ 15,399 $ 11,416
Current portion of long-term debt 3,000 4,000
Accrued liabilities 30,597 26,274
------------ -------------
TOTAL CURRENT LIABILITIES 48,996 41,690
Long-term debt, less current portion 235,708 22,000
Other liabilities 1,816 1,909
Deferred income taxes 17,626 16,232
Due to parent - 28,033
------------ -------------
TOTAL LIABILITIES 304,146 109,864
Commitments and contingent liabilities (Notes 16 and 17)
Stockholders' equity (deficit):
Common stock, $1.00 par value; 100 shares authorized, issued and outstanding - -
Additional paid-in capital - 66,944
Retained earnings (deficit) (7,843) 90,202
Accumulated other comprehensive loss (14) (43)
------------ -------------
TOTAL STOCKHOLDER'S EQUITY (DEFICIT) (7,857) 157,103
------------ -------------
TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY (DEFICIT) $ 296,289 $ 266,967
============ =============
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
28
<PAGE> 30
O'SULLIVAN INDUSTRIES, INC. AND SUBSIDIARIES
(A wholly owned subsidiary of O'Sullivan Industries Holdings, Inc.)
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands)
<TABLE>
<CAPTION>
For the year ended June 30,
------------------------------------------
2000 1999 1998
---- ---- ----
<S> <C> <C> <C>
Net sales $ 423,425 $ 379,632 $ 339,407
Costs and expenses:
Cost of sales 298,387 267,630 244,086
Selling, marketing and administrative 82,244 74,962 69,212
Compensation expense associated with stock options administrative 10,627 - -
Loss on settlement of interest rate swap 408 - -
------------ ----------- ------------
Total costs and expenses 391,666 342,592 313,298
------------ ----------- ------------
Operating income 31,759 37,040 26,109
Other income (expense):
Interest expense (18,226) (3,110) (2,847)
Interest income 781 266 379
------------ ----------- ------------
Income before income tax provision 14,314 34,196 23,641
Income tax provision 5,153 12,311 8,742
------------ ----------- ------------
Income before extraordinary item 9,161 21,885 14,899
Extraordinary loss from early extinguishment of debt, net of (305) - -
income tax benefit of $171 ------------- ------------ -------------
Net income $ 8,856 $ 21,885 $ 14,899
============ =========== ============
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
29
<PAGE> 31
O'SULLIVAN INDUSTRIES, INC. AND SUBSIDIARIES
(A wholly owned subsidiary of O'Sullivan Industries Holdings, Inc.)
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
For the year ended June 30,
----------------------------------
2000 1999 1998
------- ------- -------
<S> <C> <C> <C>
Cash flows provided by operating activities:
Net income $ 8,856 $ 21,885 $ 14,899
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization 15,416 13,962 11,560
Amortization of debt issuance costs 1,166 - -
Bad debt expense 1,047 524 1,581
Loss on disposal of assets 117 223 11
Deferred income taxes (540) 481 414
Employee option amortization 498 749 749
Deferred compensation - 160 -
Compensation expense associated with stock options 10,627 - -
Changes in current assets and liabilities:
Trade receivables 3,246 (2,244) (4,468)
Inventories (9,122) (9,407) (2,569)
Other assets (1,218) 13 (335)
Accounts payable and accrued liabilities 10,068 (1,049) 5,322
------- ------- -------
Net cash flows provided by operating activities 40,161 25,297 27,164
------- ------- -------
Cash flows used for investing activities:
Capital expenditures (16,559) (15,779) (28,359)
------- ------- -------
Cash flows used for financing activities:
Proceeds from borrowings 233,546 10,000 -
Repayment of long-term debt (21,000) (14,000) -
Dividend to parent (186,827) - -
Debt issuance costs (12,640) - -
Net addition to (repayment of) revolver - (4,000) 4,000
Advances (repayment) on due to/from parent (28,554) 412 (7,970)
------- ------- -------
Net cash flows used for financing activities (15,475) (7,588) (3,970)
Net increase (decrease) in cash and cash equivalents 8,127 1,930 (5,165)
Cash and cash equivalents, beginning of year 3,740 1,810 6,975
------- ------- -------
Cash and cash equivalents, end of year $ 11,867 $ 3,740 $ 1,810
======= ======= =======
Supplemental cash flow information:
Interest paid $ 13,571 $ 3,110 $ 2,847
Income taxes paid 5,172 10,150 11,650
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
30
<PAGE> 32
O'SULLIVAN INDUSTRIES, INC. AND SUBSIDIARIES
(A wholly owned subsidiary of O'Sullivan Industries Holdings, Inc.)
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)
(in thousands)
<TABLE>
<CAPTION>
Accumulated
other
compre- Total
Additional Retained hensive stockholder's Compre-
paid-in earnings income equity hensive
capital (deficit) (loss) (deficit) income
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
Balance, June 30, 1997 $ 66,944 $ 53,418 $ 13 $ 120,375
Net Income 14,899 14,899 $ 14,899
Other comprehensive income (49) (49) (49)
--------- --------- --------- --------- ---------
Balance, June 30, 1998 66,944 68,317 (36) 135,225 $ 14,850
=========
Net income 21,885 21,885 $ 21,885
Other comprehensive income (7) (7) (7)
--------- --------- --------- --------- ---------
Balance, June 30, 1999 66,944 90,202 (43) 157,103 $ 21,878
=========
Net income 8,856 8,856 $ 8,856
Other comprehensive income 29 29 29
Compensation expense associated
with stock options 12,982 12,982
Dividend to parent (79,926) (106,901) (186,827)
--------- --------- --------- --------- ---------
Balance, June 30, 2000 $ - $ (7,843) $ (14) $ (7,857) $ 8,885
========= ========= ========= ========= =========
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
31
<PAGE> 33
O'SULLIVAN INDUSTRIES, INC. AND SUBSIDIARIES
(A Wholly Owned Subsidiary Of O'Sullivan Industries Holdings, Inc.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - GENERAL INFORMATION.
O'Sullivan Industries, Inc. ("O'Sullivan"), a wholly owned subsidiary
of O'Sullivan Industries Holdings, Inc. ("O'Sullivan Holdings"), is a Delaware
corporation and a domestic producer of ready-to-assemble ("RTA") furniture.
O'Sullivan's RTA furniture includes desks, computer tables, cabinets, home
entertainment centers, audio equipment racks, 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, OEM and internationally.
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. They are
presented as if O'Sullivan had existed as a corporation separate from
O'Sullivan Holdings during the periods presented and include the historical
assets, liabilities and expenses that are directly related to O'Sullivan's
operations. All material intercompany transactions with its consolidated
subsidiaries have been eliminated. O'Sullivan Holdings has no assets other than
the stock of O'Sullivan and an intercompany receivable from O'Sullivan.
Expenses incurred by O'Sullivan Holdings for the benefit of O'Sullivan are paid
by O'Sullivan. The financial information included in the financial statements
may not necessarily reflect what the financial position, results of operations
or cash flows would have been if O'Sullivan had been a separate, stand-alone
company during the periods presented.
Pervasiveness of Estimates: The preparation of financial statements in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amounts of assets and
liabilities, and related revenues and expenses, and disclosure of gain and loss
contingencies at the date of the financial statements. Actual results could
differ from those 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 68% and 62% of the
trade receivable balance at June 30, 2000 and 1999, 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.
Revenues: Revenue is recognized at the date product is shipped to
customers.
Inventories: Inventories are stated at the lower of cost, determined on
a first-in, first-out (FIFO) basis, or market.
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 property
retired or sold are removed from the accounts, and gains or losses on disposal
are recognized in the statement of operations.
32
<PAGE> 34
Amortization of Excess Purchase Price Over Net Tangible Assets of
Businesses Acquired: Cost in excess of net assets acquired is amortized over a
40-year period using the straight-line method. Accumulated amortization at June
30, 2000 and 1999 approximated $28,086,000 and $26,419,000, respectively.
Impairment of Long-Lived Assets: Long-lived assets (i.e., property,
plant and equipment and goodwill) held and used are reviewed for possible
impairment whenever events or changes in circumstances indicate that the net
book value of the asset may not be recoverable. O'Sullivan recognizes an
impairment loss if the sum of the expected future cash flows (undiscounted and
before interest) from the use of the asset is less than the net book value of
the asset. The amount of the impairment loss is measured as the difference
between the net book value of the assets and the estimated fair value of the
related assets.
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.
Derivatives: O'Sullivan utilizes derivative financial instruments to
reduce interest rate risks. O'Sullivan does not hold or issue derivative
financial instruments for trading purposes. Amounts to be paid or received under
the agreement are accrued as interest rates change and are recognized over the
life of the agreement as adjustments to interest expense.
Advertising Costs: Advertising costs are expensed the first time the
advertising takes place. Cooperative advertising costs are accrued and expensed
when the related revenues are recognized. Advertising expense for fiscal 2000,
1999 and 1998 was $25,032,000, $21,147,000 and $19,625,000, respectively.
Income Taxes: Deferred taxes are provided on the liability method
whereby deferred tax assets are recognized for deductible temporary differences
and operating loss carryforwards and deferred tax liabilities for 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 is more likely than not that
some portion or all of the deferred tax assets will not be realized. Deferred
tax assets and liabilities are adjusted for the effects of changes in tax laws
and rates on the date of enactment.
Environmental Remediation and Compliance: Environmental remediation and
compliance expenditures that relate to current operations are expensed or
capitalized, as appropriate. Expenditures that relate to an existing condition
caused by past operations and that do not contribute to current or future
revenue generation are expensed. Liabilities are recognized when environmental
assessments and/or remedial efforts are probable and the costs can be reasonably
estimated. Generally, the timing of these accruals coincides with completion of
a feasibility study or O'Sullivan's commitment to a formal plan of action. To
date, environmental expenditures have not been material, and management is not
aware of any material environmental related contingencies.
Significant Fourth Quarter Adjustments: During the fourth quarter of
fiscal 1999, O'Sullivan recorded merger related expenses of approximately $1.1
million incurred for legal, accounting, printing and investment banking fees.
Accounting for Stock-Based Compensation: O'Sullivan accounts for stock
based compensation pursuant to the intrinsic value based method of accounting as
prescribed by Accounting Principles Board Opinion No. 25, Accounting for Stock
Issued to Employees. O'Sullivan has made pro forma disclosures of net income as
if the fair value based method of accounting defined in Statement of Financial
Accounting Standards ("SFAS") No. 123, Accounting for Stock-Based Compensation,
had been applied.
Comprehensive Income: Effective July 1, 1998, O'Sullivan adopted SFAS
No. 130, Reporting Comprehensive Income. O'Sullivan has reported the components
of comprehensive income in the accompanying consolidated statement of changes in
stockholders equity. Comprehensive income is defined as the change in equity
(net assets) of a business enterprise during a period from transactions and
other events and circumstances from non-owner sources. It includes all changes
in equity during a period except those resulting from investments by owners and
distributions to owners. For O'Sullivan, other comprehensive income consists of
foreign currency
33
<PAGE> 35
translation adjustments. The tax benefit (expense) related to other
comprehensive income (loss) approximated $(10,000), $4,000 and $31,000 for the
years ended June 30, 2000, 1999 and 1998, respectively.
Reclassifications: Certain items in the prior years' financial
statements have been reclassified to conform with the current year's
presentation.
NOTE 3 - LEVERAGED RECAPITALIZATION.
On March 24, 1999, O'Sullivan Holdings announced that members of its
senior management team, in conjunction with a financial buyer, had made a
proposal to O'Sullivan Holding's Board of Directors to acquire O'Sullivan
Holdings, subject to requisite financing. On May 18, 1999, O'Sullivan Holdings
announced that it had entered into a definitive merger agreement with an
investment group that includes members of O'Sullivan's senior management and
Bruckmann, Rosser, Sherrill & Co., LLC ("BRS"). The merger agreement was amended
effective October 18, 1999 and the transaction closed on November 30, 1999.
Under the merger agreement, O'Sullivan Holdings is the surviving entity
after the merger. Certain directors and members of senior management
participated with BRS in the buyout of existing O'Sullivan Holdings
stockholders. The management participants in the recapitalization and merger own
a total of approximately 27.1% of the outstanding common stock of the surviving
corporation. BRS and its affiliates own the balance.
Each share of outstanding common stock of O'Sullivan Holdings was
exchanged for $16.75 in cash and one share of senior preferred stock with an
initial liquidation value of $1.50 per share. Some of the shares of O'Sullivan
common stock, options and cash held by the management participants in the
recapitalization and merger were exchanged for 371,400 shares of common stock,
72,748 shares of Series B junior preferred stock and options to acquire 60,319
shares of Series A junior preferred stock of the surviving company.
The total amount of funds necessary to fund the recapitalization and
merger and related transactions was approximately $357.0 million. These funds
came primarily from the following sources:
- an equity investment by an affiliate of BRS of approximately
$45.3 million in cash in the common stock and Series B junior
preferred stock of O'Sullivan Holdings;
- an equity investment in O'Sullivan Holdings by the management
participants in the recapitalization and merger in the amount
of approximately $13.7 million. This investment consisted of
the exchange by the management participants of common stock of
O'Sullivan Holdings with a value of $6.9 million, options to
acquire common stock of O'Sullivan Holdings with an intrinsic
value of $6.1 million and cash of $0.7 million for shares of
common stock, shares of Series B junior preferred stock and
options to acquire shares of Series A junior preferred stock,
each of O'Sullivan Holdings;
- the issuance by O'Sullivan Holdings of senior preferred stock
with a total liquidation value of $24.6 million to the
existing stockholders of O'Sullivan Holdings;
- the issuance by O'Sullivan Holdings of a $15.0 million senior
note and warrants exercisable in aggregate into 93,273 shares
of O'Sullivan Holdings' common stock and 39,273 shares of
O'Sullivan Holdings' junior preferred stock on a fully
diluted basis as of the date of the issuance of the warrants;
- the issuance by O'Sullivan of $100.0 million of senior
subordinated notes together with warrants issued by O'Sullivan
Holdings exercisable in aggregate into 93,273 shares of
O'Sullivan Holdings common stock and 39,273 shares of
O'Sullivan Holdings junior preferred stock on a fully
diluted basis as of the date of issuance of the warrants;
- borrowings by O'Sullivan totaling approximately $139.0 million
under the senior credit facilities; and
- Approximately $9.4 million of existing cash from O'Sullivan.
34
<PAGE> 36
In addition, $10.0 million of variable rate industrial revenue bonds
remain outstanding following the recapitalization transactions.
BRS and management participants in the recapitalization and merger
received shares of O'Sullivan's Series B junior preferred stock with an initial
liquidation value of $100.00 per share. Dividends accrue on the Series B junior
preferred stock at the rate of 14% per annum and, if unpaid, will accumulate and
compound during the period that the junior preferred stock is outstanding. The
Series B junior preferred stock is not subject to mandatory redemption.
The leveraged recapitalization required approximately $357 million to
complete the merger and pay related fees and expenses. Approximately $264
million was funded via debt proceeds.
NOTE 4 - DERIVATIVE FINANCIAL INSTRUMENTS.
Effective October 1, 1998, O'Sullivan had a forward starting interest
rate swap agreement with a notional principal amount of $10.0 million, which was
to terminate on October 1, 2008. Pursuant to the agreement, O'Sullivan paid a
fixed rate of 7.13% and received a floating interest rate during the duration of
the swap agreement. On November 30, 1999, O'Sullivan terminated the swap as
required by the counter-party due to the merger and recapitalization, incurring
a loss of $408,000. This amount has been presented as a separate line within
operating expenses in the accompanying consolidated statement of operations.
O'Sullivan Industries - Virginia, Inc., a subsidiary of O'Sullivan
("O'Sullivan Industries - Virginia"), called its existing $10.0 million of 8.25%
industrial development revenue bonds on October 1, 1998 at a redemption price of
103%. The $300,000 premium on the early retirement of the bonds was recognized
as a loss in O'Sullivan's second quarter of fiscal 1999 and was included in
interest expense. O'Sullivan Industries - Virginia refinanced these bonds with
new, ten-year industrial revenue bonds with a tax-exempt variable interest rate,
which is reset weekly. Interest on the bonds is paid monthly. At June 30, 2000,
the interest rate was 3.8%. The bonds mature on October 1, 2008.
As required under the new senior credit facilities, O'Sullivan hedged
one-half of its term loans with an initial notational amount of $67.5 million
with a costless interest rate collar. The collar is based on three month LIBOR
and has a floor of 6.43% and a ceiling of 8.75%. To terminate this contract at
June 30, 2000, O'Sullivan would have had to pay the counter-party approximately
$144,000.
NOTE 5 - NEW ACCOUNTING STANDARDS.
In June 1999, the FASB issued SFAS No. 138, which delayed the effective
date of SFAS No. 133, Accounting for Derivative Instruments and Hedging
Activities. Accordingly, O'Sullivan adopted SFAS No. 133 effective July 1, 2000.
This new accounting standard requires that derivative instruments be measured at
fair value and recognized in the balance sheet as either assets or liabilities,
as the case may be. The treatment of changes in the fair value of a derivative
(i.e., gains and losses) will depend on its use and designation. O'Sullivan will
initially report gains and losses on derivatives designated as hedges against
the cash flow effect of a forecasted transaction as a component of other
comprehensive income and, subsequently, reclassify the gains and losses into
earnings when the forecasted transaction affects earnings. The implementation of
SFAS No. 133 is not expected to have a material impact on O'Sullivan.
In March 2000, the FASB issued Interpretation No. 44, Accounting for
Certain Transactions Involving Stock Compensation - an Interpretation of APB
Opinion No. 25 ("FIN 44"). Among other issues, this interpretation clarifies the
definition of employee for purposes of applying APB Opinion No. 25, Accounting
for Stock Issued to Employees ("APB 25"), the criteria for determining whether a
plan qualifies as a non-compensatory plan, the accounting consequence of various
modifications to the terms of previously fixed stock options or awards and the
accounting for an exchange of stock compensation awards in a business
combination. This Interpretation is effective July 1, 2000, but certain
conclusions in this Interpretation cover specific events that occurred after
either December 15, 1998 or January 12, 2000. Management believes that FIN 44
will not have a material effect on O'Sullivan's financial position or the
results of operations upon adoption.
In addition, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101, Revenue Recognition in Financial Statements ("SAB
No. 101"), in late 1999. SAB No. 101 provides guidance in the recognition,
presentation and disclosure of revenue in financial statements. The SEC recently
delayed the date
35
<PAGE> 37
that companies are required to adopt the provisions of SAB No. 101 to the fourth
quarter of fiscal years beginning after December 31, 1999. O'Sullivan is
currently analyzing the provisions of SAB No. 101 and the SEC interpretations as
they relate to O'Sullivan's revenue recognition policies. The impact of the
adoption of SAB No. 101, if any, has not been determined at this time.
NOTE 6 - COMPENSATION EXPENSE ASSOCIATED WITH OPTIONS.
Approximately $13.0 million in total compensation associated with
employee stock options was exchanged as part of the merger. Of this amount,
$6.0 million was exchanged for options to purchase 60,319 shares of Series A
junior preferred stock, $5.9 million in cash was paid and $1.1 million in
liquidation value of senior preferred stock was distributed to the option
holders. Prior to the merger, O'Sullivan had incurred approximately $2.4
million in compensation expense associated with employee stock options issued
in fiscal 1997. Accordingly, only that portion of the options payment not
expensed prior to the merger of $10.6 million was recognized as compensation
expense in fiscal 2000. The compensation expense related to the options has
been included as a separate line item within the accompanying consolidated
statement of operations.
NOTE 7 - EXTRAORDINARY ITEM.
O'Sullivan repaid private placement notes held with a principal amount
of $16.0 million for $16.5 million on November 30, 1999. The $476,000 prepayment
fee has been recognized as a $305,000 extraordinary loss, net of related tax
benefit.
NOTE 8 - INVENTORY.
Inventory consists of the following:
<TABLE>
<CAPTION>
June 30,
-----------------------
2000 1999
---------- ---------
(in thousands)
<S> <C> <C>
Finished goods $ 47,350 $ 39,623
Work in process 6,258 6,263
Raw materials 11,648 10,248
---------- ---------
$ 65,256 $ 56,134
========== =========
</TABLE>
NOTE 9 - PROPERTY, PLANT & EQUIPMENT.
Property, plant, and equipment consist of the following:
<TABLE>
<CAPTION>
June 30,
-----------------------
2000 1999
---------- ---------
(in thousands)
<S> <C> <C>
Land $ 1,034 $ 1,034
Buildings and improvements 43,219 42,289
Machinery and equipment 118,778 111,505
Construction in progress 9,395 3,068
---------- ----------
172,426 157,896
Less: accumulated depreciation (72,878) (61,212)
---------- ----------
$ 99,548 $ 96,684
========== ==========
</TABLE>
Depreciation expense was $13,578,000, $12,295,000 and $9,893,000 for
fiscal 2000, 1999 and 1998 respectively, of which $11,098,000, $9,912,000 and
$8,200,000, respectively, was included in cost of sales.
36
<PAGE> 38
NOTE 10 - ACCRUED LIABILITIES.
Accrued liabilities consist of the following:
<TABLE>
<CAPTION>
June 30,
------------------------
2000 1999
---------- ----------
(in thousands)
<S> <C> <C>
Accrued employee compensation $ 11,997 $ 14,591
Accrued advertising 12,462 9,055
Other current liabilities 6,138 2,628
---------- ----------
$ 30,597 $ 26,274
========== ==========
</TABLE>
NOTE 11 - LONG-TERM DEBT AND OTHER BORROWING ARRANGEMENTS.
Long-term debt consisted of the following:
<TABLE>
<CAPTION>
------------------------
June 30,
------------------------
2000 1999
---------- ----------
(in thousands)
<S> <C> <C>
Senior term notes, tranche A $ 34,000 $ -
Senior term notes, tranche B 100,000 -
Senior notes - 16,000
Industrial revenue bonds 10,000 10,000
Senior subordinated notes 94,708 -
----------- -----------
Total debt 238,708 26,000
Less current portion of senior term notes (3,000) (4,000)
Total long-term debt ----------- -----------
$ 235,708 $ 22,000
=========== ===========
</TABLE>
O'Sullivan's total debt, inclusive of discount of $5.3 million, matures
in annual amounts as follows (in thousands):
<TABLE>
<S> <C>
2001 $ 3,000
2002 4,000
2003 5,000
2004 8,500
2005 14,000
Thereafter 209,500
------------
$ 244,000
============
</TABLE>
SENIOR SECURED CREDIT FACILITY. O'Sullivan is the obligor under a
senior secured credit facility totaling $175.0 million. O'Sullivan entered into
an agreement for the senior secured credit facility on November 30, 1999. The
senior secured credit facility consisted of the following:
- Senior term note, tranche A - $35.0 million term loan facility
payable in 23 quarterly installments beginning March 31, 2000.
The first two quarterly payments made in fiscal 2000 reduced
the outstanding balance to $34.0 million.
- Senior term note, tranche B - $100.0 million term loan
facility payable in 26 quarterly installments beginning March
31, 2001.
- Revolving credit facility - $40.0 million revolving credit
facility due November 30, 2005, which includes a $15.0 million
letter of credit subfacility and a $5.0 million swing line
subfacility. At June 30, 2000, O'Sullivan had no borrowings
outstanding on the credit facility and approximately $12.8
million of letters of credit outstanding.
37
<PAGE> 39
O'Sullivan's obligations under the senior secured facility are secured
by first priority liens and security interests in the stock of O'Sullivan and
O'Sullivan Industries - Virginia, Inc. ("O'Sullivan Industries - Virginia") and
substantially all of the assets of O'Sullivan and O'Sullivan Industries -
Virginia.
At O'Sullivan's option, borrowings under the senior secured credit
facility accrue interest at the varying rates based on (a) a Eurodollar rate
plus an applicable margin or (b) an applicable margin plus the highest of a
bank's prime rate, the federal funds effective rate plus 0.5% or three-month
certificates of deposit secondary market rates as adjusted for statutory
reserves plus 1.0%. Prior to June 30, 2000, the applicable margins for the $35.0
million term loan and the revolving credit facility were fixed at 3.25% for
Eurodollar loans and 2.25% for base rate loans. Subsequent to June 30, 2000, the
applicable margins vary based upon O'Sullivan's leverage ratio. The applicable
margins for the $100.0 million term loan are 3.75% for Eurodollar loans and
2.75% for base rate loans for the life of the loan. O'Sullivan also pays a
quarterly fee equal to 0.5% per annum of the unused commitment under the senior
secured credit facility. On June 30, 2000 the interest rates for tranche A and
tranche B notes were 10.1% and 10.6%, respectively.
O'Sullivan is subject to various covenants associated with the $175.0
million senior secured credit facility such as leverage and coverage ratios and
other customary covenants. These covenants limited O'Sullivan's available
borrowing capacity under the revolver at June 30, 2000 to approximately $27.2
million under the senior credit facilities of which approximately $2.2 million
can be used for letters of credit. In addition, O'Sullivan has certain
restrictions on its ability to incur additional debt, make capital
expenditures, pay dividends, sell its assets, issue securities, engage in
acquisitions and other restrictions.
INDUSTRIAL REVENUE BONDS. O'Sullivan Industries - Virginia was obligor
on $10.0 million of 8.25% industrial revenue bonds ("IRB's") that were to mature
on October 1, 2008. On October 1, 1998, O'Sullivan Industries - Virginia
refinanced these bonds with new, ten year variable rate IRB's. The $300,000
premium on the early retirement of the bonds was recognized as a loss in the
second quarter of 1999 and is included in interest expense in the accompanying
consolidated statement of operations. Interest on the IRB's is paid monthly. The
loan is secured by a $10.6 million standby letter of credit under the revolving
credit facility.
Effective October 1, 1998, O'Sullivan entered into a forward starting
interest rate swap agreement with a notional principal amount of $10.0 million
that was to terminate October 1, 2008. O'Sullivan contracted to pay a fixed rate
of 7.13% and receive a floating interest rate during the duration of the swap
agreement. On November 30, 1999, as part of the merger and recapitalization,
O'Sullivan terminated this swap incurring a loss of $408,000. The loss has been
included as a separate line item in the accompanying consolidated statement of
operations.
SENIOR SUBORDINATED NOTES. The senior subordinated notes issued by
O'Sullivan totaling $100.0 million bear interest at the rate of 13.375% per
annum and are due in 2009. The notes were sold at 98.046% of their face value.
Interest is payable semiannually on April 15 and October 15. The senior
subordinated notes contain various covenants including restrictions on
additional indebtedness based on EBITDA coverage. In connection with these
notes, O'Sullivan Holdings issued warrants to purchase 93,273 shares of
O'Sullivan Holdings common stock at an exercise price of $0.01 per share and
39,273 share of O'Sullivan Holdings Series B junior preferred stock at an
exercise price of $0.01 per share. The warrants are immediately exercisable.
The notes were recorded net of discount, which consisted of $2.0 million of
original issue discount and $3.5 million of the proceeds allocated to the fair
value of the warrants, which amount was paid to O'Sullivan Holdings in return
for the warrants.
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 approximated $12.6 million and have
been capitalized and recorded as other assets. Of this amount, $1.0 million was
paid to BRS.
38
<PAGE> 40
NOTE 12 - INCOME TAXES.
The income tax provision consists of the following:
<TABLE>
<CAPTION>
For the year ended June 30,
--------------------------------
2000 1999 1998
-------- -------- --------
Current: (in thousands)
<S> <C> <C> <C>
Federal $ 5,614 $ 11,282 $ 7,886
State 79 548 442
-------- -------- --------
5,693 11,830 8,328
Deferred (540) 481 414
-------- -------- --------
$ 5,153 $ 12,311 $ 8,742
======== ======== ========
</TABLE>
The following table reconciles O'Sullivan's federal corporate statutory rate and
its effective income tax rate:
<TABLE>
<CAPTION>
For the year ended June 30,
--------------------------------
2000 1999 1998
-------- -------- --------
<S> <C> <C> <C>
Statutory rate 35.0% 35.0% 35.0%
State income taxes, net of federal benefit 0.6 1.6 1.7
Goodwill amortization 2.2 1.1 1.3
Other, net (1.8) (1.7) (1.0)
-------- -------- --------
Effective tax rate 36.0% 36.0% 37.0%
======== ======== ========
</TABLE>
Deferred tax assets and liabilities consist of the following:
<TABLE>
<CAPTION>
June 30,
------------------------
2000 1999
---------- ----------
(in thousands)
<S> <C> <C>
Deferred tax assets:
--------------------
Bad debt reserve $ 1,145 $ 895
Insurance reserves 613 592
Accrued compensation 2,827 1,184
Other 297 154
---------- ----------
Total deferred tax assets 4,882 2,825
---------- ----------
Deferred tax liabilities:
-------------------------
Depreciation and amortization (17,721) (16,318)
Inventories - (98)
Other (584) (372)
---------- ----------
Total deferred tax liabilities (18,305) (16,788)
---------- ----------
Net deferred tax liability $ (13,423) $ (13,963)
========== =========
Reported as:
------------
Current assets (included in prepaid expenses and other current assets) $ 4,203 $ 2,269
Noncurrent liabilities-deferred income taxes (17,626) (16,232)
---------- ----------
Net deferred tax liability $ (13,423) $ (13,963)
========== =========
</TABLE>
SFAS 109 provides that the allocation of current and deferred tax
expense to each member of a consolidated group should be made on a systematic,
rational method. The tax provision and the deferred tax assets/liabilities
presented in the accompanying consolidated financial statements have been
determined on a stand-alone basis as allowed pursuant to SFAS 109.
39
<PAGE> 41
In connection with the 1994 initial public offering of O'Sullivan's
Holdings' common stock, Tandy Corporation, TE Electronics Inc. and O'Sullivan
Holdings entered into a Tax Sharing and Tax Benefit Reimbursement Agreement.
Pursuant to the tax agreement, Tandy is primarily responsible for all U.S.
federal income taxes, state income taxes and foreign income taxes with respect
to O'Sullivan for all periods ending on or prior to the date of consummation of
O'Sullivan Holdings' initial public offering and for audit adjustments to
such federal income and foreign income taxes. O'Sullivan Holdings is
responsible for all other taxes owing with respect to O'Sullivan, including
audit adjustments to state and local income and for franchise taxes.
O'Sullivan and Tandy made an election under Sections 338(g) and
338(h)(10) of the Internal Revenue Code with the effect that the tax basis of
O'Sullivan's assets was increased to the deemed purchase price of the assets. An
amount equal to such increase was included in income in the consolidated federal
income tax return filed by Tandy. This additional tax basis results in increased
income tax deductions and, accordingly, reduced income taxes payable by
O'Sullivan Holdings. Pursuant to the tax agreement, O'Sullivan Holdings pays
Tandy nearly all of the federal tax benefit expected to be realized with respect
to such additional basis. Amounts payable to Tandy pursuant to the tax agreement
are recorded as current federal income tax expense in the accompanying
consolidated statements of operations. Income tax expense thus approximates the
amount which would be recognized by O'Sullivan Holdings in the absence of the
tax agreement. Although the amount of the payment required to be made in a
particular year under the tax agreement may differ somewhat from the difference
in that tax year between O'Sullivan Holdings' actual taxes and the taxes that
O'Sullivan Holdings would have owed had the increase in basis not occurred, the
aggregate amount of payments required to be made by O'Sullivan Holdings to Tandy
over the life of the tax agreement will not differ materially from the
difference over the life of the tax agreement between O'Sullivan Holdings'
actual taxes and the amount of taxes that O'Sullivan Holdings would have owed
had the increase in basis not occurred. Consequently, such payments should have
no effect on O'Sullivan Holdings' earnings and should not have a material effect
on its cash flow. The tax agreement provides for adjustments to the amount of
tax benefit payable in the event of certain material transactions, such as a
business combination or significant disposition of assets. During fiscal 2000,
1999 and 1998, $4.3 million, $9.7 million, $11.7 million, respectively, were
paid to Tandy pursuant to this agreement. See note 17.
NOTE 13 - STOCK OPTIONS.
Under O'Sullivan Holdings' Amended and Restated 1994 Incentive Stock
Plan, designated officers, employees, employee directors and consultants of
O'Sullivan were eligible to receive awards in the form of incentive stock
options, nonqualified stock options, stock appreciation rights, restricted stock
grants or performance awards. Annually, non-employee directors of Holdings
received options to purchase 2,000 shares of common stock (increased from 1,000
shares beginning in fiscal 1998). The purchase price of common stock subject to
an option was to be not less than the market value of the stock on the date of
the grant and for a term not to exceed ten years. An aggregate of 2,000,000
shares of common stock were reserved for issuance under the Plan, no more than
300,000 of which could be awarded as restricted stock or performance awards. In
fiscal 1994, O'Sullivan Holdings awarded restricted shares of common stock
totaling 19,950 shares. The restrictions on these shares lapsed in fiscal 1999.
In July 1996, the compensation committee granted, subject to
stockholder approval, options to purchase 625,250 shares of common stock to
O'Sullivan's officers and other key employees. Depending on whether certain
performance objectives were met, the options would become exercisable in
one-third increments on each of the first three anniversaries of the date of the
grant and would expire ten years after the date of the grant. To the extent
performance objectives were not met, the options would become exercisable on
August 10, 2003 and would expire September 10, 2003. As a result of O'Sullivan's
performance in fiscal 1997, the options became exercisable over three years
through fiscal 1999 and would expire in July 2006. The stockholders approved the
grants in November 1996; accordingly, O'Sullivan recognized compensation expense
of approximately $2.2 million over the three year vesting period, which amount
was based on the difference between the exercise price and the fair market value
of common stock on the date of stockholder approval. O'Sullivan recognized
compensation expense of $749,000 in each of fiscal 1999 and fiscal 1998 related
to the granting of these options.
In connection with the recapitalization and merger of O'Sullivan
Holdings, all outstanding options issued by O'Sullivan were either converted
into options to purchase shares of O'Sullivan Holdings Series A junior
40
<PAGE> 42
preferred stock or exchanged for shares of O'Sullivan Holdings senior preferred
stock and a cash payment equal to the difference between $16.75 and the exercise
price of the option times the number of option shares. As a result, all of the
outstanding options under O'Sullivan Holdings' Amended and Restated 1994
Incentive Stock Plan were converted or exchanged. O'Sullivan recognized
compensation expense of $10.6 million in connection with the conversion and
exchange of the stock options, which has been shown as a separate line item
within the accompanying consolidated statement of operations. (See note 6)
In January 2000, O'Sullivan adopted its 2000 Common Stock Option Plan.
Pursuant to this plan, O'Sullivan Holdings may issue up to 81,818 shares of
O'Sullivan Holdings common stock to employees of O'Sullivan. The exercise price
for shares issued under the plan is 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 is the estimated
fair value of the underlying common stock at the date of grant. The expiration
date of these options is November 30, 2009. None of these options were
exercisable at June 30, 2000.
Summary of Common Stock Option Transactions
(share amounts in thousands)
<TABLE>
<CAPTION>
June 30, 2000 June 30, 1999 June 30, 1998
----------------------- --------------------- -------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
---------------------- ---------------------- -------------------------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning of year 1,593 $ 9.84 1,544 $ 9.77 1,215 $ 7.61
Grants 86 3.50 91 10.60 378 15.90
Exercised (42) 8.68 (14) 7.23 (38) 7.13
Converted into Series A junior (828) 10.97 - - - -
preferred stock options
Extinguished and exchanged for (725) 8.66 - - - -
Senior Preferred stock and cash
Canceled (8) 12.94 (28) 10.00 (11) 9.32
------ ------ ------
Outstanding at end of year 76 1.90 1,593 9.84 1,544 9.77
====== ====== ======
Exercisable at end of year - 928 8.82 500 8.45
====== ====== ======
Weighted average fair value of $ 0.53 $ 5.38 $ 7.95
options granted during the year ======== ====== ======
</TABLE>
In the merger, O'Sullivan Holdings issued options to purchase 60,318.67
shares of its Series A junior preferred stock, par value $.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 Holding 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 Holdings 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 Holdings. When
made, payment of the special accrual may be made in cash or by a reduction in
the option price for the option. The special accrual for fiscal 2000 of
approximately $498,000 was pushed down to O'Sullivan and is included in selling,
marketing and administrative expense in the accompanying consolidated
statement of operations.
O'Sullivan has adopted the disclosure-only provisions of SFAS 123.
Accordingly, no compensation cost has been recognized for O'Sullivan Holdings
options granted to O'Sullivan employees except as mentioned above. Had
compensation cost for stock option plans been determined based on the fair
value at the grant date for awards in fiscal 2000, 1999 and fiscal 1998 in
41
<PAGE> 43
accordance with the provisions of SFAS No. 123, O'Sullivan's net
income would have been adjusted to the pro forma amounts indicated below (in
thousands):
<TABLE>
<CAPTION>
Year Ended June 30,
---------------------------------------------
2000 1999 1998
----------- ---------- -----------
<S> <C> <C> <C> <C>
Net income As reported $ 8,856 $ 21,885 $ 14,899
Pro forma 14,377 19,825 13,729
</TABLE>
The fair value of each option grant on the date of grant is estimated
using the Black-Scholes option-pricing model based upon the following weighted
average assumptions:
<TABLE>
<CAPTION>
2000 1999 1998
-------- -------- --------
<S> <C> <C> <C>
Risk-free interest rate 6.24% 5.10% 6.24%
Dividend yield None None None
Volatility factor 5.5% 42.57% 37.56%
Weighted average expected life (years) 3.6 6.0 6.6
</TABLE>
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the vesting period. The effects of applying
SFAS No. 123 in this pro forma disclosure are not indicative of the impact on
future years as the pro forma amounts above do not include the impact of stock
option awards granted prior to fiscal 1996.
NOTE 14 - EMPLOYEE BENEFIT PLANS.
O'Sullivan Holdings maintains a stock purchase program that is
available to most O'Sullivan employees. The stock purchase program (the "SPP"),
as amended, allows a maximum employee contribution of 5%, while O'Sullivan's
matching contribution is 25%, 40% or 50% of the employee's contribution,
depending on the length of the employee's participation in the program.
Effective with the closing of the recapitalization and merger the program was
amended to invest contributions in a broad-based mutual fund. The matching
contributions to the stock purchase program for O'Sullivan employees were
$685,000, $700,000 and $700,000 in fiscal years 2000, 1999 and 1998,
respectively.
O'Sullivan Holdings also has a Savings and Profit Sharing Plan in which
most employees of O'Sullivan are eligible to participate. Under the savings or
section 401(k) portion of the plan, employees may contribute from 1% to 15% of
their compensation (subject to certain limitations imposed by the Internal
Revenue Code), and O'Sullivan makes matching contributions equal to 50% of the
first 5% of eligible employee contributions. 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 2000, 1999 and 1998, O'Sullivan accrued
approximately $2.5 million, $2.5 million and $1.7 million, respectively, for
the profit sharing portion of the plan. The matching contributions to the
savings portion of the plan were $750,000, $800,000 and $700,000 in fiscal year
2000, 1999 and 1998, respectively.
Effective July 1, 1997, O'Sullivan Holdings implemented its Deferred
Compensation Plan for the employees of O'Sullivan. 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 Holdings to
the participants. Matching and profit sharing accruals under the this plan were
not material in fiscal 2000, 1999 or 1998.
NOTE 15 - TERMINATION PROTECTION AGREEMENTS.
O'Sullivan Holdings has entered into Termination Protection Agreements
with most 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
42
<PAGE> 44
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
Holdings 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 Holdings will, upon request, repurchase the officer's primary
residence at a price determined in accordance with the agreement.
In March 1999, O'Sullivan Holdings entered into 24 Termination
Protection Agreements with its director-level managers, three of whom were
promoted to officers in July 1999. The Termination Protection Agreements (all of
which are substantially similar) have initial terms of two years which
automatically extend for successive one-year periods unless terminated by either
party. If the employment of any of these employees is terminated (with certain
exceptions) within twelve months following a "Change in Control," or in certain
other instances in connection with a Change in Control, the employees are
entitled to receive a cash payment equal to the total of six months salary and
one-half of their respective annual bonus (twelve months salary and an annual
bonus amount with respect to the officers). The employees would also be entitled
to the continuation of certain insurance benefits (life insurance, disability,
medical, dental and hospitalization benefits) for a period of up to six (or
twelve) months. The agreements also provide for outplacement services for the
employee.
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 Holdings, (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 Holdings approve a merger, consolidation or reorganization involving
O'Sullivan Holdings; (iv) there is a complete liquidation or reorganization
involving O'Sullivan; or (v) O'Sullivan Holdings enters into an agreement for
the sale or other disposition of all or substantially all of the assets of
O'Sullivan Holdings.
NOTE 16 - RELATED PARTY TRANSACTIONS.
BRS provided various advisory services to O'Sullivan Holdings related
to the merger. These services included arranging and negotiating the financing
of the merger, arranging and structuring the transaction, planning O'Sullivan
Holdings' capital structure and related services. BRS received a transaction fee
of $4.0 million from O'Sullivan Holdings and expenses of $62,000 for these
services. Of the $4.0 million transaction fee, $3.0 million was recognized as a
merger related expense by O'Sullivan Holdings and $1.0 million was pushed down
and capitalized into loan fees at O'Sullivan.
O'Sullivan entered into a management services agreement with BRS for
strategic and financial advisory services on November 30, 1999. The fee for
these services is the greater of (a) 1% of O'Sullivan Industries' consolidated
earnings before interest, taxes, depreciation, and amortization or (b) $300,000
per year. Under the management services agreement, BRS can also receive
reimbursement for expenses which are limited to $50,000 a year by the senior
credit facility agreement. The accrued management fee for the period ended June
30, 2000 was $364,000 and is included in accounts payable in the accompanying
consolidated balance sheet with the expense being included in selling, marketing
and administrative expense in the accompanying statements of operations.
43
<PAGE> 45
The senior credit facilities and the management services agreement both
contain certain restrictions on the payment of the management fee. The
management services agreement provides that no cash payment for the management
fee can be made unless the fixed charge coverage ratio for O'Sullivan's most
recently ended four full fiscal quarters would have been at least 2.0 to 1.0.
All fees and expenses under the management services agreement are subordinated
to the senior subordinated notes.
NOTE 17 - COMMITMENTS AND CONTINGENCIES.
Leases. O'Sullivan leases warehouse space, computers and certain other
equipment under operating leases. As of June 30, 2000, minimum future lease
payments for all noncancellable lease agreements were as follows (in thousands):
<TABLE>
<S> <C>
2001 $ 1,442
2002 831
2003 587
2004 405
2005 75
-----------
Total $ 3,340
===========
</TABLE>
Amounts incurred by O'Sullivan under operating leases (including
renewable monthly leases) were $1,945,000, $1,679,000 and $1,367,000 in fiscal
2000, 1999 and 1998, respectively.
Tandy Litigation. On June 29, 1999, Tandy Corporation filed a complaint
against O'Sullivan Holdings in the District Court of Texas in Tarrant County.
The complaint relates to a potential reduction in O'Sullivan Holdings tax
benefit payments to Tandy that would result from increased interest expense
after the completion of the merger. Tandy claims that this reduction would
violate the tax sharing and tax reimbursement agreement. The complaint sought a
court order compelling O'Sullivan Holdings to submit to a dispute resolution
process. Alternatively, the complaint sought a declaratory judgment that after
the merger O'Sullivan Holdings must continue to make tax-sharing payments to
Tandy as if the merger had not occurred.
On September 9, 1999, Tandy filed a motion for summary judgment in its
lawsuit against O'Sullivan Holdings. On October 8, 1999, Tandy's motion was
denied, as was all other relief sought by Tandy, except that O'Sullivan
Holdings was directed to commence dispute resolution procedures before an
arbitrator, according to the terms of the tax sharing agreement. Arbitrators
have been selected to hear the dispute and discovery is proceeding. To support
its motion for summary judgment, Tandy referred to a letter it received from
its independent outside auditors, PricewaterhouseCoopers LLP
("PricewaterhouseCoopers"). PricewaterhouseCoopers audits both Tandy's
financial statements and O'Sullivan's financial statements. The
PricewaterhouseCoopers letter advised Tandy on how PricewaterhouseCoopers
expected the tax sharing agreement would operate, if certain assumptions were
valid. On its face, the letter made clear that it was not expressing an
"opinion" on how the actual dispute between Tandy and O'Sullivan Holdings would
in fact be resolved, and the letter addressed assumptions that
PricewaterhouseCoopers had been given by Tandy.
O'Sullivan Holdings' annual report to stockholders on SEC Form 10-K for
the year ended June 30, 1999 disclosed these facts, and expressed management's
view, based on an opinion of our outside counsel, that Tandy's position in its
suit was without merit. Because PricewaterhouseCoopers both wrote its letter to
Tandy but did not object to the inclusion of management's view in the Form 10-K
on the merits of Tandy's lawsuit, the SEC Staff asked O'Sullivan Holdings to
clarify "whether PricewaterhouseCoopers has a reasonable basis to doubt
management's view that Tandy's lawsuit has no merit." In management's view,
PricewaterhouseCoopers had a reasonable basis for its acquiescence in the
footnote disclosure in the Form 10-K that Tandy's position was without merit.
First, O'Sullivan Holdings received an opinion from its outside counsel that
supports
44
<PAGE> 46
management's view that Tandy's position in the litigation was without merit.
That opinion was made available to PricewaterhouseCoopers in connection with its
annual audit, and clearly supports the decision not to object to the inclusion
of that footnote in O'Sullivan's financial statements. Second,
PricewaterhouseCoopers also has advised O'Sullivan Holdings that its letter was
predicated on assumptions it now understands are not relevant to the merger as
actually structured, and therefore, PricewaterhouseCoopers has reaffirmed that
its original letter did not attempt to offer an expert opinion to Tandy on the
merger or predict the actual outcome of the litigation between Tandy and
O'Sullivan Holdings. Neither PricewaterhouseCoopers nor O'Sullivan Holdings
believe there is any inconsistency between PricewaterhouseCoopers' original
letter, and its non-objection to the inclusion of that footnote disclosure in
the Form 10-K. In light of PricewaterhouseCoopers' response, the
PricewaterhouseCoopers letter has no relevance to the merger. At the SEC Staff's
request, however, we have included this discussion of PricewaterhouseCoopers'
letter. Finally, the Staff suggested that its concerns about this situation
could be eliminated if PricewaterhouseCoopers were to withdraw the letter to
Tandy. But, since the letter is not an expert opinion on any pending matter, a
position PricewaterhouseCoopers has since reaffirmed to us, management does not
believe there is any reason for PricewaterhouseCoopers formally to withdraw its
letter.
O'Sullivan believes it is now, and expects to continue to be, in full
compliance with the tax sharing agreement. O'Sullivan believes that Tandy's
position is without merit and intends to defend itself vigorously.
Other Litigation. In addition, O'Sullivan 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 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 has been designated as a potentially responsible
party under the Arkansas Remedial Action Trust Fund Act in connection with the
cost of cleaning up one site in Diaz, Arkansas and has entered into a de minimis
buyout agreement with certain other potentially responsible parties, pursuant to
which it has contributed $2,000 to date toward cleanup costs. O'Sullivan
believes that amounts it may be required to pay in the future, if any, will be
immaterial.
Retirement Agreement. In October 1998, Mr. Daniel F. O'Sullivan,
Chairman of the Board of Directors and Chief Executive Officer, completed
negotiations of a retirement and consulting agreement with O'Sullivan Holdings
contingent upon the hiring of his successor. In May 1999, the original
retirement agreement was amended, removing the contingency relating to the
hiring of his successor. The retirement agreement contains noncompetition
provisions. 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. The initial value of the
noncompetition asset which represents the present value of the future payments
to be paid pursuant to the agreement, and the corresponding liability
approximated $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. 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.
The present value of all future payments to Mr. O'Sullivan under this
agreement have been capitalized and recorded as an intangible asset associated
with the noncompetition provisions. The noncompetition asset is being amortized
on a straight line basis over the term of the agreement which amortization
commenced on March 31, 2000. The amortization period will be approximately 6.3
years.
45
<PAGE> 47
During fiscal 1999, O'Sullivan also recorded compensation expense equal
to the intrinsic value of Mr. O'Sullivan's outstanding options in conjunction
with the acceleration of the vesting of Mr. O'Sullivan's unvested options and
the extension of the exercise period for all of Mr. O'Sullivan's options. The
compensatory charge related to the options, combined with the associated legal
and other costs, approximated $235,000.
NOTE 18 - MAJOR CUSTOMERS AND INTERNATIONAL OPERATIONS.
Sales to three customers exceeded 10% of net sales in at least one of
the prior three fiscal years. Sales to such customers as a percentage of gross
sales were:
<TABLE>
<CAPTION>
Year ended June 30,
--------------------------------
2000 1999 1998
---- ---- ----
<S> <C> <C> <C>
Customer A 22.0% 21.4% 21.5%
Customer B 18.2% 13.1% 12.5%
Customer C 10.5% 9.1% 4.6%
</TABLE>
There are no material foreign operations or export sales.
NOTE 19 - QUARTERLY OPERATING RESULTS - UNAUDITED (in thousands)
<TABLE>
<CAPTION>
Fiscal 2000 (By Quarter)
---------------------------------------------------------
1 2 3 4
---------------------------------------------------------
<S> <C> <C> <C> <C>
Net sales $ 101,992 $ 111,023 $ 116,686 $ 93,724
Gross profit 29,761 33,806 33,954 27,517
Net income 5,628 (1,911) 3,502 1,637
<CAPTION>
Fiscal 1999 (By Quarter)
-----------------------------------------------------------
1 2 3 4
-----------------------------------------------------------
<S> <C> <C> <C> <C>
Net sales $ 87,673 $ 97,786 $ 108,529 $ 85,644
Gross profit 24,893 28,099 32,809 26,201
Net income 3,715 4,733 7,732 5,705 (a)
</TABLE>
(a) See note 2 regarding significant fourth quarter adjustments.
NOTE 20--SUBSIDIARY FINANCIAL INFORMATION
The following summarized financial information for O'Sullivan
Industries - Virginia is presented as if O'Sullivan Industries - Virginia had
existed as a corporation separate from O'Sullivan during the periods presented
and includes the historical assets, liabilities, revenues and expenses that are
directly related to O'Sullivan Industries - Virginia's operations. All material
intercompany transactions have been eliminated. For the periods presented,
certain expenses reflected in the combined financial statements included
allocations of corporate expenses from O'Sullivan to O'Sullivan Industries -
Virginia. These allocations include expenses for general management, management
information systems, treasury, legal, benefits administration, insurance, tax
compliance and other miscellaneous services. The allocation of expenses was
generally based on actual costs incurred, and such costs were apportioned to
O'Sullivan Industries - Virginia using varying methods including volume of sales
and number of employees. In addition, O'Sullivan Industries - Virginia sells all
customer trade receivables at face value to O'Sullivan immediately after
consummation of the sale.
Management believes that the foregoing allocations were made on a
reasonable basis; however, the allocations of costs and expenses do not
necessarily indicate the costs that would have been incurred by O'Sullivan
Industries - Virginia on a stand-alone basis. Also, the financial information
included in accompanying consolidated financial statements may not necessarily
reflect what the financial position, results of operations and cash flows of the
consolidated entity would have been had O'Sullivan and O'Sullivan Industries -
Virginia been separate, stand-alone companies during the periods presented.
46
<PAGE> 48
<TABLE>
<CAPTION>
STATEMENT OF OPERATIONS DATA
FOR THE YEAR ENDED JUNE 30,
-------------------------------------------
2000 1999 1998
-------- -------- -------
<S> <C> <C> <C>
Net sales 91,292 $71,282 $63,138
Gross profit 19,819 14,112 15,460
Operating income 6,840 5,161 6,680
Net income (loss) 3,646 2,682 3,705
</TABLE>
<TABLE>
<CAPTION>
BALANCE SHEET DATA
------------------
2000 1999
-------- --------
<S> <C> <C>
Current assets 16,403 $12,061
Noncurrent assets 27,405 26,658
Current liabilities 4,923 2,831
Noncurrent liabilities 9,750 10,403
</TABLE>
47
<PAGE> 49
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The following sets forth certain information with respect to the
business experience of each Director of O'Sullivan during the past five years
and certain other directorships held by Director.
CLASS I DIRECTORS--TERM EXPIRING 2000.
Richard D. Davidson, 52, was promoted to President and Chief Executive Officer
of O'Sullivan Holdings, O'Sullivan and O'Sullivan Industries - Virginia in
January 2000. He was named President and Chief Operating Officer of O'Sullivan
Holdings, O'Sullivan and O'Sullivan Industries - Virginia in July 1996. He was
named a Director of O'Sullivan and O'Sullivan Industries - Virginia in July 1996
and O'Sullivan Holdings in August 1996. From October 1995 to July 1996 he was a
private investor. For more than five years prior to October 1995, he served as a
Senior Vice President of Sunbeam Corporation and as President of Sunbeam's
Outdoor Products Division.
CLASS II DIRECTORS--TERM EXPIRING 2001.
Stephen F. Edwards, 37 was appointed a director of O'Sullivan Holdings,
O'Sullivan and O'Sullivan Industries - Virginia in connection with the merger.
Mr. Edwards has been a principal of BRS since August 1995. Mr. Edwards was an
officer of Citicorp Venture Capital from 1993 through July 1995. Mr. Edwards is
a director of Town Sports International, Inc., Anvil Knitwear, Inc., and
American Paper Group, Inc.
Harold O. Rosser, 51, was appointed a director of O'Sullivan Holdings,
O'Sullivan and O'Sullivan Industries - Virginia in connection with the merger.
Mr. Rosser has been a principal of BRS since August 1995. Mr. Rosser was an
officer of Citicorp Venture Capital from 1987 through July 1995. He is a
director of B&G Foods, Inc., California Pizza Kitchen, Inc., American Paper
Group, Inc., Jitney-Jungle Stores of America, Inc., Acapulco Restaurants, Inc.
and Penhall International, Inc. Mr. Rosser is also Chairman of the Board of
Trustees of Hope Church in Wilton, Connecticut.
CLASS III DIRECTORS--TERM EXPIRING 2002.
Daniel F. O'Sullivan, 59, 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
in July 1996 and resigned as Chief Executive Officer in October 1998. He served
as President of O'Sullivan Industries from 1986 until July 1996, and was
appointed Chairman of the Board and Chief Executive Officer in 1994. He also
served as Chairman of the Board and Chief Executive Officer of O'Sullivan
Industries - Virginia. Mr. O'Sullivan was employed by O'Sullivan from 1962 until
his retirement. Under the terms of his retirement and consulting agreement with
O'Sullivan Holdings, Mr. O'Sullivan retired as an executive of O'Sullivan
Holdings, O'Sullivan and O'Sullivan Industries - Virginia effective March 31,
2000. He remains as non-executive Chairman of the Board for each company.
48
<PAGE> 50
EXECUTIVE OFFICERS.
O'Sullivan's executive officers, and their ages and positions with
O'Sullivan as of September 1, 2000, are as follows:
<TABLE>
<CAPTION>
NAME AGE OFFICER POSITION(S)
SINCE(1)
<S> <C> <C> <C>
Richard D. Davidson 52 1996 President and Chief Executive Officer and Director
Tyrone E. Riegel 57 1969 Executive Vice President
Phillip J. Pacey 35 1999 Senior Vice President and Chief Financial Officer
Thomas M. O'Sullivan, Jr. 45 1993 Senior Vice President-Sales
Michael P. O'Sullivan 41 1995 Senior Vice President-Marketing
Rowland H. Geddie, III 46 1993 Vice President, General Counsel and Secretary
E. Thomas Riegel 56 1993 Vice President-Strategic Operations
James C. Hillman 55 1973 Vice President-Human Resources
Tommy W. Thieman 49 1999 Vice President-Manufacturing-Lamar
Stuart D. Schotte 38 1999 Vice President-Supply Chain Management
</TABLE>
----------------------------------
(1)Includes officer positions held with O'Sullivan Industries
Tyrone E. Riegel, 57, has been Executive Vice President of O'Sullivan
since July 1986 and served as a Director from March 1994 through November 1999.
He was appointed as Executive Vice President and a Director of O'Sullivan
Holdings in November 1993. His service as a director of O'Sullivan Holdings
ended November 1999. Mr. Riegel also serves as Executive Vice President of
O'Sullivan Industries - Virginia. Mr. Riegel has been employed by O'Sullivan
since January 1964.
Phillip J. Pacey was promoted to Senior Vice President and Chief
Financial Officer of O'Sullivan Holdings, O'Sullivan and O'Sullivan Industries -
Virginia in January 2000. He was appointed Vice President-Finance and Treasurer
of O'Sullivan Holdings, O'Sullivan Industries and O'Sullivan Industries
-Virginia in July 1999. From November 1995 until July 1999, he served as
Treasurer of O'Sullivan Holdings, O'Sullivan Industries and O'Sullivan
Industries - Virginia. From 1994 until November 1995, Mr. Pacey served as
Corporate Tax Manager of Savannah Foods and Industries, Inc., a sugar refiner
and marketer.
Thomas M. O'Sullivan, Jr. was promoted to Senior Vice President-Sales
of O'Sullivan Holdings, O'Sullivan Holdings and O'Sullivan Industries - Virginia
in January 2000. He had been Vice President-Sales of O'Sullivan, O'Sullivan
Industries and O'Sullivan Industries - Virginia, Inc. since 1993. Mr. O'Sullivan
has been employed by O'Sullivan since June 1979.
Rowland H. Geddie, III has been Vice President, General Counsel and
Secretary of O'Sullivan Holdings, O'Sullivan and O'Sullivan Industries -
Virginia since December 1993. He served as a Director of O'Sullivan and
O'Sullivan Industries - Virginia from March 1994 through November 1999.
E. Thomas Riegel has been Vice President-Strategic Operations of
O'Sullivan Holdings, O'Sullivan Industries and O'Sullivan Industries - Virginia
since November 1995. From June 1993 until November 1995, he was Vice
President-Marketing of O'Sullivan Holdings, O'Sullivan Industries and O'Sullivan
Industries - Virginia. Mr. Riegel has been employed by O'Sullivan since May
1971.
James C. Hillman has been Vice President-Human Resources of O'Sullivan
Holdings since November 1993 and of O'Sullivan since 1980. He also serves as
Vice President-Human Resources of O'Sullivan Industries - Virginia. Mr. Hillman
has been employed by O'Sullivan since May 1971.
Michael P. O'Sullivan was named Senior Vice President-Marketing of
O'Sullivan Holdings, O'Sullivan and O'Sullivan Industries - Virginia in January
2000. He had been Vice President-Marketing of O'Sullivan Holdings, O'Sullivan
and O'Sullivan Industries - Virginia since November 1995. He served as National
Sales Manager of O'Sullivan and O'Sullivan Industries - Virginia from July 1993
until November 1995. Mr. O'Sullivan has been employed by O'Sullivan since 1984.
49
<PAGE> 51
Tommy W. Thieman was appointed Vice President-Manufacturing-Lamar in
July 1999 for O'Sullivan Holdings and O'Sullivan. Since 1987, he has served as
the Plant Manager in Lamar for O'Sullivan. Mr. Thieman has been employed by
O'Sullivan since 1984.
Stuart D. Schotte was appointed Vice President-Supply Chain Management
in July 1999 for O'Sullivan Holdings, O'Sullivan and O'Sullivan Industries -
Virginia. From February 1998 to July 1999, Mr. Schotte served as Controller for
O'Sullivan Holdings, O'Sullivan and O'Sullivan Industries - Virginia. From July
1996 until February 1998, Mr. Schotte served as Director of Financial Analysis
and Planning for Fast Food Merchandisers, Inc. From October 1994 to July 1996,
he was a certified public accountant.
CERTAIN RELATIONSHIPS. Daniel F. O'Sullivan, Thomas M. O'Sullivan, Jr.
and Michael P. O'Sullivan are brothers. Tommy W. Thieman is the brother-in-law
of Daniel F. O'Sullivan, Thomas M. O'Sullivan, Jr. and Michael P. O'Sullivan.
Tyrone E. Riegel and James C. Hillman were, prior to the deaths of their
respective spouses, brothers-in-law of Daniel F. O'Sullivan, Thomas M.
O'Sullivan, Jr. and Michael P. O'Sullivan. Tyrone E. Riegel and E. Thomas Riegel
are brothers.
ITEM 11. EXECUTIVE COMPENSATION.
SUMMARY COMPENSATION TABLE
The following table reflects the cash and non-cash compensation for the
chief executive officer of O'Sullivan and the four next most highly compensated
executive officers at June 30, 2000 and two executives who are no longer
employees of O'Sullivan.
<TABLE>
<CAPTION>
LONG-TERM
ANNUAL COMPENSATION(1) COMPENSATION
---------------------- ------------
SALARY BONUS SECURITIES ALL OTHER
FISCAL ($) ($) UNDERLYING STOCK COMPENSATION
NAME AND PRINCIPAL POSITION YEAR OPTIONS (#)(2) ($)(3)
<S> <C> <C> <C> <C> <C>
Daniel F. O'Sullivan(4) 2000 216,827 - 189,993
Chairman of the Board 1999 275,000 229,279 - 44,107
1998 273,269 74,856 80,000 35,939
Richard D. Davidson 2000 244,231 176,623 8,500 45,984
President and 1999 225,000 174,263 - 37,104
Chief Executive Officer 1998 224,423 56,942 65,000 31,760
Tyrone E. Riegel 2000 204,616 109,586 4,000 39,860
Executive Vice President 1999 195,000 116,276 - 35,009
1998 194,615 38,062 28,000 35,441
Terry L. Crump(5) 2000 53,077 16,164 - 303,184
Executive Vice President and 1999 160,000 95,460 - 28,576
Chief Financial Officer 1998 159,423 31,284 28,000 27,366
Thomas M. O'Sullivan, Jr. 2000 144,423 66,005 4,000 26,181
Senior Vice President-Sales 1999 130,000 54,422 - 24,222
1998 129,615 17,922 12,000 23,660
Michael P. O'Sullivan 2000 134,423 61,473 4,000 24,807
Senior Vice President-Marketing 1999 120,000 50,259 - 20,627
1998 109,615 15,211 12,000 20,681
E. Thomas Riegel 2000 134,731 50,678 3,000 26,980
Vice President-Strategic 1999 128,000 53,589 - 22,241
Operations 1998 127,692 17,651 12,000 24,482
</TABLE>
50
<PAGE> 52
-----------------------------
(1)For the years shown, the named officers did not receive any annual
compensation not properly categorized as salary or bonus, except for certain
perquisites and other personal benefits. The amounts for perquisites and other
personal benefits for the named officers are not shown because the aggregate
amount of such compensation, if any, for each of the Named Officers during the
fiscal year shown does not exceed the lesser of $50,000 or 10% of total salary
and bonus reported for such officer.
(2)Includes all options granted to the named officers during fiscal
years shown under O'Sullivan's 1994 Amended and Restated Incentive Stock Plan
and its 2000 Common Stock Option Plan. No stock appreciation rights were granted
with any options.
(3)In fiscal 2000, other compensation for the named officers consisted
of the following:
<TABLE>
<CAPTION>
DEFERRED
STOCK PURCHASE COMPENSATION
SPSP PROGRAM PLAN MATCHING
GROUP LIFE MATCHING AND ("SPP") AND SEVERANCE OR
INSURANCE AUTO PROFIT SHARING MATCHING PROFIT SHARING RETIREMENT
NAME PREMIUMS ALLOWANCE CONTRIBUTIONS CONTRIBUTIONS CONTRIBUTIONS PAYMENTS
<S> <C> <C> <C> <C> <C> <C>
Daniel F. O'Sullivan $ 3,150 $ - * $ 9,539 $ 11,549 $ 7,827 $ 163,930
Richard D. Davidson $ 2,016 $ 9,000 $ 9,539 $ 8,841 $ 16,588 $ -
Tyrone E. Riegel $ 3,150 $ 8,500 $ 9,539 $ 8,022 $ 10,648 $ -
Terry L. Crump $ 609 $ 1,635 $ 2,994 $ 2,426 $ - $ 295,520
Thomas M. O'Sullivan, Jr. $ 662 $ 8,116 $ 9,539 $ 4,971 $ 2,893 $ -
Michael P. O'Sullivan $ 393 $ 8,250 $ 9,539 $ 4,617 $ 2,007 $ -
E. Thomas Riegel $ 2,160 $ 8,000 $ 9,539 $ 4,708 $ 2,573 $ -
</TABLE>
*Mr. Daniel F. O'Sullivan had the use of a company-owned automobile as
a perquisite during his employment at O'Sullivan.
The table does not include amounts payable in the event of a Change in
Control. See "Change in Control Protections".
(4) Mr. Daniel F. O'Sullivan retired as an employee of O'Sullivan
effective March 31, 2000. The table includes amounts paid to Mr. O'Sullivan
under his retirement agreement in fiscal 2000.
(5) Mr. Crump resigned as an officer of O'Sullivan on August 31, 1999.
Severance payments to Mr. Crump are included in Mr. Crump's figures for fiscal
2000.
OPTION GRANTS IN THE LAST YEAR
During the fiscal year ended June 30, 2000, options were granted to the
named officers as specified below. The potential value of such options at the
specified rates of appreciation are shown in the table below. The O'Sullivan
2000 Common Stock Option Plan does not authorize the grant of stock appreciation
rights.
<TABLE>
<CAPTION>
% OF TOTAL
NUMBER OF OPTIONS POTENTIAL REALIZABLE VALUE
SECURITIES GRANTED TO EXERCISE AT ASSUMED ANNUAL RATES
UNDERLYING EMPLOYEES OR BASE ---------------------------
OPTIONS GRANTED DURING THE PRICE EXPIRATION 5%(2) 10%(2)
NAME (#)(1) FISCAL YEAR ($/SHARE) DATE ($) ($)
<S> <C> <C> <C> <C> <C> <C>
Daniel F. O'Sullivan - - - -
Richard D. Davidson 8,500 11.2% 1.90 11/30/09 9,458 23,592
Tyrone E. Riegel 4,000 5.3% 1.90 11/30/09 4,451 11,102
Terry L. Crump - - - -
Thomas M. O'Sullivan 4,000 5.3% 1.90 11/30/09 4,451 11,102
Michael P. O'Sullivan 4,000 5.3% 1.90 11/30/09 4,451 11,102
E. Thomas Riegel 3,000 4.0% 1.90 11/30/09 3,338 8,337
</TABLE>
51
<PAGE> 53
----------
(1) Each named officer received incentive stock options in the amount
shown. Each option becomes exercisable over five years, assuming certain
performance targets are met. If the targets are not met with respect to any
option shares, these option shares become exercisable on the earlier of June 19,
2007 or the day before expiration of the option. For persons who continue to
serve as employees of O'Sullivan, the options expire on November 30, 2009. The
exercise price and any tax withholding may be paid in cash or by delivery of
already owned shares and cash.
(2) The potential gains reported are net of the per share option
exercise price, but before taxes associated with the exercise. These gains are
calculated based on the market price on the date of grant and the stated assumed
rates of appreciation each year over the life of the option. Actual gains, if
any, on stock option exercises depend on the future performance of the common
stock and the option holder's continued employment through the option exercise
date. The amounts in the table may not be achieved.
OPTION EXERCISES IN THE LAST YEAR
AND YEAR-END OPTION VALUES
In connection with the recapitalization and merger, all outstanding
options held were either converted into cash and shares of senior preferred
stock or converted into options to purchase shares of Series A junior preferred
stock. The following table summarizes information regarding the treatment of
options held by the named officers in the recapitalization and merger and the
outstanding options to purchase common stock held by the named officers as of
June 30, 2000.
<TABLE>
<CAPTION>
OPTIONS FOR COMMON COMMON VALUE OF VALUE OF
SHARES OF SERIES A OPTION OPTION EXER- UNEXER-
SENIOR JUNIOR SHARES SHARES CISABLE CISABLE
CASH PREFERRED PREFERRED EXER- UNEXER- COMMON COMMON
RECEIVED STOCK STOCK CISABLE CISABLE OPTIONS OPTIONS
NAME ($) RECEIVED RECEIVED @ 6/30/00 @ 6/30/00 @ 6/30/00 @ 6/30/00
<S> <C> <C> <C> <C> <C> <C> <C>
Daniel F. O'Sullivan 1,409,263 147,758 4,432 - -- $ -- $ --
Richard D. Davidson 132,769 13,874 10,929 - 8,500 -- --
Tyrone E. Riegel 841,378 88,103 3,378 - 4,000 -- --
Terry L. Crump 787,575 106,670 -- - -- -- --
Thomas M. O'Sullivan, Jr. 32,764 3,423 5,996 - 4,000 -- --
Michael P. O'Sullivan -- -- 6,176 - 4,000 -- --
E. Thomas Riegel 171,617 17,946 4,390 - 3,000 -- --
</TABLE>
CHANGE IN CONTROL PROTECTIONS
O'Sullivan Holdings has termination agreements with its executive
officers. If the employment of a protected employee is terminated by us within a
period of up to 24 months after a change in control, the employee will be
entitled to receive various benefits. The completion of the merger is a change
of control for purposes of these agreements. These benefits include:
1. a cash payment equal to the current base salary and highest bonus
received in the previous 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;
52
<PAGE> 54
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 bonus become immediately
exercisable;
9. O'Sullivan Holdings 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 employee's primary residence; and
12. if the executive officer is required to pay an excise tax under
Section 4999 of the Internal Revenue code of 1986, we will pay the
employee an additional amount to offset the effect of the tax.
The agreements for certain executive officers also provide for cash
payments in lieu of matching payments under the Stock Purchase Program and the
Savings and Profit Sharing Plan. The agreements for certain executive officers
also provide that, in some circumstances, they may voluntarily leave our
employment after a change in control and receive the benefits under the
protection agreements. These circumstances include:
- an adverse change in the executive's status, title or duties;
- a reduction in the executive's salary or bonus;
- relocation of the executive's office to a site which is more than 20
miles from its present location;
- a reduction in the executive's benefit levels;
- the insolvency or bankruptcy of O'Sullivan Holdings; or
- the executive leaves our employment for any reason during the 60-day
period beginning on the first anniversary of the change in control
However, for purposes of the merger, each of the executive officers who
is a management participant in the buyout waived his right to receive benefits
under the protection agreements in these circumstances, other than a reduction
in his salary or bonus.
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 2001.
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 Holdings stock or options to acquire O'Sullivan
Holdings stock. These amounts also do not include payments which we would make
to offset the effect of excise taxes or to purchase any executive officer's
home. We have assumed for this purpose that the named officers are terminated on
September 30, 2000.
<TABLE>
<CAPTION>
OFFICER AMOUNT
<S> <C>
Daniel F. O'Sullivan.................................................................................$ -
Chairman of the Board
Richard Davidson.....................................................................................$ 637,537
President and Chief Operating Officer
Tyrone E. Riegel.....................................................................................$ 454,181
Executive Vice President
Terry L. Crump.......................................................................................$ -
Executive Vice President and Chief Financial Officer
Thomas M. O'Sullivan, Jr.............................................................................$ 303,930
Senior Vice President-Sales
Michael P. O'Sullivan................................................................................$ 278,044
Senior Vice President-Marketing
</TABLE>
53
<PAGE> 55
<TABLE>
<S> <C>
E. Thomas Riegel.....................................................................................$ 266,757
Vice President-Strategic Operations
</TABLE>
COMPENSATION COMMITTEE INTERLOCKS
AND INSIDER PARTICIPATION
The members of the Compensation Committee are Stephen F. Edwards and
Harold O. Rosser. No member of the Compensation Committee was an officer or
employee of O'Sullivan Holdings or its subsidiaries during the fiscal year ended
June 30, 2000. Neither was formerly an officer of O'Sullivan Holdings or any of
its subsidiaries. In addition, no executive officer of O'Sullivan serves on the
board of directors or the compensation committee of another entity where a
committee member is employed.
DIRECTORS' COMPENSATION
Directors of O'Sullivan who are not employees of O'Sullivan Holdings or
its subsidiaries or of BRS are paid an annual retainer of $25,000. The chairmen
of the compensation committee and the audit committee each receive an additional
$1,000 per year if not employed by BRS. Expenses of attendance at meetings are
paid by O'Sullivan. No fees are paid for attendance at Board or compensation or
audit committee meetings. Employees of O'Sullivan do not receive additional
compensation for their service as a director other than payment of expenses, if
any, to attend a meeting.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Under the securities laws of the United States, O'Sullivan Holdings'
directors, executives and any persons holding 10% or more of Common Stock are
required to report their ownership of O'Sullivan Holdings' Company's 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, 2000. All of these filing requirements were satisfied by
O'Sullivan Holdings' directors and Executives during fiscal 2000.
54
<PAGE> 56
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
SECURITY OWNERSHIP OF CERTAIN
BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth, as of September 21, 2000, 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 executives and directors as a group and (iv) the only
other owner of five percent of any class of O'Sullivan's equity securities known
to us.
<TABLE>
<CAPTION>
OPTIONS TO
PURCHASE
SHARES OF SHARES OF
PERCENTAGE SHARES OF SERIES A SERIES B
SHARES OF OF SENIOR JUNIOR JUNIOR
COMMON COMMON PREFERRED PREFERRED PREFERRED
NAME OF BENEFICIAL OWNER STOCK STOCK STOCK STOCK STOCK
--------- ---------- ---------- ---------- ---------
<S> <C> <C> <C> <C> <C>
BRS(1) 989,617 72.34% - - 442,933
Richard D. Davidson 81,549 5.96% 14,819 10,929 20,839
Daniel F. O'Sullivan 9,972 0.73% 197,681 4,432 -
Tyrone E. Riegel 21,265 1.55% 101,939 3,378 3,644
Michael P. O'Sullivan 31,305 2.29% 5,080 6,176 5,117
Thomas M. O'Sullivan, Jr. 34,151 2.50% 6,664 5,996 6,561
E. Thomas Riegel 19,816 1.45% 20,711 4,390 2,425
Directors and executive officers
as a group (13 persons) 1,280,277(2) 94.10% 181,452 47,706 53,529
BancBoston Investments, Inc. 93,273(3) 6.38% - - 39,273(3)
</TABLE>
------------------
(1) The principals of BRS's parent are Bruce C. Bruckmann, Harold O.
Rosser, Stephen C. Sherrill, Stephen F. Edwards and Paul D. Kaminsky, each of
whom could be deemed to beneficially own the shares of O'Sullivan Holdings held
by BRS.
(2) Consists of shares held by BRS that may be deemed to be
beneficially owned by Stephen F. Edwards and Harold O. Rosser, Directors of
O'Sullivan.
(3) BancBoston Investments, Inc. holds warrants to purchase these
shares.
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.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
During fiscal 2000, Casey O'Sullivan, a son of Daniel F. O'Sullivan,
worked as a salesman for Bennett Packaging, which that provides O'Sullivan
corrugated boxes for its products. Bennett Packaging has long been
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<PAGE> 57
one of O'Sullivan's suppliers; O'Sullivan paid Bennett $6.2 million during
fiscal 2000. O'Sullivan has followed the practice of awarding purchase orders
for cartons for a model to the lowest bidder for the carton.
BRS TRANSACTION FEES
BRS provided various advisory services to Holdings and to us related to
the recapitalization and merger. These services included arranging and
negotiating the financing of the recapitalization and merger, arranging and
structuring the transaction, including forming OSI, planning its capital
structure, planning our capital structure and related services. For these
services, BRS received a transaction fee of $4.0 million plus $62,000 in
expenses upon completion of the recapitalization and merger.
BRS also provided $15.0 million of financing pursuant to a securities
purchase agreement with O'Sullivan Holdings. BRS received a transaction fee of
$300,000 in connection with its provision of this financing. BRS subsequently
sold the securities it acquired under this agreement to BancBoston Investments,
Inc.
MANAGEMENT SERVICES AGREEMENT
In connection with the merger, O'Sullivan entered into a management
services agreement with BRS. Under the terms of this agreement, BRS provides:
- general management services;
- assistance with the negotiation and analysis of financial
alternatives; and
- other services agreed upon by BRS.
In exchange for these services, BRS will earn an annual fee equal to the greater
of:
- 1.0% of O'Sullivan's annual consolidated earnings before
interest, taxes, depreciation and amortization; or
- $300,000.
In addition to certain restrictions on the payment of the management
fee contained in the senior credit facilities, the management services agreement
contains certain restrictions on the payment of that fee. The management
services agreement, among other things, provides that no cash payment of the
management fee will be made unless the Fixed Charge Coverage Ratio for our most
recently ended four full fiscal quarters for which internal financial statements
are available to management immediately preceding the date when the management
fee is to be paid is at least 2.0 to 1. The management services agreement also
provides that the payment of all fees and other obligations under the management
services agreement will be subordinated to the prior payment in full in cash of
all interest, principal and other obligations on O'Sullivan's senior
subordinated notes in the event of a bankruptcy, liquidation or winding-up of
O'Sullivan.
SEVERANCE 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 August 1999, O'Sullivan Holdings entered into a severance agreement
with Terry Crump, our Executive Vice President and Chief Financial Officer at
the time. Pursuant to the agreement, Mr. Crump resigned
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<PAGE> 58
as an officer of O'Sullivan Holdings and O'Sullivan Industries effective August
31, 1999, although he remained an employee until January 2000. Under Mr. Crump's
severance agreement, O'Sullivan Holdings paid Mr. Crump approximately $325,000
in January 2000. This amount has been recorded as a non-current asset and is
being amortized over the life of the non-compete agreement. The $325,000 payment
did not include payment for shares of O'Sullivan Holdings' common stock or stock
options held by Mr. Crump.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a)(1) Financial Statements
The following consolidated statements of O'Sullivan Industries
Holdings, Inc. and subsidiaries are filed as part of this report:
<TABLE>
<S> <C>
Report of Independent Accountants................................................................... 27
Consolidated Balance Sheets as of June 30, 2000 and 1999............................................ 28
Consolidated Statements of Operations for each of the three years in the period ended June 30, 2000 29
Consolidated Statements of Cash Flows for each of the three years in the period ended June 30, 2000. 30
Consolidated Statements of Changes in Stockholders' Equity for each of the three years in the
period ended June 30, 2000.......................................................................... 31
Notes to Consolidated Financial Statements.......................................................... 32
</TABLE>
(a)(2) Financial Statements Schedules
Schedules have been omitted because they are not required or
are not applicable or the information required to be set forth therein
either is not material or is included in the financial statements or
notes thereto.
(a)(3) Exhibits:
A list of exhibits required to be filed as part of this report
is set forth in the Index to Exhibits, which immediately precedes such
exhibits, and is incorporated herein by reference.
(b) Reports on Form 8-K
None
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<PAGE> 59
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, 2000.
O'SULLIVAN INDUSTRIES HOLDINGS, INC.
By /s/ Richard D. Davidson
---------------------------------------
Richard D. Davidson
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
<TABLE>
<S> <C> <C>
/s/ Daniel F. O'Sullivan Chairman of the Board September 28, 2000
----------------------------
Daniel F. O'Sullivan
President and Chief Executive Officer
/s/ Richard D. Davidson and Director September 28, 2000
----------------------------- (Principal Executive Officer)
Richard D. Davidson
Senior Vice President and
/s/ Phillip J. Pacey Chief Financial Officer September 28, 2000
----------------------------- (Principal Financial and Accounting Officer)
Phillip J. Pacey
/s/ Stephen F. Edwards Director September 28, 2000
-----------------------------
Stephen F. Edwards
/s/ Harold O. Rosser Director September 28, 2000
------------------------------
Harold O. Rosser
</TABLE>
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<PAGE> 60
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT DESCRIPTION PAGE
NO. NO.
<S> <C> <C>
2.1 Amended and Restated Agreement of Merger dated as of October 18, 1999 by and among OSI
Acquisition, Inc. and O'Sullivan Holdings, (incorporated by reference to Appendix A to
Proxy Statement /Prospectus included in Registration Statement on Form S-4
(File No. 333-81631))
3.1 & Certificate of Incorporation of O'Sullivan (incorporated by reference to Exhibit 3.1
4.1 to Appendix A to Registration Statement on Form S-4 (File No. 333-31282))
3.2 & By-laws of O'Sullivan (incorporated by reference to Exhibit 3.3 to Registration
4.2 Statement on Form S-4 (File No. 333-31282))
4.3 Indenture dated as of November 30, 1999 by and among O'Sullivan, 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 this 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 on Form 10-Q of O'Sullivan
Holdings for the quarter ended December 31, 1999 (File No. 0-28493))
9 Stockholders Agreement dated November 30, 1999 by and among O'Sullivan, 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 on Form 10-Q of
O'Sullivan Holdings for the quarter ended December 31, 1999 (File No. 0-28493))
10.1 Debt Registration Rights Agreement dated as of November 30, 1999 by and among O'Sullivan,
Inc., Lehman Brothers and O'Sullivan Industries - Virginia, as guarantor (incorporated
by reference to Exhibit 10.1 to Registration Statement on Form S-4 (File No. 333-31282))
10.2* Stock Purchase Agreement dated as of November 30, 1999 by and among Bruckmann, Rosser,
Sherrill & Co. II, L.P. and the individuals whose names appear on the signature pages
attached thereto (incorporated by reference to Exhibit 10.2 to Registration Statement on
Form S-4 (File No. 333-31282))
</TABLE>
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<PAGE> 61
<TABLE>
<CAPTION>
EXHIBIT DESCRIPTION PAGE
NO. NO.
<S> <C> <C>
10.3 Unit Agreement dated as of November 30, 1999 by and among O'Sullivan, O'Sullivan
Holdings, O'Sullivan Industries - Virginia, and Norwest Bank of Minnesota, National
Association (incorporated by reference to Exhibit 10.3 to Registration Statement on Form S-4
(File No. 333-31282))
10.4 Credit Agreement dated as of November 30, 1999 by and among O'Sullivan, O'Sullivan
Holdings, Lehman Brothers Inc. and Lehman Commercial Paper, Inc. (incorporated by
reference to Exhibit 10.1 to Quarterly Report on Form 10-Q of O'Sullivan Holdings for the
quarter ended December 31, 1999 (File No. 0-02843))
10.4a First Amendment to Credit Agreement, effective as of November 30, 1999 (incorporated by
reference to Exhibit 10.4a to Amendment No. 2 to Registration Statement on Form S-4 (File
No. 333-31282))
10.5 Deed of Trust, Assignment of Leases and Rents, Security Agreement and Fixture Filing dated as
of November 30, 1999 from O'Sullivan to the trustee named therein for the benefit of Lehman
Brothers Inc., Lehman Commercial Paper, Inc. and the several lenders and financial
institutions which become parties thereto from time to time (incorporated by reference to
Exhibit 10.5 to Registration Statement on Form S-4 (File No. 333-31282))
10.6 Guarantee and Collateral Agreement dated as of November 30, 1999 by and among O'Sullivan,
O'Sullivan Holdings, O'Sullivan Industries - Virginia, and Lehman Commercial Paper, Inc.
(incorporated by reference to Exhibit 10.6 to Registration Statement on Form S-4 (File
No. 333-31282))
10.7 Intellectual Property Security Agreement dated as of November 30, 1999 by and among
O'Sullivan and Lehman Commercial Paper, Inc. (incorporated by reference to Exhibit 10.7 to
Registration Statement on Form S-4 (File No. 333-31282))
10.8 Intercompany Subordinated Demand Promissory Note dated as of November 30, 1999 by and
among O'Sullivan and O'Sullivan Industries - Virginia, (incorporated by reference to Exhibit
10.8 to Registration Statement on Form S-1 (File No. 333-31282))
*10.9 Management Stock Agreement dated November 30, 1999 by and among O'Sullivan Holdings,
Bruckmann, Rosser, Sherrill & Co. II, L.P., and the individuals whose signatures appear
on the signature pages thereto (incorporated by reference to Exhibit 10.7 to Quarterly
Report on Form 10-Q of O'Sullivan Holdings for the quarter ended
December 31, 1999 (File No. 0-28493))
*10.10 Subscription Agreement dated November 30, 1999 by and among OSI Acquisition, Inc.,
Bruckmann, Rosser, Sherrill & Co. II, L.P. and the individuals whose signatures appear on
the signature pages thereto (incorporated by reference to Exhibit 10.10 to Registration
Statement on Form S-4 (File No. 333-31282))
*10.11 O'Sullivan Holdings 2000 Common Stock Option Plan (incorporated by reference to Exhibit 10.11
to Registration Statement on Form S-4 (File No. 333-31282))
*10.12 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))
*10.13 O'Sullivan Holdings Preferred Stock Option Plan (incorporated by reference to Exhibit 10.3 to
Quarterly Report on Form 10-Q of O'Sullivan Holdings for the quarter ended December 31, 1999
(File No. 0-28493))
</TABLE>
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<PAGE> 62
<TABLE>
<CAPTION>
EXHIBIT DESCRIPTION PAGE
NO. NO.
<S> <C> <C>
*10.14 Form of Preferred Stock Option Agreement dated November 30, 1999 (incorporated by reference to
Exhibit 10.4 to Quarterly Report on Form 10-Q of O'Sullivan Holdings for the quarter ended
December 31, 1999 File No. 0-28493))
*10.15 Registration Rights Agreement dated November 30, 1999 by and among O'Sullivan Holdings,
Bruckmann, Rosser, Sherrill & Co. II, L.P. and the individuals who executed executive
signature pages or warrant holder signature pages or acquired warrants after execution of
the signature pages attached thereto (incorporated by reference to Exhibit 10.6 to
Quarterly Report on Form 10-Q of O'Sullivan Holdings for the quarter ended December 31, 1999
(File No. 0-28493))
*10.16 Agreement and Acknowledgment of Optionee dated November 30, 1999 by and among O'Sullivan
Holdings and each of the individuals who executed an individual signature page thereto
(incorporated by reference to Exhibit 10.15 to Registration Statement on Form S-4 (File No.
333-31282))
*10.17 Form of Election to Roll Shares dated November 30, 1999 by and among O'Sullivan Holdings
and each of the individuals who executed an individual signature page thereto (incorporated
by reference to Exhibit 10.1 to Registration Statement on Form S-4 (File No. 333-31282))
*10.18 Management Services Agreement dated November 30, 1999 by and among O'Sullivan Holdings
and Bruckmann, Rosser, Sherrill & Co. II, L.P. (incorporated by reference to Exhibit 10.2
to Quarterly Report on Form 10-Q of O'Sullivan Holdings for the quarter ended December
31, 1999 (File No. 0-28493))
*10.19 Form of Amended and Restated Termination Protection Agreement between O'Sullivan Holdings
and certain members of management (incorporated by reference to Exhibit 10.2 to Quarterly
Report of O'Sullivan Holdings on Form 10-Q for the quarter ended March 31, 1996
(File No. 1-12754))
*10.20 Form of Termination Protection Agreement between O'Sullivan Holdings and certain members
of management (incorporated by reference to Exhibit 10.3 to Annual Report on Form 10-K of
O'Sullivan Holdings for the year ended June 30, 1999 (File No. 1-12754))
*10.21 O'Sullivan Holdings, Deferred Compensation Plan (the "DCP") (incorporated by reference to
Exhibit 10.2 to Quarterly Report on Form 10-Q of O'Sullivan Holdings for the quarter ended
March 31, 1997 (File No. 1-12754))
*10.21a First Amendment to the DCP (incorporated by reference to Exhibit 10.4a to Annual Report on
Form 10-K of O'Sullivan Holdings for the year ended June 30, 1997 (File No. 1-12754))
*10.21b Second Amendment to the DCP (incorporated by reference to Exhibit 10.20b to Registration
Statement on Form S-4 (File No. 333-31282))
*10.21c Third Amendment to the DCP (incorporated by reference to Exhibit 10.21(c) to Annual
Report on Form 10-K of O'Sullivan Holdings for the year ended June 30, 2000 (File No. 0-28493))
10.22 Amended and Restated Tax Sharing and Tax Reimbursement Agreement dated as of June 19, 1997
between O'Sullivan Holdings and Tandy 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))
</TABLE>
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<PAGE> 63
<TABLE>
<CAPTION>
EXHIBIT DESCRIPTION PAGE
NO. NO.
<S> <C> <C>
*10.23 Form of Indemnity Agreement between O'Sullivan Holdings and certain directors and
officers (incorporated by reference to Exhibit 10.7 to Amendment No. 1 to Registration
Statement on Form S-1 (File No. 33-72120))
*10.24 Retirement and Consulting Agreement, Release and Waiver of Claims between O'Sullivan
Holdings and Daniel F. O'Sullivan dated October 16, 1998 (incorporated by reference to
Exhibit 10 to Quarterly Report on Form 10-Q of O'Sullivan Holdings for the quarter ended
September 30, 1998 (File No. 1-12754))
*10.24a Amendment to Retirement Agreement dated as of May 16, 1999 between O'Sullivan Holdings
and Daniel F. O'Sullivan (incorporated by reference to Exhibit 10.9a to Annual Report on
Form 10-K of O'Sullivan Holdings for the year ended June 30, 1999 (File No. 1- 12754))
*10.25 Description of O'Sullivan Holdings' 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))
21 Subsidiaries of the Registrant (incorporated by reference to Exhibit 21 to Annual Report
on Form 10-K of O'Sullivan Holdings for the year ended June 30, 1995 (File No. 1-12754))
27 Financial Data Schedule 64
</TABLE>
----------------
* Each of these exhibits is a "management contract or compensatory plan
or arrangement."
Pursuant to item 601 (b) (4) (iii) of Regulation S-K, O'Sullivan has
not filed agreements relating to certain long-term debt of O'Sullivan
aggregating $10 million. O'Sullivan agrees to furnish the Securities and
Exchange Commission a copy of such agreements upon request.
62
