<PAGE>
FILED PURSUANT TO RULE 424(b)(1)
REGISTRATION NO. 33-51437
PROSPECTUS
$100,000,000
[LOGO OF ORCHARD SUPPLY HARDWARE APPEARS HERE]
ORCHARD SUPPLY HARDWARE CORPORATION
9 3/8% SENIOR NOTES DUE 2002
------------
UNCONDITIONALLY GUARANTEED BY
ORCHARD SUPPLY HARDWARE STORES CORPORATION
------------
Interest Payable February 15 and August 15
------------
Orchard Supply Hardware Corporation ("Orchard Supply") is offering (the
"Offering") $100,000,000 aggregate principal amount of its 9 3/8% Senior Notes
Due 2002 (the "Notes"). Interest on the Notes will be payable semi-annually on
February 15 and August 15 of each year, commencing August 15, 1994. The Notes
will be redeemable at the option of Orchard Supply, in whole or in part, on or
after February 15, 1998, at the redemption prices set forth herein. The Notes
will not be subject to any mandatory sinking fund provisions.
Upon the occurrence of a Change of Control (as defined), each holder of the
Notes will have the option to cause Orchard Supply to repurchase all or a
portion of such holder's Notes at 101% of the principal amount thereof, plus
accrued interest to the date of repurchase.
The Notes will be unsecured and will rank pari passu in right of payment
with all senior indebtedness of Orchard Supply. The Notes will be
unconditionally guaranteed on a senior basis (the "Parent Guarantee") by
Orchard Supply Hardware Stores Corporation, the parent of Orchard Supply. As
of October 31, 1993, the aggregate amount of senior indebtedness of Orchard
Supply, as adjusted to give effect to the application of the estimated net
proceeds from this Offering, would have been approximately $139.7 million. See
"Description of Notes."
------------
SEE "INVESTMENT CONSIDERATIONS" FOR CERTAIN FACTORS THAT SHOULD BE
CONSIDERED BY PROSPECTIVE INVESTORS.
------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION
PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------
Price to Underwriting Proceeds to
Public(1) Discount(2) Company(1)(3)
- ---------------------------------------------------------------------------------
<S> <C> <C> <C>
Per Note............................... 100% 2.50% 97.50%
- ---------------------------------------------------------------------------------
Total.................................. $100,000,000 $2,500,000 $97,500,000
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
</TABLE>
(1) Plus accrued interest, if any, from January 27, 1994 to the date of
delivery.
(2) The Company has agreed to indemnify the Underwriters against certain
liabilities, including liabilities under the Securities Act of 1933, as
amended. See "Underwriting."
(3) Before deducting expenses payable by Orchard Supply estimated at $500,000.
------------
The Notes offered by this Prospectus are offered by the Underwriters subject
to prior sale, withdrawal, cancellation or modification of the offer without
notice, to delivery to and acceptance by the Underwriters and to certain
further conditions. It is expected that delivery of the Notes will be made at
the offices of Lehman Brothers Inc., New York, New York, on or about January
27, 1994.
------------
LEHMAN BROTHERS
JEFFERIES & COMPANY, INC.
MONTGOMERY SECURITIES
January 20, 1994
<PAGE>
[COMPANY LOGO]
[MAP OF CALIFORNIA] [PHOTO 1]
Existing Stores, Store located in Salinas,
Distribution Center and California.
Expected 1994 Store
Openings
[PHOTO 2]
Quick and easy check
out.
[PHOTO 4] [PHOTO 3]
Extensive selection of Orchard offers a broad range
striking tools and of quality plants, shrubs
replacement handles. and bedding plants.
IN CONNECTION WITH THIS OFFERING, THE UNDERWRITERS MAY OVER-ALLOT OR EFFECT
TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICE OF THE NOTES OFFERED
HEREBY AT LEVELS ABOVE THOSE WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN MARKET.
SUCH STABILIZING, IF COMMENCED, MAY BE DISCONTINUED AT ANY TIME.
2
<PAGE>
PROSPECTUS SUMMARY
The following summary is qualified in its entirety by the more detailed
information and financial statements (including the Notes thereto) appearing
elsewhere in this Prospectus. As used in this Prospectus, the term "Orchard
Holding" refers to Orchard Supply Hardware Stores Corporation, a Delaware
corporation, the term "Orchard Supply" refers to its wholly owned subsidiary,
Orchard Supply Hardware Corporation, a Delaware corporation, and unless the
context indicates otherwise, the terms "Company" and "Orchard" refer to Orchard
Holding and Orchard Supply and its predecessor company. Unless otherwise
indicated, as used in this Prospectus all references to a fiscal year shall
mean the fiscal year of the Company which commences in such year (for example,
the fiscal year commencing January 27, 1992 and ending January 31, 1993 is
referred to herein as fiscal 1992).
THE COMPANY
Orchard, founded in 1931, operates 43 hardware superstores which average
approximately 40,000 square feet of interior and exterior selling space. All of
the Company's current stores are located in Northern and Central California.
Orchard primarily targets the "fix-it" homeowner focused on repair and
maintenance projects and is positioned in a unique niche between small, high-
priced independent hardware retailers and large warehouse home center chains.
Orchard strives to offer the service and convenience of a "mom and pop"
hardware store and a greater depth and breadth of "fix-it" products in its core
product categories than the large warehouse home center chains.
Orchard's business strategy is to provide a broad merchandise selection,
outstanding service, convenient, well organized stores and fair everyday
pricing, thereby encouraging its customers to perceive Orchard as the primary
destination for their "fix-it" needs.
Broad Selection. Orchard offers a wide selection of brand name and private
label merchandise, including many products not carried by its competitors, in
its core areas of hardware, plumbing, electrical and garden and nursery.
Orchard's stores carry approximately 45,000 stock keeping units ("SKUs") and
maintain a high in stock position (98% on average) to ensure the availability
of its merchandise to customers. This breadth of selection contrasts with the
Company's warehouse competitors, which typically carry only 25,000 to 33,000
SKUs.
High Levels of Customer Service. The Company is committed to furnishing
outstanding levels of customer service through knowledgeable, well trained
personnel and a number of value-added services. These services include pick-up
stations at each location, a proprietary credit card and "how-to" fairs.
Convenient, Well Organized Stores. Orchard currently operates 43 conveniently
located stores. Orchard stores have low profile shelving, descriptive signs and
efficient check-out stations which provide customers an attractive shopping
environment and the ability to get in and out of the store quickly. The
Company's stores follow a standard merchandise layout and maintain a consistent
appearance.
Value Pricing. The Company provides the customer with value through a
combination of broad merchandise selection, outstanding service, convenient,
well organized stores and fair everyday pricing. Fair everyday pricing entails
competitive pricing on high visibility, high volume products and higher margins
on other products which in many cases are not carried by competitors.
Consistent with the Company's expansion strategy to increase market share in
existing markets and to open stores in attractive new markets, the Company
announced on November 9, 1993 its intent to acquire nine former Builders
Emporium store sites (the "Expansion"). The Company completed the acquisition
of
3
<PAGE>
six of these sites (Pasadena, Burbank, Van Nuys and Hollywood in metropolitan
Los Angeles, and Pismo Beach and Redding in Central and Northern California,
respectively) on November 16, 1993 and completed the acquisition of the
remaining three sites (South Pasadena and West Los Angeles in metropolitan Los
Angeles and Goleta in Central California) on December 22, 1993. All nine
Expansion stores will be converted into the Orchard format and are expected to
open in the second quarter of fiscal 1994. The Expansion store sites are proven
retail hardware locations and include seven of the top eight sales volume
stores in the Builders Emporium chain. The Company plans to finance the
Expansion from a portion of the estimated net proceeds from the Offering. See
"Investment Considerations--Expansion Program," "Use of Proceeds" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
Building on its current 43 store base, the Company intends to open 14 stores
in fiscal 1994, including the nine Expansion stores, six of which will be
located in metropolitan Los Angeles. The remaining five new stores for fiscal
1994 will be located in Northern and Central California. Management believes
that the metropolitan Los Angeles market, one of the largest do-it-yourself
("DIY") markets in the United States, presents an attractive opportunity for
the broad selection, high service Orchard format, particularly in light of the
recent liquidation of the Builders Emporium chain which operated approximately
40 DIY stores in metropolitan Los Angeles. In fiscal 1995, the Company plans to
open five to ten new stores, the majority of which are expected to be in
metropolitan Los Angeles. The Company believes it has the potential to expand
to a total of 70 stores in Northern and Central California and 45 stores in
metropolitan Los Angeles and Orange County.
THE EQUITY INVESTMENT
In order to improve the Company's capital structure and to enhance its
financial flexibility, Orchard Holding has entered into an agreement (the
"Preferred Stock Agreement") to sell 800,000 shares of 6% Cumulative
Convertible Preferred Stock, $.01 par value per share (the "Preferred Stock"),
with an aggregate liquidation preference of $20.0 million (the "Preferred Stock
Offering") to an affiliate of Freeman Spogli & Co. ("FS&Co."). The Preferred
Stock Agreement contains certain customary conditions to closing which will be
eliminated upon the closing of the Offering, at which time the purchase of the
Preferred Stock will become unconditional. The aggregate net proceeds of $19.3
million will be contributed as common equity to Orchard Supply to fund the
redemption of Orchard Supply's outstanding 14.5% Senior Subordinated Discount
Notes (the "14.5% Subordinated Notes") at their stated redemption price of
107.25% of the principal amount thereof. The purchase of the Preferred Stock
will be consummated not later than the time the proceeds are needed to fund the
redemption of the 14.5% Subordinated Notes. After giving effect to the
Preferred Stock Offering, FS&Co. through its affiliates will own approximately
48.4% of the outstanding Common Stock (assuming full conversion of the
Preferred Stock). See "Certain Transactions" and "Description of Capital
Stock--Preferred Stock."
BACKGROUND
The Company is the successor to the Orchard Supply Hardware division ("OSH"
or the "Predecessor Company") of Wickes Companies, Inc. ("Wickes"). The Company
acquired certain assets and liabilities of the Predecessor Company in May 1989
in a transaction (the "1989 Transaction") organized by FS&Co. The Company
completed its initial public offering of 3,800,000 shares of Common Stock (the
"Initial Public Offering") in April 1993 and immediately thereafter
reclassified its Series A Preferred Stock, $.01 par value per share (the
"Series A Preferred Stock"), into Common Stock (the "Reclassification"). In
November 1993, in connection with the Expansion, Orchard Supply increased its
borrowing capacity under its revolving credit facility (the "Financing
Agreement") to $40.0 million from $20.0 million to finance the purchase of the
nine Expansion store sites. The Company intends to reduce its credit line to
$20.0 million following the application of the proceeds of this Offering.
4
<PAGE>
THE OFFERING
Securities Offered...... $100.0 million principal amount of 9 3/8% Senior
Notes due 2002.
Interest Payment Dates.. February 15 and August 15, commencing Au-
gust 15, 1994.
Maturity Date........... February 15, 2002.
Sinking Fund............ None.
Optional Redemption..... The Notes will be redeemable at the option of Orchard
Supply, in whole or in part, on or after Februar-
y 15, 1998, at the redemption prices set forth here-
in, together with accrued and unpaid interest to the
redemption date. See "Description of Notes--Redemp-
tion."
Ranking................. The Notes will be senior unsecured obligations of Or-
chard Supply. The Notes will be senior to all subor-
dinated indebtedness of Orchard Supply and will rank
pari passu in right of payment with all senior in-
debtedness of Orchard Supply. As of October 31, 1993,
the aggregate amount of senior indebtedness of Or-
chard Supply, as adjusted to give effect to the ap-
plication of the estimated net proceeds from this Of-
fering, would have been approximately $139.7 million.
Parent Guarantee........ The Notes will be unconditionally guaranteed on a se-
nior unsecured basis by Orchard Holding.
Change of Control....... Upon the occurrence of a Change of Control (as de-
fined herein), each holder of the Notes will have the
option to cause Orchard Supply to repurchase such
holder's Notes, in whole or in part, at 101% of the
principal amount thereof, plus accrued interest to
the date of repurchase. There can be no assurance
that Orchard Supply would have sufficient funds to
satisfy its obligations to repurchase Notes upon a
Change of Control. See "Investment Considerations--
Exercise of Change of Control Rights" and "Descrip-
tion of Notes--Certain Covenants of Orchard Supply--
Repurchase of Notes Upon Change of Control."
Certain Covenants....... The Indenture under which the Notes will be issued
will contain certain restrictive covenants that,
among other things, will limit the ability of Orchard
Supply to incur additional Indebtedness (as defined
herein), create liens, issue preferred stock of sub-
sidiaries, pay dividends, repurchase capital stock,
make certain other Restricted Payments (as defined
herein), engage in transactions with affiliates, sell
assets, engage in sale and leaseback transactions and
engage in mergers or consolidations. See "Description
of Notes--Certain Covenants of Orchard Supply."
Use of Proceeds......... Orchard Supply will use the estimated net proceeds
from the issuance of the Notes as follows: (i) ap-
proximately $30.9 million to retire Orchard Supply's
9% senior notes due 1997 (the "Old Senior Notes") at
their stated redemption price of 103.0% of the prin-
cipal amount thereof, (ii) $20.0 million to repay ad-
ditional borrowings under the Financing Agreement
used to finance the Expansion, (iii) $35.0 million to
fund additional investments required to open the nine
Expansion stores and (iv) the remainder for general
corporate purposes. See "Use of Proceeds."
5
<PAGE>
SUMMARY CONSOLIDATED FINANCIAL INFORMATION
The summary consolidated historical financial information presented below
should be read in conjunction with the Consolidated Financial Statements and
Condensed Consolidated Financial Statements of the Company and related Notes
thereto, "Capitalization," "Selected Consolidated Financial Data" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" included elsewhere in this Prospectus.
<TABLE>
<CAPTION>
PREDECESSOR COMPANY THE COMPANY(1)
----------------------- ------------------------------------------------------------------------
FOUR MONTHS EIGHT MONTHS YEAR ENDED NINE MONTHS ENDED
YEAR ENDED ENDED ENDED ----------------------------------- -----------------------
JANUARY 28, MAY 27, JANUARY 28, JANUARY 27, JANUARY 26, JANUARY 31, OCTOBER 25, OCTOBER 31,
1989 1989 1990 1991 1992 1993 1992 1993
(52 WEEKS) (17 WEEKS) (35 WEEKS) (52 WEEKS) (52 WEEKS) (53 WEEKS) (39 WEEKS) (39 WEEKS)
----------- ----------- ------------ ----------- ----------- ----------- ----------- -----------
(IN THOUSANDS, EXCEPT STORE DATA) (UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Sales.................. $255,541 $ 91,757 $194,759 $299,924 $308,562 $346,158 $259,365 $280,455
Gross margin(2)(3)..... 89,418 31,446 52,834 108,109 109,510 121,559 90,034 99,826
Operating expenses(2).. 74,223 25,261 57,411 88,444 91,296 99,944 72,562 79,022
Pre-opening expenses... 559 177 869 579 1,192 924 910 1,713
Operating income
(loss)................ 14,636 6,008 (5,446) 19,086 17,022 20,691 16,562 19,091
Interest expense(4).... 310 99 10,658 15,160 14,773 16,725 12,376 9,096
Write-off of deferred
financing charges..... -- -- 2,157 -- -- -- -- --
Income (loss) before
provision for income
taxes................. 14,326 5,909 (18,261) 3,926 2,249 1,959 2,179 9,995
Income (loss) before
extraordinary
items(5).............. 8,350 3,462 (18,261) 2,259 1,278 1,093 1,245 9,995
Extraordinary items(5). -- -- -- 1,667 971 (200) 934 (5,363)
Net income (loss)...... 8,350 3,462 (18,261) 3,926 2,249 893 2,179 4,632
Preferred stock
dividends(6).......... -- -- 1,780 3,046 3,446 4,208 3,031 814
Net income (loss)
available to common
stock................. $ 8,350 $ 3,462 $(20,041) $ 880 $ (1,197) $ (3,315) $ (852) $ 3,818
OTHER DATA:
EBITDA(7).............. $ 19,769 $ 7,733 $ (1,276) $ 25,371 $ 23,115 $ 26,731 $ 21,123 $ 23,648
Depreciation and
amortization(8)....... 5,133 1,725 4,757 7,153 6,998 7,080 5,383 5,062
Capital
expenditures(9)....... 4,890 2,535 2,722 10,999 19,675 4,318 2,466 7,704
Comparable store sales
growth................ 2.9% 5.2% 8.8% 1.9% (1.3)% 5.3% 4.6% 3.2%
Number of stores (at
end of period)........ 30 31 33 34 37 39 39 43
Ratio of EBITDA to cash
interest
expense(7)(10)........ 63.8x 78.1x -- 2.2x 2.2x 1.9x 2.1x 2.8x
Ratio of EBITDA to cash
interest expense and
preferred stock
dividends(6)(7)(10)... 63.8x 78.1x -- 1.7x 1.6x 1.5x 1.6x 2.5x
BALANCE SHEET DATA:
Working capital........ $ 35,867 $ 35,082 $ 32,227 $ 34,090 $ 44,649 $ 52,274 $ 54,359 $ 56,282
Total assets........... 149,921 153,242 165,215 175,549 198,463 197,996 199,825 207,757
Long-term debt and
capital leases........ 2,783 2,684 109,056 111,648 125,892 130,374 130,855 85,173
Stockholders' equity... 112,816 112,940 7,499 11,432 13,628 14,848 15,791 65,632
</TABLE>
(See Notes on following page)
6
<PAGE>
NOTES TO SUMMARY CONSOLIDATED FINANCIAL INFORMATION
(1) On May 27, 1989, the Company acquired substantially all of the assets and
assumed certain liabilities of the Predecessor Company from Wickes in the
1989 Transaction which was accounted for as a purchase transaction.
(2) The Predecessor Company incurred certain expenses for legal services,
audit and tax services and employee benefits administration which were
paid by Wickes prior to the 1989 Transaction. In addition, increases in
real estate taxes and insurance expenses have occurred as a result of the
1989 Transaction. These expenses, which are estimated by management to be
approximately $0.6 million annually, are not reflected in the historical
financial information prior to May 27, 1989 set forth herein, but are
included in the historical financial statements for subsequent periods.
Operating results for all periods subsequent to the 1989 Transaction
include charges associated with the purchase accounting adjustments
recorded as a result of the 1989 Transaction. These charges include the
amortization of goodwill and other intangible assets, the income effect
related to the initial carrying value of inventories and increased
depreciation resulting from the adjustment of the carrying values of
depreciable property to estimated fair values at the acquisition dates.
(3) In the 1989 Transaction, the Company allocated the purchase price of the
acquired assets and liabilities to reflect their relative fair market
values. In connection with the allocation, the Company valued its
inventories at amounts equal to selling prices less a reasonable profit
allowance for selling efforts, which resulted in an inventory valuation
which exceeded the pre-acquisition basis in the Company's inventory by
$16.7 million. The carrying amount of inventory as of the acquisition date
has been charged to cost of goods sold during the eight-month period ended
January 28, 1990.
(4) Data includes non-cash amortization of deferred financing costs and
original issue discount related to debt incurred in the 1989 Transaction
and subsequent refinancings.
(5) Extraordinary items include: (i) the loss on extinguishment of debt
resulting from the premium paid for the partial redemption of the 14.5%
Subordinated Notes at 109.06% of the principal amount thereof and the
write-off of deferred financing costs in connection therewith pursuant to
the Initial Public Offering, (ii) the loss on extinguishment of debt
resulting from the write-off of deferred financing costs in connection
with the refinancing in fiscal 1992 of the indebtedness incurred pursuant
to the Company's senior credit facility and (iii) the realization of
income tax benefits from net operating loss carryforwards.
(6) Preferred stock dividends reflect dividends earned on the Series A
Preferred Stock prior to the Reclassification which occurred in April
1993. Prior to April 1993, no preferred stock dividends had been declared.
In April 1993, all previously earned dividends were declared and paid. The
payment consisted of a cash payment of $2.5 million and the settlement of
the remaining dividends through the issuance of additional shares of
Series A Preferred Stock. The shares of Series A Preferred Stock were then
converted into shares of Common Stock pursuant to the Reclassification. In
addition, preferred stock dividend requirements of $1.2 million annually
will be applicable upon the consummation of the Preferred Stock Offering.
(7) EBITDA represents net income before taking into consideration interest
expense, income tax expense, extraordinary items, the write-down in
carrying value of assets held for disposal, depreciation and amortization
expense. EBITDA is presented as an alternative measure of the Company's
financial condition. This data is not intended to be substituted for net
income as a measure of the Company's profitability.
(8) Data includes non-cash amortization of deferred financing costs related to
debt incurred in the 1989 Transaction and subsequent refinancings.
(9) Amounts for the years ended January 27, 1991 and January 26, 1992 include
capital expenditures for the new warehouse facility of $5.1 million and
$14.3 million, respectively.
(10) Cash interest expense excludes non-cash amortization of deferred financing
costs and original issue discount in the amounts of $1.8 million, $3.6
million, $4.1 million, $2.7 million, $2.5 million and $0.6 million for the
eight month period ended January 28, 1990, the year ended January 27,
1991, the year ended January 26, 1992, the year ended January 31, 1993,
the nine month period ended October 25, 1992 and the nine month period
ended October 31, 1993, respectively.
7
<PAGE>
SUMMARY UNAUDITED PRO FORMA FINANCIAL DATA
The following summary unaudited pro forma financial data has been derived
from and should be read in conjunction with the Unaudited Pro Forma Financial
Data included elsewhere in this Prospectus and has been prepared by the Company
based on certain adjustments to the Consolidated Financial Statements of the
Company which are included elsewhere in this Prospectus. The pro forma amounts
reflect adjustments for the Initial Public Offering, the Reclassification, the
Preferred Stock Offering and the Offering as if such transactions had occurred
as of the beginning of the period presented for income statement data and other
data and as of October 31, 1993 (with the exception of the Initial Public
Offering and Reclassification which occurred on April 6, 1993) for balance
sheet data.
The pro forma financial data does not purport to present the financial
position and results of operations of the Company had the Initial Public
Offering, the Reclassification, the Preferred Stock Offering and the Offering
and the application of the net proceeds therefrom actually occurred as of such
dates, nor is it necessarily indicative of the results of operations that may
be achieved in the future. The pro forma amounts presented do not reflect the
anticipated operating results of the Expansion stores.
<TABLE>
<CAPTION>
YEAR NINE MONTHS
ENDED ENDED
JANUARY 31, OCTOBER 31,
1993 1993
----------- -------------
(IN THOUSANDS)
<S> <C> <C>
INCOME STATEMENT DATA:
Sales............................................... $346,158 $ 280,455
Gross margin........................................ 121,559 99,826
Operating expenses.................................. 99,944 79,022
Pre-opening expenses................................ 924 1,713
Operating income.................................... 20,691 19,091
Write-down in carrying amount of asset held for
disposal........................................... 2,007 --
Interest expense(1)................................. 14,490 10,573
Income before provision for income taxes(2)......... 4,194 8,518
Income before extraordinary items(3)................ 2,432 8,518
Preferred stock dividends(4)........................ 1,200 900
Income before extraordinary items available to
common stock(3).................................... 1,232 7,618
OTHER DATA:
EBITDA(5)........................................... $ 26,731 $ 23,648
Ratio of EBITDA to cash interest expense(6)......... 1.9x
Ratio of EBITDA to cash interest expense and
preferred stock dividends(6)....................... 1.8x
- -----------
- -
Ratio of LTM EBITDA to LTM cash interest expense(6). 2.1x
Ratio of LTM EBITDA to LTM cash interest expense and
preferred stock dividends(6)....................... 2.0x
<CAPTION>
OCTOBER 31,
1993
-------------
<S> <C> <C>
BALANCE SHEET DATA: (IN THOUSANDS)
Working capital(7).................................. $ 102,102
Total assets(8)..................................... 274,846
Long-term debt and capital leases(9)................ 137,100
Stockholders' equity(10)............................ 80,794
</TABLE>
(See Notes on following page)
8
<PAGE>
NOTES TO SUMMARY UNAUDITED PRO FORMA FINANCIAL DATA
(1) The unaudited pro forma financial data reflects: (i) a decrease in
interest expense which results from the application of the net proceeds of
the Initial Public Offering to redeem approximately $44.7 million
aggregate principal amount of 14.5% Subordinated Notes which offset an
increase in interest resulting from the borrowings under the Financing
Agreement to finance the $2.5 million cash dividend on the Series A
Preferred Stock; (ii) the reduced interest expense resulting from the
application of the net proceeds from the Preferred Stock Offering to
redeem the remaining $19.3 million principal amount of the 14.5%
Subordinated Notes; (iii) the increased interest costs resulting from the
Notes; (iv) the increased interest expense associated with the $1.0 million
mortgage debt assumed pursuant to the Expansion; and (v) the reduced
interest costs resulting from the use of a portion of the proceeds from the
Offering to retire the Old Senior Notes.
(2) As of February 1, 1993, the Company adopted SFAS 109. If SFAS 109 had been
adopted retroactively, the income tax provision for the year ended January
31, 1993 would have been zero due to the effective tax rate of zero
applicable to the Company. Such rate reflects available net operating loss
carry forwards for which a valuation allowance exists.
(3) Extraordinary items include: (i) the loss on extinguishment of debt
resulting from the premiums paid or to be paid for the redemptions of the
14.5% Subordinated Notes and the Old Senior Notes, (ii) the loss on
extinguishment of debt resulting from the write-off of deferred financing
costs in connection with the redemptions of the 14.5% Subordinated Notes
and the Old Senior Notes, the reduction in the credit facility under the
Financing Agreement and the refinancing in fiscal 1992 of the revolving
credit agreement and (iii) the realization of income tax benefits from net
operating loss carryforwards in fiscal 1992. The redemption of the 14.5%
Subordinated Notes is assumed to have occurred with the call premium
amounts actually paid or payable (9.06% on the principal amount of $44.7
million and 7.25% on the remaining principal amount of $19.3 million). Had
the amounts actually been redeemed at the beginning of the periods
presented, the call premiums would have been the contractually specified
amounts on the applicable dates.
(4) Pro forma adjustments reflect the elimination of the earned dividends on
the Series A Preferred Stock offset by dividends earned on the Preferred
Stock.
(5) EBITDA represents net income before taking into consideration interest
expense, income tax expense, extraordinary items, the write-down in
carrying value of assets held for disposal, depreciation and amortization
expense. EBITDA is presented as an alternative measure of the Company's
financial condition. This data is not intended to be substituted for net
income as a measure of the Company's profitability.
(6) Pro forma cash interest expense excludes non-cash amortization of deferred
financing costs in the amount of $0.7 million and $0.7 million for the
year ended January 31, 1993 and the 12 months ("LTM") ended October 31,
1993.
(7) Pro forma amounts reflect (i) the use of internal cash available of $1.5
million to pay the call premium of $1.4 million and a portion of the
transaction-related costs, and (ii) the estimated cash remaining after the
application of proceeds as described in "Use of Proceeds."
(8) Pro forma amounts reflect the items discussed in Note 7 above, as well as
(i) the write-off of deferred financing costs totaling $0.5 million due to
the redemption of the remaining $19.3 million principal amount of the
14.5% Subordinated Notes, (ii) the acquisition of the store sites pursuant
to the Expansion at a purchase price of $19.7 million, (iii) the addition
of estimated deferred financing costs totaling $3.0 million related to the
Notes, and (iv) the write-off of deferred financing costs totaling $0.9
million due to the retirement of the Old Senior Notes.
(9) Reflects the revised capitalization arising from the Preferred Stock
Offering and the Offering--see "Capitalization."
(10) Reflects the net proceeds of $19.3 million from the Preferred Stock
Offering partially offset by extraordinary charges of $4.1 million. See
Note 3 above.
9
<PAGE>
INVESTMENT CONSIDERATIONS
Prospective investors should consider carefully, in addition to other
information contained in this Prospectus, the following factors before
purchasing the Notes offered hereby.
EXPANSION PROGRAM
The Company currently operates 43 hardware superstores located in Northern
and Central California. The Company has acquired nine former Builders Emporium
store sites, including six in metropolitan Los Angeles, with planned openings
in the spring of 1994. The Company expects to open five additional stores in
Northern and Central California during fiscal 1994 and an additional five to
ten stores, mostly in metropolitan Los Angeles, in fiscal 1995. This compares
to four store openings completed by the Company in fiscal 1993.
The Company's ability to execute its expansion plans will depend to a great
extent on the Company's ability to obtain acceptable store sites and open them
on a timely basis. The Company may encounter substantial delays, increased
expenses or loss of potential sites due to the complexities associated with the
regulatory and permitting processes involved in opening retail stores. The
Company's expansion will further depend on its ability to obtain financing, to
complete tenant improvements in a timely manner, to hire and train competent
store managers and staff and to integrate these employees and new stores into
its overall systems and operations. The Company's future sales and earnings may
be adversely affected if it is unable to execute its store opening program.
The Company believes that the Expansion and its entry into metropolitan Los
Angeles, one of the largest DIY markets in the United States, presents an
attractive growth opportunity. However, the success of the Company's expansion
into this new market area will depend to a significant degree on its ability to
achieve name recognition in a large and complex market and to reach acceptable
sales volumes in its new stores to recover higher than average start-up,
marketing and distribution costs. The Company anticipates that it will incur
for each of the six metropolitan Los Angeles Expansion stores pre-opening
expenses of approximately $850,000. The Company expects that for its subsequent
metropolitan Los Angeles stores, pre-opening expenses will average
approximately $600,000 (compared to $450,000 in its Northern and Central
California markets). The Los Angeles media market is more expensive than
Northern and Central California, and Orchard will initially lack the store
concentration it enjoys in its existing markets. Accordingly, the Company
expects to incur substantially higher marketing costs per store, and there can
be no assurance that the Company will be able to reduce these costs over time.
In addition, metropolitan Los Angeles is approximately 350 miles from the
Company's Tracy, California distribution center, which will result in higher
transportation costs, and there can be no assurance that the Company will
achieve the number of stores in this area necessary to support a local
distribution center.
To achieve the desired economies in distribution and advertising and to
establish critical market presence, the Company believes it is necessary to
open more stores in metropolitan Los Angeles in addition to the six Expansion
stores. Due to the high density and level of commercial development prevalent
in metropolitan Los Angeles, the Company may experience difficulties in
identifying suitable locations at acceptable prices which may delay the
Company's store opening program. Moreover, the metropolitan Los Angeles market
is large and complex and there can be no assurance that these new stores will
be profitable, or as to their level of profitability.
As the Company accelerates its store opening program, it will incur
additional pre-opening costs as well as higher operating costs as a percentage
of sales in its new stores, thereby adversely affecting overall margins until
the new stores achieve sales maturity. This effect will initially be magnified
due to the additional operating costs in its Expansion stores. Orchard's stores
typically have an operating loss in the fiscal year in which they commence
operations, due primarily to the stores' pre-opening expenses. In the
subsequent fiscal year, a new store is generally profitable before allocation
of overhead expenses not directly related to the
10
<PAGE>
store. While this has been the Company's historical experience, no assurance
can be given that similar store level profitability will be achieved in
connection with future new stores. Sales in an existing store may be adversely
affected by the opening of a new Orchard store within the same market; however,
these new stores are intended to increase overall market penetration and
customer convenience.
See "Management's Discussion and Analysis of Financial Condition and Results
of Operations" and "Business--Expansion Strategy."
COMPETITION
The retail hardware business is highly competitive, and some of the Company's
competitors have substantially greater resources than the Company. The Company
competes with numerous warehouse home center chains, traditional home
improvement centers and local independent retailers. Management believes that
the warehouse home center chains, including HomeBase (formerly Home Club, Inc.)
and The Home Depot, Inc. ("Home Depot"), are its primary competitors. Since
1984, when the first warehouse home center was opened in Orchard's markets,
HomeBase and Home Depot have opened and currently operate 12 and 21 stores,
respectively, in the Company's Northern and Central California markets. As of
October 31, 1993, the Company estimates that 32 Orchard stores competed with
warehouse operators. Management believes that the competitive situation in
metropolitan Los Angeles is substantially similar to the highly competitive
environment of Orchard's existing Northern and Central California markets.
Management believes that HomeBase and Home Depot currently operate
approximately 12 and 17 stores, respectively, in metropolitan Los Angeles and
that three of the six metropolitan Los Angeles Expansion stores will be in
direct competition with two HomeBase stores and two Home Depot stores. See
"Business--Competition."
SEASONALITY AND SENSITIVITY TO WEATHER
The Company's results of operations exhibit some degree of seasonality.
During the three years ended January 31, 1993, approximately 28% of the
Company's annual sales and approximately 37% to 43% of its annual operating
income were generated in the second fiscal quarter. This is due primarily to
increased sales during this quarter of garden, nursery and related products.
Sales in the second quarter of the fiscal year generate a substantial
percentage of the Company's annual operating income; therefore, any adverse
impact on second quarter sales and profitability has a disproportionate effect
on the Company's financial results for that year. Conversely, during the three
years ended January 31, 1993, approximately 24% of the Company's annual sales
and approximately 13% to 18% of its annual operating income were generated in
the fourth fiscal quarter, due primarily to lower sales of garden, nursery and
related products during this quarter. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations" and Note 12 to Consolidated
Financial Statements for certain quarterly financial information.
Sales of garden and nursery products, which comprised 26.6% of the Company's
total sales in fiscal 1992, can be negatively impacted by adverse weather
conditions, particularly during the spring gardening season. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations--
Results of Operations."
COMPARABLE STORE SALES
The Company's historical comparable store sales have been affected by a
variety of factors, including consumer confidence, promotional marketing
efforts, the maturation of new stores, weather conditions and the opening of
competing stores. In fiscal 1990, comparable store sales increased by only 1.9%
and in fiscal 1991, comparable store sales decreased by 1.3%. Although
comparable store sales increased by 5.3% for fiscal 1992 and by 3.2% through
the third quarter of fiscal 1993, there can be no assurance that the Company
will achieve similar increases in the future. Competing store openings, current
economic conditions and comparison to last year's fourth quarter which
experienced a strong 7.9% comparable store sales gain are expected to have a
negative impact on fourth quarter 1993 comparable store sales. See "Selected
Consolidated
11
<PAGE>
Financial Data" and "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Results of Operations."
REGIONAL ECONOMY
The economy in California as a whole is suffering from the effects of a
prolonged recession. Areas of Southern California, including metropolitan Los
Angeles, have been especially hard hit by the recession. If the current
weakness in California's economy continues or increases, there may be an
adverse impact on the Company's sales and profitability and the ability of the
Company to expand at the planned rate.
LEVERAGE AND CERTAIN RESTRICTIONS IMPOSED BY LENDERS
The Company is, and after the completion of the Offering will continue to be,
highly leveraged. After giving effect to the Preferred Stock Offering, the
Offering and the application of the estimated net proceeds therefrom, as of
October 31, 1993, the Company's ratio of long-term debt to stockholders' equity
would have been approximately 1.7:1 and the Company's long-term debt as a
percentage of total capitalization would have been 63%. See "Capitalization."
The Company's operating results have been and will continue to be impacted by
significant fixed charges related to its indebtedness and dividends with
respect to its preferred stock. The debt instruments of Orchard Supply contain
financial and operating covenants including, among other things, requirements
that the Company maintain certain financial ratios and satisfy certain
financial tests and limitations on the Company's ability to make capital
expenditures, to incur other indebtedness and to pay dividends. If the Company
fails to comply with the various covenants, the lenders will be able to either
accelerate the maturity of or cause the Company to repurchase the applicable
indebtedness. See "Terms of Continuing Debt Instruments."
The degree to which the Company is leveraged and the terms governing Orchard
Supply's indebtedness, including restrictive covenants and events of default,
could have important consequences to holders of the Notes, including the
following: (i) a substantial portion of the Company's cash flow from operations
must be dedicated to service its indebtedness; (ii) the Company may be more
leveraged than other providers of similar products and services, which may
place the Company at a competitive disadvantage; and (iii) the Company's
leverage could make it more vulnerable to changes in general economic
conditions. Assuming that the Company successfully completes the Preferred
Stock Offering and the Offering, the Company believes that funds from
operations, together with borrowings under the Financing Agreement and
financings through operating leases, will be adequate to fund the Company's
operating requirements and capital expenditure program and meet its debt and
dividend obligations through at least fiscal 2000. However, unexpected declines
in the Company's future business, increases in interest rates, or the inability
to borrow additional funds for its operations if and when required could impair
the Company's ability to meet its debt service obligations and, therefore,
could have a materially adverse effect on the Company's business and future
prospects. No assurance can be given that additional debt or equity funds would
be available if needed or, if available, on terms which are favorable to the
Company. See "Capitalization," "Unaudited Pro Forma Financial Data," "Selected
Consolidated Financial Data," "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Liquidity and Capital
Resources," "Description of Notes" and "Terms of Continuing Debt Instruments."
TRADING MARKET FOR NOTES
There is no existing market for the Notes. The Underwriters have advised the
Company that they currently intend to make a market in the Notes. However, they
are not obligated to do so, and any market making with respect to the Notes may
be discontinued at any time without notice. The Company does not intend to
apply for the listing of the Notes on any securities exchange. Accordingly,
there can be no assurance as to the liquidity of any markets that may develop
for the Notes, the ability of holders of the Notes to sell their Notes or the
price such holders would receive upon the sale of their Notes. If such a market
were to develop, the Notes could trade at prices that may be lower than the
initial offering price thereof, depending
12
<PAGE>
on many factors, including prevailing interest rates, the Company's operating
results and the market for similar debt securities.
CONTROL OF THE COMPANY
Orchard Supply is a wholly-owned subsidiary of Orchard Holding. Presently,
the Boards of Directors of Orchard Holding and Orchard Supply are identical,
and six of the eight members of each are affiliated with FS&Co. or management.
FS&Co. currently controls through affiliates the power to vote 38.9% (48.4% if
the proposed Preferred Stock is fully converted) of the outstanding shares of
Common Stock of the Company. As a result, FS&Co. may effectively control the
Company's management policy and financing decisions and may have the power to
elect the Board of Directors; however, all major corporate transactions
including certain mergers and acquisitions, sales of substantially all assets
of the Company or going private transactions require approval of a majority of
the Company's outstanding stock entitled to vote thereon (other than
transactions subject to Section 203 of the Delaware General Corporation Law).
FS&Co. does not control such stockholder approval. See "Management," "Principal
Stockholders" and "Description of Notes--Certain Covenants of Orchard Supply--
Limitations on Transactions with Affiliates."
EXERCISE OF CHANGE OF CONTROL RIGHTS
Upon the occurrence of a Change of Control, the holders of the Notes will
have the right to require Orchard Supply to offer to purchase the Notes at 101%
of their principal amount, together with all accrued and unpaid interest, if
any. A change of control would also trigger a repurchase right or default under
all of Orchard Supply's other indebtedness. If a change of control occurs,
Orchard Supply may not have sufficient resources to satisfy all of its
repayment and repurchase obligations resulting therefrom and, in such event,
the lenders will be able to accelerate the maturity of the applicable
indebtedness.
THE COMPANY
Orchard, founded in 1931, operates 43 hardware superstores which average
approximately 40,000 square feet of interior and exterior selling space. All of
the Company's current stores are located in Northern and Central California.
Orchard primarily targets the "fix-it" homeowner focused on repair and
maintenance projects and is positioned in a unique niche between small, high-
priced independent hardware retailers and large warehouse home center chains.
Orchard strives to offer the service and convenience of a "mom and pop"
hardware store and a greater depth and breadth of "fix-it" products in its core
product categories than the large warehouse home center chains.
Orchard's business strategy is to provide a broad merchandise selection,
outstanding service, convenient, well organized stores and fair everyday
pricing, thereby encouraging its customers to perceive Orchard as the primary
destination for their "fix-it" needs.
Broad Selection. Orchard offers a wide selection of brand name and private
label merchandise, including many products not carried by its competitors, in
its core areas of hardware, plumbing, electrical and garden and nursery.
Orchard's stores carry approximately 45,000 stock keeping units ("SKUs") and
maintain a high in stock position (98% on average) to ensure the availability
of its merchandise to customers. This breadth of selection contrasts with the
Company's warehouse competitors, which typically carry only 25,000 to 33,000
SKUs.
High Levels of Customer Service. The Company is committed to furnishing
outstanding levels of customer service through knowledgeable, well trained
personnel and a number of value-added services. These services include pick-up
stations at each location, a proprietary credit card and "how-to" fairs.
13
<PAGE>
Convenient, Well Organized Stores. Orchard currently operates 43 conveniently
located stores. Orchard stores have low profile shelving, descriptive signs and
efficient check-out stations which provide customers an attractive shopping
environment and the ability to get in and out of the store quickly. The
Company's stores follow a standard merchandise layout and maintain a consistent
appearance.
Value Pricing. The Company provides the customer with value through a
combination of broad merchandise selection, outstanding service, convenient,
well organized stores and fair everyday pricing. Fair everyday pricing entails
competitive pricing on high visibility, high volume products and higher margins
on other products which in many cases are not carried by competitors.
Consistent with the Company's expansion strategy to increase market share in
existing markets and to open stores in attractive new markets, the Company
announced on November 9, 1993 its intent to acquire nine former Builders
Emporium store sites. The Company completed the acquisition of six of these
sites (Pasadena, Burbank, Van Nuys and Hollywood in metropolitan Los Angeles,
and Pismo Beach and Redding in Central and Northern California, respectively)
on November 16, 1993 and completed the acquisition of the remaining three sites
(South Pasadena and West Los Angeles in metropolitan Los Angeles and Goleta in
Central California) on December 22, 1993. All nine Expansion stores will be
converted into the Orchard format and are expected to open in the second
quarter of fiscal 1994. The Expansion store sites are proven retail hardware
locations and include seven of the top eight sales volume stores in the
Builders Emporium chain. The Company plans to finance the Expansion from a
portion of the estimated net proceeds from the Offering. See "Investment
Considerations--Expansion Program," "Use of Proceeds" and "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
Building on its current 43 store base, the Company intends to open 14 stores
in fiscal 1994, including the nine Expansion stores, six of which are located
in metropolitan Los Angeles. The remaining five new stores for fiscal 1994 will
be located in Northern and Central California. Management believes that the
metropolitan Los Angeles market, one of the largest DIY markets in the United
States, presents an attractive opportunity for the broad selection, high
service Orchard format, particularly in light of the recent liquidation of the
Builders Emporium chain which operated approximately 40 DIY stores in
metropolitan Los Angeles. In fiscal 1995, the Company plans to open five to ten
new stores, the majority of which are expected to be in metropolitan Los
Angeles. The Company believes it has the potential to expand to a total of 70
stores in Northern and Central California and 45 stores in metropolitan Los
Angeles and Orange County.
The principal executive offices of Orchard Holding and Orchard Supply are
located at 6450 Via Del Oro, San Jose, California 95119 and the telephone
number is (408) 281-3500.
14
<PAGE>
USE OF PROCEEDS
The net proceeds to Orchard Supply from the Offering are estimated to be
approximately $97.0 million, after deducting the underwriting discounts and
estimated offering expenses. Orchard Supply will use the estimated net proceeds
of the Offering as follows: (i) $30.9 million to retire the Old Senior Notes at
their stated redemption price of 103.0% of the principal amount thereof, (ii)
$20.0 million to repay additional borrowings under the Financing Agreement used
to finance the Expansion, (iii) $35.0 million to fund additional investments
required to open the nine Expansion stores (consisting of capital expenditures
of approximately $10.0 million for renovation and $9.0 million for furniture,
fixtures and equipment; inventory of approximately $8.1 million (net of trade
credit); pre-opening expenses of approximately $6.8 million; and estimated
transaction costs relating to the Expansion of approximately $1.0 million) and
(iv) the remainder for general corporate purposes. The indenture pursuant to
which the Old Senior Notes were issued requires 30 days' notice to redeem the
Old Senior Notes; therefore, the Old Senior Notes will be called for redemption
promptly following the closing of the Offering and will be redeemed 30 days
thereafter. The Old Senior Notes bear interest at the rate of 9.0% per annum,
payable semi-annually, and have a final maturity date of July 1, 1997. The
Financing Agreement provides for a total credit facility of up to $40.0
million, with an $8.0 million sublimit for guarantees of letters of credit.
Amounts outstanding under the Financing Agreement bear interest, at the
election of the Company, at a defined prime rate plus 1.0% or at a defined
London Interbank Offered Rate plus 3.25%. See "Unaudited Pro Forma Financial
Data," "Management's Discussion and Analysis of Financial Condition and Results
of Operations--Liquidity and Capital Resources" and "Terms of Continuing Debt
Instruments--Description of the Financing Agreement."
15
<PAGE>
CAPITALIZATION
The following table sets forth the consolidated short-term debt and
capitalization of the Company as of October 31, 1993. The as adjusted for
Preferred Stock amounts reflect the anticipated sale of 800,000 shares of
Preferred Stock and the redemption of the 14.5% Subordinated Notes with the
proceeds therefrom. The pro forma as adjusted amounts reflect (i) the items set
forth in the as adjusted for Preferred Stock column and (ii) the sale of the
Notes pursuant to the Offering in the principal amount of $100.0 million and
the application of the estimated net proceeds therefrom as described in "Use of
Proceeds" and the assumption of mortgage debt of $1.0 million in the Expansion.
See "Unaudited Pro Forma Financial Data."
<TABLE>
<CAPTION>
OCTOBER 31, 1993
-------------------------------
AS ADJUSTED
FOR PRO FORMA
PREFERRED AS
ACTUAL STOCK ADJUSTED
-------- ----------- ---------
(IN THOUSANDS)
<S> <C> <C> <C>
Short-term debt(1):
Current portion of capitalized leases and
long-term debt.............................. $ 748 $ 748 $ 748
Notes payable................................ 1,872 1,872 1,872
-------- -------- --------
Total short-term debt...................... $ 2,620 $ 2,620 $ 2,620
======== ======== ========
Long-term debt:
9 3/8% senior notes due 2002................. $ -- $ -- $100,000
Mortgage financing(2)........................ 34,542 34,542 35,535
9% senior notes due 1997..................... 29,744 29,744 --
14.5% subordinated notes due 1999............ 19,322 -- --
Obligations under capitalized leases......... 1,565 1,565 1,565
-------- -------- --------
Total long-term debt....................... 85,173 65,851 137,100
-------- -------- --------
Stockholders' equity:
Preferred Stock $.01 par value; liquidation
preference of $25.00 per share: 2,000,000
shares authorized, no shares issued and out-
standing actual; 800,000 shares issued and
outstanding, as adjusted for Preferred Stock
and pro forma as adjusted(3)................ -- 20,000 20,000
Common Stock $.01 par value: 8,000,000 shares
authorized, 6,933,693 shares issued,
6,929,973 shares outstanding(4)............. 69 69 69
Additional paid-in capital(5)................ 72,299 71,549 71,549
Less: notes receivable from sale of capital
stock....................................... (175) (175) (175)
Accumulated deficit(6)....................... (6,561) (8,479) (10,649)
-------- -------- --------
Total stockholders' equity................. 65,632 82,964 80,794
-------- -------- --------
Total capitalization..................... $150,805 $148,815 $217,894
======== ======== ========
</TABLE>
(See Notes on following page)
16
<PAGE>
NOTES TO CAPITALIZATION
(1) At October 31, 1993, no borrowings were outstanding under the Financing
Agreement. Effective November 15, 1993, the Company amended the Financing
Agreement to provide for an additional $20.0 million in borrowings and
immediately borrowed all of the additional $20.0 million for the Expansion.
The $20.0 million is assumed to be repaid with a portion of the estimated
net proceeds from the Offering, and, following the repayment, the Company
intends to reduce its credit line to $20.0 million.
(2) See "Terms of Continuing Debt Instruments" for a discussion of existing
mortgage financing.
(3) See "Description of Capital Stock" for a description of the Preferred
Stock. The Preferred Stock is carried at its liquidation preference of
$25.00 per share. See Note 5 below.
(4) Amounts do not include 160,506 shares issuable upon the exercise of stock
options as of November 29, 1993, 79,669 shares issuable upon the exercise
of outstanding warrants as of November 29, 1993 and shares which may be
issuable upon conversion of the Preferred Stock. See "Description of
Capital Stock--Preferred Stock."
(5) The as adjusted for Preferred Stock and pro forma as adjusted amounts
reflect the reduction in additional paid-in capital resulting from the
liquidation preference applicable to the Preferred Stock over the net
proceeds of the Preferred Stock Offering.
(6) The as adjusted for Preferred Stock amounts reflect the extraordinary
charges for the $1.4 million call premium and $0.5 million write-off of
deferred financing costs associated with the redemption of the 14.5%
Subordinated Notes at their stated redemption price of 107.25% of the
principal amount thereof. The pro forma as adjusted amounts reflect the
items set forth above in this Note 6 and the extraordinary charges for: (i)
the $0.9 million call premium and $0.9 million write-off of deferred
financing costs associated with the redemption of the Old Senior Notes at
their stated redemption price of 103.0% of the principal amount thereof,
(ii) the $0.3 million write-off of the remaining original issue discount on
the Old Senior Notes and (iii) the $0.2 million write-off of deferred
financing costs incurred to temporarily increase the available borrowings
under the Financing Agreement.
17
<PAGE>
UNAUDITED PRO FORMA FINANCIAL DATA
The following unaudited pro forma financial data has been prepared by the
Company based on certain adjustments to the Consolidated Financial Statements
of the Company which are included elsewhere in this Prospectus. The pro forma
amounts reflect adjustments for the Initial Public Offering, the
Reclassification, the Preferred Stock Offering and the Offering as if such
transactions occurred as of the beginning of the period presented for income
statement data and other data and as of October 31, 1993 (with the exception
of the Initial Public Offering and Reclassification which occurred on April 6,
1993) for balance sheet data. Initial Public Offering adjustments reflect the
sale of 3,800,000 shares of Common Stock and the application of the net
proceeds therefrom and the Reclassification, including the $2.5 million cash
dividend on the Series A Preferred Stock. The Preferred Stock Offering
adjustments reflect the anticipated sale of 800,000 shares of Preferred Stock
and the application of the proceeds therefrom. The Offering adjustments
reflect the issuance of the Notes in the principal amount of $100.0 million
and the use of the estimated net proceeds therefrom as described in "Use of
Proceeds."
The pro forma financial data should be read in conjunction with the
Consolidated Financial Statements of the Company and the related Notes thereto
contained elsewhere in this Prospectus and "Management's Discussion and
Analysis of Financial Condition and Results of Operations." The pro forma
financial data is based on the assumptions and adjustments described above and
in the accompanying Notes and does not purport to present the financial
position and results of operations of the Company had the Initial Public
Offering, the Reclassification, the Preferred Stock Offering and the Offering
and the application of the net proceeds therefrom actually occurred as of such
dates, nor is it necessarily indicative of the results of operations that may
be achieved in the future. The pro forma amounts presented do not reflect the
anticipated operating results of the Expansion stores.
<TABLE>
<CAPTION>
YEAR ENDED JANUARY 31, 1993
-------------------------------------------------
ADJUSTMENTS
----------------------------
INITIAL PREFERRED
PUBLIC STOCK
ACTUAL OFFERING OFFERING OFFERING PRO FORMA
-------- -------- --------- -------- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Sales.......................... $346,158 -- -- -- $346,158
Cost of goods sold............. 224,599 -- -- -- 224,599
-------- ------- ------- ------- --------
Gross margin................. 121,559 -- -- -- 121,559
Operating expenses............. 99,944 -- -- -- 99,944
Pre-opening expenses........... 924 -- -- -- 924
-------- ------- ------- ------- --------
Operating income............. 20,691 -- -- -- 20,691
Write-down in carrying amount
of asset held for disposal.... 2,007 -- -- -- 2,007
Interest expense (1)........... 16,725 $(6,539) $(2,907) $ 7,211 14,490
-------- ------- ------- ------- --------
Income before provision for
income taxes................ 1,959 6,539 2,907 (7,211) 4,194
Provision for income taxes (2). 866 2,622 1,166 (2,892) 1,762
-------- ------- ------- ------- --------
Income before extraordinary
items (3)................... 1,093 3,917 1,741 (4,319) 2,432
Preferred stock dividends (4).. 4,208 (4,208) 1,200 -- 1,200
-------- ------- ------- ------- --------
Income (loss) before
extraordinary items
available to common stock
(3)......................... $ (3,115) $ 8,125 $ 541 $(4,319) $ 1,232
======== ======= ======= ======= ========
OTHER DATA:
EBITDA (5)..................... $ 26,731 $ 26,731
Ratio of earnings to fixed
charges and preferred stock
dividends (6)................. 1.2x
Ratio of EBITDA to cash
interest expense (7).......... 1.9x
Ratio of EBITDA to cash
interest expense and preferred
stock dividends (7)........... 1.8x
</TABLE>
(See Pro Forma Income Statement Data, Other Data,
Balance Sheet Data and Notes on following pages)
18
<PAGE>
<TABLE>
<CAPTION>
NINE MONTHS ENDED OCTOBER 31, 1993
------------------------------------------------
ADJUSTMENTS
----------------------------
INITIAL PREFERRED
PUBLIC STOCK
ACTUAL OFFERING OFFERING OFFERING PRO FORMA
-------- -------- --------- -------- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Sales........................... $280,455 -- -- -- $280,455
Cost of goods sold.............. 180,629 -- -- -- 180,629
-------- ------- ------- ------- --------
Gross margin................... 99,826 -- -- -- 99,826
Operating expenses.............. 79,022 -- -- -- 79,022
Pre-opening expenses............ 1,713 -- -- -- 1,713
-------- ------- ------- ------- --------
Operating income............... 19,091 -- -- -- 19,091
Interest expense(1)............. 9,096 $(1,495) $(2,172) $ 5,144 10,573
-------- ------- ------- ------- --------
Income before provision for
income taxes.................. 9,995 1,495 2,172 (5,144) 8,518
Provision for income taxes(2)... -- -- -- -- --
-------- ------- ------- ------- --------
Income before extraordinary
items(3)...................... 9,995 1,495 2,172 (5,144) 8,518
Preferred stock dividends(4).... 814 (814) 900 -- 900
-------- ------- ------- ------- --------
Income (loss) before
extraordinary items available
to common stock(3)............ $ 9,181 $ 2,309 $ 1,272 $(5,144) $ 7,618
======== ======= ======= ======= ========
OTHER DATA:
EBITDA(5)....................... $ 23,648 $ 23,648
Ratio of earnings to fixed
charges and preferred stock
dividends(6)................... 1.5x
- -------------------
- -
Ratio of LTM EBITDA to LTM cash
interest
expense(7)..................... 2.1x
Ratio of LTM EBITDA to LTM cash
interest
expense and preferred stock
dividends(7)................... 2.0x
</TABLE>
<TABLE>
<CAPTION>
OCTOBER 31, 1993
---------------------------------------
ADJUSTMENTS
-------------------
PREFERRED
STOCK
ACTUAL OFFERING OFFERING PRO FORMA
-------- --------- -------- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
BALANCE SHEET DATA:
Working capital (8)...................... $ 56,282 $ (1,473) $ 47,293 $102,102
Total assets(9).......................... 207,757 (1,990) 69,079 274,846
Long-term debt and capital leases(10).... 85,173 (19,322) 71,249 137,100
Stockholders' equity(11)................. 65,632 17,332 (2,170) 80,794
</TABLE>
(See Notes on following pages)
19
<PAGE>
NOTES TO UNAUDITED PRO FORMA FINANCIAL DATA
(1) The Initial Public Offering adjustments reflect a decrease in interest
expense resulting from the application of the net proceeds to redeem
approximately $44.7 million aggregate principal amount of 14.5%
Subordinated Notes which offset an increase in interest costs resulting
from the borrowings under the Financing Agreement to finance the $2.5
million cash dividend on the Series A Preferred Stock. The Preferred Stock
Offering adjustments reflect the reduced interest expense resulting from
the redemption of the remaining $19.3 million principal amount of the
14.5% Subordinated Notes. The Offering adjustments reflect the increased
interest costs resulting from the Notes and the interest expense
associated with the $1.0 million mortgage debt assumed pursuant to the
Expansion net of the reduced interest costs resulting from the use of a
portion of the proceeds from the Offering to retire the Old Senior Notes.
The following summarizes the net change in interest costs (in thousands):
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED ---------------------------------
JANUARY 31, 1993 OCTOBER 25, 1992 OCTOBER 31, 1993
---------------- ---------------- ----------------
<S> <C> <C> <C>
INITIAL PUBLIC OFFERING
ADJUSTMENTS
Reduction from
retirement of 14.5%
Subordinated Notes:
Interest expense.... $ 6,478 $ 4,860 $ 1,487
Elimination of
amortization of
existing deferred
financing costs.... 249 185 42
Increase in interest
costs to fund Series
A Preferred Stock
dividend............. (188) (141) (34)
------- ------- --------
6,539 4,904 1,495
------- ------- --------
PREFERRED STOCK OFFERING
ADJUSTMENTS
Reduction from
retirement of 14.5%
Subordinated Notes:
Interest expense.... 2,802 2,102 2,102
Elimination of
amortization of
existing deferred
financing costs.... 105 80 70
------- ------- --------
2,907 2,182 2,172
------- ------- --------
OFFERING ADJUSTMENTS
Increase in interest
costs from Notes:
Interest expense.... (9,375) (7,031) (7,031)
Amortization of new
deferred financing
costs.............. (375) (281) (281)
Increase in interest
expense related to
$1.0 million mortgage
debt assumed in the
Expansion............ (119) (89) (89)
Reduction from
retirement of debt
under previous bank
facility and Old
Senior Notes:
Interest expense.... 2,294 1,578 2,073
Elimination of
amortization of
existing deferred
financing costs.... 364 304 184
------- ------- --------
(7,211) (5,519) (5,144)
------- ------- --------
Net (increase) decrease
in interest cost....... $ 2,235 $ 1,567 $ (1,477)
======= ======= ========
</TABLE>
(2) As of February 1, 1993, the Company adopted SFAS 109. If SFAS 109 had been
adopted retroactively, the income tax provision for the year ended January
31, 1993 would have been zero due to the effective tax rate of zero
applicable to the Company. Such rate reflects available net operating loss
carryforwards for which a valuation allowance exists.
(Notes continued on following page)
20
<PAGE>
(3) Extraordinary items include: (i) the loss on extinguishment of debt
resulting from the premiums paid or to be paid for the redemptions of the
14.5% Subordinated Notes and the Old Senior Notes, (ii) the loss on
extinguishment of debt resulting from the write-off of deferred financing
costs in connection with the redemptions of the 14.5% Subordinated Notes
and the Old Senior Notes, the reduction in the credit facility under the
Financing Agreement and the refinancing in fiscal 1992 of the revolving
credit agreement and (iii) the realization of income tax benefits from net
operating loss carryforwards in fiscal 1992. See Note 11 below. The
redemption of the 14.5% Subordinated Notes is assumed to have occurred
with the call premium amounts actually paid or payable (9.06% on the
principal amount of $44.7 million and 7.25% on the remaining principal
amount of $19.3 million). Had the amounts actually been redeemed at the
beginning of the periods presented, the call premiums would have been the
contractually specified amounts on the applicable dates.
(4) Initial Public Offering adjustments reflect the elimination of the earned
dividends on the Series A Preferred Stock. No dividends were actually paid
until the Reclassification, which occurred in conjunction with the Initial
Public Offering. The Preferred Stock Offering adjustments reflect
dividends earned on the Preferred Stock at a 6.0% dividend rate.
(5) EBITDA represents net income before taking into consideration interest
expense, income tax expense, extraordinary items, the write-down in
carrying value of assets held for disposal, depreciation and amortization
expense. EBITDA is presented as an alternative measure of the Company's
financial condition. This data is not intended to be substituted for net
income as a measure of the Company's profitability.
(6) Earnings are computed as income before extraordinary items and provision
for income taxes, plus fixed charges. Fixed charges consist of: (i)
interest costs, including amortization of deferred financing costs and
(ii) the portion of rental expense representing interest.
(7) Pro forma cash interest expense excludes non-cash amortization of deferred
financing costs in the amount of $0.7 million and $0.7 million for the
year ended January 31, 1993 and the 12 months ("LTM") ended October 31,
1993, respectively.
(8) Preferred Stock Offering adjustments reflect the use of internal cash
available of $1.5 million to pay the call premium of $1.4 million and a
portion of the transaction-related costs. Offering adjustments reflect the
estimated cash remaining after the application of proceeds as described in
"Use of Proceeds."
(9) Adjustments reflect the items discussed in Note 8 above. In addition,
Preferred Stock Offering adjustments reflect the write-off of deferred
financing costs totaling $0.5 million due to the redemption of the
remaining $19.3 million principal amount of the 14.5% Subordinated Notes.
Offering adjustments reflect (i) the acquisition of the store sites
pursuant to the Expansion at a purchase price of $19.7 million, (ii) the
addition of estimated deferred financing costs totaling $3.0 million
related to the Notes, and (iii) the write-off of deferred financing costs
totaling $0.9 million due to the retirement of the Old Senior Notes.
(10) Reflects the revised capitalization arising from the Preferred Stock
Offering and the Offering. See "Capitalization."
(11) Reflects the net proceeds of $19.3 million from the Preferred Stock
Offering partially offset by the following extraordinary charges (in
thousands):
<TABLE>
<S> <C>
Repayment of the $19.3 million principal amount of 14.5% Subordi-
nated Notes:
Call premium.................................................... $1,401
Write-off of deferred financing costs........................... 517
Repayment of $30.0 million principal amount of Old Senior Notes:
Call premium.................................................... 900
Write-off of deferred financing costs........................... 864
Write-off of remaining original issue discount.................. 256
Reduction in credit facility under Financing Agreement:
Write-off of deferred financing costs........................... 150
------
$4,088
======
</TABLE>
21
<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA
The selected consolidated financial data presented below has been derived
from the historical consolidated financial statements of the Predecessor
Company and of the Company, except store data. The selected consolidated
financial data for the year ended January 28, 1989, the four-month period ended
May 27, 1989, the eight-month period ended January 28, 1990, and the years
ended January 27, 1991, January 26, 1992 and January 31, 1993 have been derived
from financial statements which were audited by Arthur Andersen & Co.,
independent public accountants. The selected unaudited, condensed consolidated
financial data for the nine months ended October 25, 1992 and October 31, 1993,
respectively, reflects all normal recurring adjustments that are, in the
opinion of management, necessary to state fairly the results for the periods
presented. The results for the nine months ended October 31, 1993 are not
necessarily indicative of the results expected for a full fiscal year. The
information set forth below should be read in conjunction with the Consolidated
Financial Statements and the Condensed Consolidated Financial Statements of the
Company and the Notes thereto, "Capitalization" and "Management's Discussion
and Analysis of Financial Condition and Results of Operations" included
elsewhere in this Prospectus.
<TABLE>
<CAPTION>
PREDECESSOR COMPANY THE COMPANY(1)
---------------------- ----------------------------------------------------------------------------------
FOUR EIGHT
YEAR MONTHS MONTHS YEAR ENDED NINE MONTHS ENDED
ENDED ENDED ENDED ------------------------------------------- -----------------------
JANUARY 28, MAY 27, JANUARY 28, JANUARY 27, JANUARY 26, JANUARY 31, OCTOBER 25, OCTOBER 31,
1989 1989 1990 1991 1992 1993 1992 1993
(52 WEEKS) (17 WEEKS) (35 WEEKS) (52 WEEKS) (52 WEEKS) (53 WEEKS) (39 WEEKS) (39 WEEKS)
----------- ---------- ----------- ------------ ------------ ------------ ----------- -----------
(IN THOUSANDS, EXCEPT PER SHARE DATA) (UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
INCOME STATEMENT
DATA:
Sales............... $255,541 $91,757 $194,759 $ 299,924 $ 308,562 $ 346,158 $259,365 $280,455
Cost of goods
sold(2)(3)......... 166,123 60,311 141,925 191,815 199,052 224,599 169,331 180,629
-------- ------- -------- ------------ ------------ ------------ -------- --------
Gross margin....... 89,418 31,446 52,834 108,109 109,510 121,559 90,034 99,826
Operating
expenses(2)........ 74,223 25,261 57,411 88,444 91,296 99,944 72,562 79,022
Pre-opening
expenses........... 559 177 869 579 1,192 924 910 1,713
-------- ------- -------- ------------ ------------ ------------ -------- --------
Operating income
(loss)............ 14,636 6,008 (5,446) 19,086 17,022 20,691 16,562 19,091
Write-down in
carrying amount of
asset held for
disposal........... -- -- -- -- -- 2,007 2,007 --
Interest expense(4). 310 99 10,658 15,160 14,773 16,725 12,376 9,096
Write-off of
deferred financing
charges............ -- -- 2,157 -- -- -- -- --
-------- ------- -------- ------------ ------------ ------------ -------- --------
Income (loss)
before provision
for income taxes.. 14,326 5,909 (18,261) 3,926 2,249 1,959 2,179 9,995
Provision for income
taxes.............. 5,976 2,447 -- 1,667 971 866 934 --
-------- ------- -------- ------------ ------------ ------------ -------- --------
Income (loss)
before
extraordinary items(5). 8,350 3,462 (18,261) 2,259 1,278 1,093 1,245 9,995
Extraordinary
items(5)........... -- -- -- 1,667 971 (200) 934 (5,363)
-------- ------- -------- ------------ ------------ ------------ -------- --------
Net income (loss).. $ 8,350 $ 3,462 (18,261) 3,926 2,249 893 2,179 4,632
======== =======
Preferred stock
dividends(6)....... 1,780 3,046 3,446 4,208 3,031 814
-------- ------------ ------------ ------------ -------- --------
Net income (loss)
available to
common stock...... $(20,041) $ 880 $ (1,197) $ (3,315) $ (852) $ 3,818
======== ============ ============ ============ ======== ========
Net income (loss)
per common and
equivalent
share(7)........... $(16.16) $0.71 $(0.96) $(2.68) $(0.70) $0.68
Weighted average
number of common
and equivalent
shares(7).......... 1,240 1,242 1,242 1,238 1,218 5,613
</TABLE>
(See Other Data, Balance Sheet Data
and Notes on following pages)
22
<PAGE>
<TABLE>
<CAPTION>
PREDECESSOR COMPANY THE COMPANY(1)
---------------------- ------------------------------------------------------------------------
FOUR EIGHT
YEAR MONTHS MONTHS YEAR ENDED NINE MONTHS ENDED
ENDED ENDED ENDED ------------------------------------ -----------------------
JANUARY 28, MAY 27, JANUARY 28, JANUARY 27, JANUARY 26, JANUARY 31, OCTOBER 25, OCTOBER 31,
1989 1989 1990 1991 1992 1993 1992 1993
(52 WEEKS) (17 WEEKS) (35 WEEKS) (52 WEEKS) (52 WEEKS) (53 WEEKS) (39 WEEKS) (39 WEEKS)
----------- ---------- ----------- ----------- ----------- ----------- ----------- -----------
(IN THOUSANDS, EXCEPT STORE DATA) (UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
OTHER DATA:
EBITDA(8)............... $ 19,769 $ 7,733 $ (1,276) $ 25,371 $ 23,115 $ 26,731 $ 21,123 $ 23,648
Depreciation and
amortization(9)........ 5,133 1,725 4,757 7,153 6,998 7,080 5,383 5,062
Capital
expenditures(10)....... 4,890 2,535 2,722 10,999 19,675 4,318 2,466 7,704
Comparable store sales
growth................. 2.9% 5.2% 8.8% 1.9% (1.3)% 5.3% 4.6% 3.2%
Number of stores (at end
of period)............. 30 31 33 34 37 39 39 43
Ratio of earnings to
fixed charges and
preferred stock
dividends(11).......... 7.5x 8.2x -- 1.0x -- -- -- 1.7x
Ratio of EBITDA to cash
interest
expense(8)(12)......... 63.8x 78.1x -- 2.2x 2.2x 1.9x 2.1x 2.8x
Ratio of EBITDA to cash
interest expense and
preferred stock
dividends(6)(8)(12).... 63.8x 78.1x -- 1.7x 1.6x 1.5x 1.6x 2.5x
</TABLE>
<TABLE>
<CAPTION>
OCTOBER 25, OCTOBER 31,
JANUARY 28, MAY 27, JANUARY 28, JANUARY 27, JANUARY 26, JANUARY 31, 1992 1993
1989 1989 1990 1991 1992 1993 (39 WEEKS) (39 WEEKS)
----------- -------- ----------- ----------- ----------- ----------- ----------- -----------
(IN THOUSANDS) (UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Working capital......... $ 35,867 $ 35,082 $ 32,227 $ 34,090 $ 44,649 $ 52,274 $ 54,359 $ 56,282
Total assets............ 149,921 153,242 165,215 175,549 198,463 197,996 199,825 207,757
Long-term debt and
capital leases......... 2,783 2,684 109,056 111,648 125,892 130,374 130,855 85,173
Stockholders' equity.... 112,816 112,940 7,499 11,432 13,628 14,848 15,791 65,632
</TABLE>
- --------
(1) On May 27, 1989, the Company acquired substantially all of the assets and
assumed certain liabilities of the Predecessor Company from Wickes in the
1989 Transaction which was accounted for as a purchase transaction.
(2) The Predecessor Company incurred certain expenses for legal services,
audit and tax services and employee benefits administration which were
paid by Wickes prior to the 1989 Transaction. In addition, increases in
real estate taxes and insurance expenses have occurred as a result of the
1989 Transaction. These expenses, which are estimated by management to be
approximately $0.6 million annually, are not reflected in the historical
financial information prior to May 27, 1989 set forth herein, but are
included in the historical financial statements for subsequent periods.
Operating results for all periods subsequent to the 1989 Transaction
include charges associated with the purchase accounting adjustments
recorded as a result of the 1989 Transaction. These charges include the
amortization of goodwill and other intangible assets, the income effect
related to the initial carrying value of inventories and increased
depreciation resulting from the adjustment of the carrying values of
depreciable property to estimated fair values at the acquisition dates.
(3) In the 1989 Transaction, the Company allocated the purchase price of the
acquired assets and liabilities to reflect their relative fair market
values. In connection with the allocation, the Company valued its
inventories at amounts equal to selling prices less a reasonable profit
allowance for selling efforts, which resulted in an inventory valuation
which exceeded the pre-acquisition basis in the Company's inventory by
$16.7 million. The carrying amount of inventory as of the acquisition date
has been charged to cost of goods sold during the eight-month period ended
January 28, 1990.
(Notes continued on following page)
23
<PAGE>
(4) Data includes non-cash amortization of deferred financing costs and
original issue discount related to debt incurred in the 1989 Transaction
and subsequent refinancings.
(5) Extraordinary items include: (i) the loss on extinguishment of debt
resulting from the premium paid for the partial redemption of the 14.5%
Subordinated Notes at 109.06% of the principal amount thereof and the
write-off of deferred financing costs in connection therewith pursuant to
the Initial Public Offering, (ii) the loss on extinguishment of debt
resulting from the write-off of deferred financing costs in connection
with the refinancing in fiscal 1992 of the indebtedness incurred pursuant
to the Company's senior credit facility and (iii) the realization of
income tax benefits from net operating loss carryforwards.
(6) Preferred stock dividends reflect dividends earned on the Series A
Preferred Stock prior to the Reclassification which occurred in April
1993. Prior to April 1993, no preferred stock dividends had been declared.
In April 1993, all previously earned dividends were declared and paid. The
payment consisted of a cash payment of $2.5 million and the settlement of
the remaining dividends through the issuance of additional shares of
Series A Preferred Stock. The shares of Series A Preferred Stock were then
converted into shares of Common Stock pursuant to the Reclassification. In
addition, preferred stock dividend requirements of $1.2 million annually
will be applicable upon the consummation of the Preferred Stock Offering.
(7) See Note 2 to Consolidated Financial Statements for information regarding
the calculation of per share data.
(8) EBITDA represents net income before taking into consideration interest
expense, income tax expense, extraordinary items, the write-down in
carrying value of assets held for disposal, depreciation and amortization
expense. EBITDA is presented as an alternative measure of the Company's
financial condition. This data is not intended to be substituted for net
income as a measure of the Company's profitability.
(9) Data includes non-cash amortization of deferred financing costs related to
debt incurred in the 1989 Transaction and subsequent refinancings.
(10) Amounts for the years ended January 27, 1991 and January 26, 1992 include
capital expenditures for the new warehouse facility of $5.1 million and
$14.3 million, respectively.
(11) Earnings are computed as income before the provision for income taxes,
plus fixed charges. Fixed charges consist of: (i) interest costs,
including the non-cash amortization of deferred financing costs and
original issue discount and (ii) the portion of rental expense
representing interest. Earnings did not cover fixed charges plus preferred
stock dividends by $20.0 million, $1.2 million, $2.2 million and $0.9
million for the eight month period ended January 28, 1990, the year ended
January 26, 1992, the year ended January 31, 1993 and the nine month
period ended October 25, 1992, respectively.
(12) Cash interest expense excludes non-cash amortization of deferred financing
costs and original issue discount in the amount of $1.8 million, $3.6
million, $4.1 million, $2.7 million, $2.5 million and $0.6 million for the
eight month period ended January 28, 1990, the year ended January 27,
1991, the year ended January 26, 1992, the year ended January 31, 1993,
the nine month period ended October 25, 1992 and the nine month period
ended October 31, 1993, respectively.
24
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of financial condition and results of
operations should be read in conjunction with the "Selected Consolidated
Financial Data" and the Consolidated Financial Statements and Condensed
Consolidated Financial Statements of the Company and related Notes thereto
appearing elsewhere in this Prospectus.
GENERAL
The first Orchard Supply Hardware Store was opened by 30 Santa Clara Valley
orchardists in 1931 as a farmers' cooperative. In May 1989, the Company
acquired certain assets and liabilities of the Predecessor Company in a
transaction organized by FS&Co. and since that transaction, the Company's store
base has increased from 31 to 43 stores. In April 1993, the Company completed
its initial public offering of 3,800,000 shares of Common Stock and immediately
thereafter reclassified its Series A Preferred Stock into Common Stock. In
November 1993, the Company announced its intention to acquire the nine
Expansion store sites.
The Company will incur substantial pre-opening expenses in connection with
opening the nine Expansion store sites (approximately $6.8 million in the
aggregate). The Company anticipates these new stores will be opened in the
second quarter of fiscal 1994. These pre-opening expenses, which consist
principally of store merchandising and stocking expenses, personnel recruitment
and training costs and grand-opening advertising and promotional expenses, will
commence in the fourth quarter of fiscal 1993 and continue until the stores
have opened. Although it is difficult to precisely forecast the timing of
incurrence, the Company expects that the most significant impact of these pre-
opening expenditures on net income will be experienced in the first quarter of
fiscal 1994.
As the Company accelerates its new store opening program, operating expenses
as a percent of sales for the new stores will initially be higher, adversely
affecting overall operating margins until these new stores achieve sales
maturity. In addition, the Company expects that it will generally experience
higher marketing, distribution and occupancy costs in its new stores in the
metropolitan Los Angeles market. The Company believes, however, that these
higher expenses will be offset by higher sales at these stores than are typical
of mature Orchard stores in Northern and Central California. The Company
expects that the impact of these factors will be to reduce operating margins in
fiscal 1994 and thereafter so long as the Company continues to open a large
number of stores relative to its existing store base.
The Company will apply the net proceeds from the Preferred Stock Offering to
redeem the outstanding 14.5% Subordinated Notes at their stated redemption
price of 107.25% of the principal amount thereof. The Company intends to use a
portion of the net proceeds of this Offering to redeem the Old Senior Notes and
to repay $20.0 million in additional borrowings under the Financing Agreement
used to purchase the Expansion sites. These early retirements of debt will give
rise to extraordinary charges of $1.9 million, $2.0 million and $0.2 million,
respectively, during the fourth quarter of fiscal 1993 and/or the first quarter
of fiscal 1994.
The Company's results of operations exhibit some measure of seasonality.
During the three years ended January 31, 1993, approximately 28% of the
Company's annual sales and approximately 37% to 43% of its annual operating
income were generated in the second fiscal quarter. This is due primarily to
increased sales of garden, nursery and related products during this quarter,
which is the beginning of the spring/summer gardening season. Conversely,
during the three years ended January 31, 1993, approximately 24% of the
Company's annual sales and approximately 13% to 18% of its annual operating
income were generated in the fourth fiscal quarter, due primarily to decreased
sales of garden, nursery and related products during this quarter. See
"Investment Considerations--Seasonality and Sensitivity to Weather."
As a consequence of the Company's high leverage, the percentage variance of
the Company's net income from period to period has been and may continue to be
magnified. Therefore, relatively small increases in
25
<PAGE>
expenses such as interest expense have resulted and will continue to result in
substantial percentage decreases in net income.
The following table sets forth selected results of operations as percentages
of sales for the periods indicated:
<TABLE>
<CAPTION>
YEAR ENDED(1) NINE MONTHS ENDED(1)
----------------------------------- -----------------------
JANUARY 27, JANUARY 26, JANUARY 31, OCTOBER 25, OCTOBER 31,
1991 1992 1993 1992 1993
----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Sales................... 100.0% 100.0% 100.0% 100.0% 100.0%
Gross Margin............ 36.0 35.5 35.1 34.7 35.6
Selling general and
administrative
expenses............... 29.5 29.6 28.9 28.0 28.2
Pre-opening expenses.... 0.2 0.4 0.3 0.4 0.6
----- ----- ----- ----- -----
Operating income........ 6.4 5.5 6.0 6.4 6.8
Write-down of asset held
for disposal........... -- -- 0.6 0.8 --
Interest expense........ 5.1 4.8 4.8 4.8 3.2
----- ----- ----- ----- -----
Income (loss) before
provision for income
taxes and extraordinary
items.................. 1.3 0.7 0.6 0.8 3.6
Income tax provision
(benefit).............. 0.6 0.3 0.3 0.4 --
----- ----- ----- ----- -----
Income before
extraordinary items.... 0.8 0.4 0.3 0.5 3.6
Extraordinary items..... 0.6 0.3 (0.1) 0.4 (1.9)
----- ----- ----- ----- -----
Net income (loss)....... 1.3% 0.7% 0.3% 0.8% 1.7%
===== ===== ===== ===== =====
</TABLE>
- --------
(1) Amounts may not total due to rounding.
RESULTS OF OPERATIONS
Nine Months (39 Weeks) ended October 31, 1993 compared to Nine Months (39
Weeks) ended October 25, 1992.
Sales for the first nine months of fiscal 1993 increased 8.1% to $280.5
million from $259.4 million in the comparable period in the prior year. This
sales increase is due in part to the opening of four new stores during the
first nine months of fiscal 1993 and the inclusion of full period results for
fiscal 1993 of the stores opened during the first nine months of fiscal 1992.
This sales increase was also due in part to a 3.2% increase in comparable store
sales for the first nine months of fiscal 1993 from the first nine months of
fiscal 1992. Sales in the first nine months of fiscal 1993 were negatively
impacted by unseasonable cool and rainy weather from the beginning of April to
the first week of June and continued sluggishness of the California economy.
During the three months ended October 31, 1993, comparable store sales
increased 2.6% over the corresponding period in the prior year. Since late
October 1993, Home Depot has opened five competing stores. These new competing
stores, current economic conditions and comparison to last year's fourth
quarter which experienced a strong 7.9% comparable store sales gain are
expected to have a negative impact on fourth quarter 1993 comparable store
sales.
Gross margin increased from $90.0 million in the first nine months of fiscal
1992 to $99.8 million in the first nine months of fiscal 1993. As a percentage
of sales, gross margin increased from 34.7% for the first nine months of fiscal
1992 to 35.6% for the first nine months of fiscal 1993. The increase in gross
margin percentage resulted primarily from an increase in purchase markup of
0.8%, due mainly to improved purchasing made possible by the Company's new
warehouse which opened in February 1992. Other favorable factors including
improved inventory shrinkage of 0.2% and reduced warehousing costs of 0.2% were
offset by higher promotional markdowns of 0.3%.
26
<PAGE>
Selling, general and administrative expenses for the nine months ended
October 31, 1993 were 28.2% of sales compared with 28.0% of sales for the nine
months ended October 25, 1992, or an increase of 0.2%. The increase was
attributable mainly to the impact on payroll and occupancy costs of the four
new stores opened during the past nine months.
Operating income increased $2.5 million, or 15.3%, to $19.1 million for the
first nine months of fiscal 1993 from $16.6 million for the first nine months
of fiscal 1992. Operating income as a percent of sales increased from 6.4% last
year to 6.8% this year. The increase in operating income was achieved despite
an additional $0.8 million of pre-opening expenses for new stores in the
current fiscal year's first nine months.
Interest expense decreased from $12.4 million for the first nine months of
fiscal 1992 to $9.1 million for the first nine months of fiscal 1993, or a
decrease of $3.3 million. This decrease is due primarily to the redemption of
$44.7 million of the 14.5% Subordinated Notes on April 30, 1993.
The Company's effective income tax rate for the first nine months of fiscal
1992 was 42.9%. There was no income tax provision in the fiscal 1993 first nine
months. See Note 4 to the Condensed Consolidated Financial Statements.
The results of operations for the first nine months of fiscal 1993 include an
extraordinary charge of $5.4 million resulting from the early extinguishment of
$44.7 million aggregate principal amount of the 14.5% Subordinated Notes due in
1999. Last year's first nine months had an extraordinary credit of $0.9 million
representing the income tax benefit from the realization of net operating loss
carryforwards.
Net income for the first nine months of fiscal 1993 was $4.6 million versus
net income of $2.2 million for the comparable period of fiscal 1992. Net income
for the nine months ended October 25, 1992 was negatively impacted by a $2.0
million one-time non-cash write-down in the carrying value of the Company's old
warehouse while the $5.4 million one-time extraordinary charge associated with
the early retirement of debt discussed above impacted the first nine months of
fiscal 1993.
53 Weeks ended January 31, 1993 (fiscal 1992) compared to 52 Weeks ended
January 26, 1992 (fiscal 1991).
Sales increased from $308.6 million in fiscal 1991 to $346.2 million in
fiscal 1992, an increase of $37.6 million or 12.2%. Approximately $5.4 million
of the increase in sales or 1.8% is attributable to the additional week in
fiscal 1992. The increase also reflects an increase of comparable store sales
(those stores open for more than one year) of 5.3% from fiscal 1991 to fiscal
1992 (as adjusted to remove the effect of the additional week in fiscal 1992).
Management believes that improved consumer confidence favorably impacted
comparable store sales in December 1992 and January 1993. The Company's sales
also benefitted from an increase in sales of garden and nursery products due to
an easing of the water restrictions imposed during the six year drought in
Northern and Central California. The remainder of the sales increase was
attributable to the full year effect of the three new stores opened during
fiscal 1991 and sales from two new stores opened during fiscal 1992. The
increase in sales was accomplished despite the opening of three new warehouse
home center stores by the Company's competitors which impacted five of the
Company's stores.
Gross margin increased $12.1 million from $109.5 million in fiscal 1991 to
$121.6 million in fiscal 1992. Gross margin as a percentage of sales decreased
from 35.5% in fiscal 1991 to 35.1% in fiscal 1992. The decrease in gross margin
as a percentage of sales reflects an increase in warehouse costs of 0.4% of
sales and an increase in inventory shrinkage of 0.3% of sales, which was offset
by a reduction in permanent markdowns of 0.2% of sales due primarily to reduced
Christmas and winter clearance markdowns and a 0.1% of sales improvement in
purchase markons. Since a portion of warehouse costs is fixed, an increase in
sales should reduce warehouse costs as a percentage of sales. See "Business--
Expansion Strategy." Management believes that the increase in inventory
shrinkage was caused in part by the recession experienced in the Company's
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markets. Orchard has acted to reduce inventory shrinkage by increasing its
security staff, installing electronic theft devices and rearranging merchandise
displays in stores with the highest inventory shrinkage.
Selling, general and administrative expenses as a percentage of sales
decreased from 29.6% in fiscal 1991 to 28.9% in fiscal 1992, a decrease of
0.7%. Tight payroll controls contributed to reducing store and administrative
base payrolls by 0.6% of sales. In addition, fringe benefits were reduced by
0.3% of sales due primarily to improved workman's compensation and medical
claims experience.
Operating income increased $3.7 million from $17.0 million in fiscal 1991 to
$20.7 million in fiscal 1992. Operating income as a percentage of sales
increased from 5.5% in fiscal 1991 to 6.0% in fiscal 1992. The higher operating
income in fiscal 1992 compared to fiscal 1991 principally reflects the decrease
in selling, general and administrative and pre-opening expenses which was
partially offset by the decrease in the Company's gross margin. The 53rd week
in fiscal 1992 is estimated to have contributed an additional $0.6 million to
the Company's operating income.
Interest expense in fiscal 1992 was $16.7 million as compared to interest
expense of $14.8 million in fiscal 1991. The increase of $1.9 million is
primarily a result of interest incurred in connection with the financing of the
Company's new warehouse facility and the higher interest on borrowings used to
refinance Orchard Supply's senior credit facility. The Company capitalized the
interest associated with the new warehouse until February 1992, when it began
expensing such interest.
The Company's effective income tax rates in fiscal 1991 and 1992 were 43.2%
and 44.2%, respectively. See Note 10 to Consolidated Financial Statements.
Net income decreased from $2.2 million in fiscal 1991 to $0.9 million in
fiscal 1992. Net income for fiscal 1992 was adversely affected by a $2.0
million pre-tax nonoperating write-down in the carrying amount of the Company's
old warehouse in San Jose, California to reflect management's estimate of its
net realizable value. In addition, the Company's net income in fiscal 1992 was
affected by extraordinary items consisting of a tax benefit relating to net
operating loss carryforwards of $0.4 million offset by an extraordinary charge
of $0.6 million relating to the early extinguishment of debt in connection with
the refinancing of Orchard Supply's senior credit facility. Net income in
fiscal 1991 was favorably impacted by an extraordinary tax benefit relating to
net operating loss carryforwards of $1.0 million.
52 Weeks Ended January 26, 1992 (fiscal 1991) Compared to 52 Weeks Ended
January 27, 1991 (fiscal 1990).
Sales in fiscal 1991 were $308.6 million which represents an increase of 2.9%
from the $299.9 million in sales in fiscal 1990. The increase was the result of
revenue generated by three new stores and was offset in part by the 1.3%
decrease in comparable store sales from fiscal 1991 to fiscal 1990. The Company
believes that the Persian Gulf War, the sluggish economy in fiscal 1991, the
California drought and inclement weather during the crucial start of the
spring/summer gardening season (which hurt sales but did not relieve the
drought) contributed to the decline in comparable store sales. The Company's
sales results were also affected by the opening of four additional stores by
the Company's warehouse home center competitors which impacted four Orchard
stores.
Gross margin as a percentage of sales decreased from 36.0% in fiscal 1990 to
35.5% in fiscal 1991, or a decrease of 0.5% of sales. The decrease was due
primarily to an increase in inventory shrinkage of 0.4% of sales. To a lesser
extent, increased markdowns also impacted gross margin in fiscal 1991. Such
markdowns resulted from the discontinuation of certain product lines following
the completion of remerchandising projects in the hardware department.
Selling, general and administrative expenses increased from 29.5% of sales in
fiscal 1990 to 29.6% of sales in fiscal 1991, or an increase of 0.1% of sales.
The increase was due, in large part, to the opening of two more stores in
fiscal 1991 than in fiscal 1990. See "--Liquidity and Capital Resources."
28
<PAGE>
Operating income decreased from $19.1 million in fiscal 1990 to $17.0 million
in fiscal 1991 or a decrease of $2.1 million. Operating income as a percentage
of sales decreased from 6.4% in fiscal 1990 to 5.5% in fiscal 1991. The
decrease is due primarily to the decline in comparable store sales, the
increase in inventory shrinkage and the increase in both selling, general and
administrative and pre-opening expenses relating to the opening of two
additional stores in fiscal 1991.
Interest expense declined from $15.2 million in fiscal 1990 to $14.8 million
in fiscal 1991, or a decrease of $0.4 million. The decrease resulted primarily
from the lower effective interest rates on variable rate indebtedness under
Orchard Supply's senior credit facility experienced in fiscal 1991 as compared
to fiscal 1990.
The Company reported provisions for income taxes of $1.7 million and $1.0
million, and its effective income tax rates were 42.5% and 43.2% for fiscal
1990 and fiscal 1991, respectively. See Note 10 to Consolidated Financial
Statements.
Net income decreased from $3.9 million in fiscal 1990 to $2.2 million in
fiscal 1991, primarily as a result of the decrease in operating income which
was partially offset by a reduction in interest expense. Extraordinary income
tax benefits from net operating loss carryforwards of $1.7 million and $1.0
million are included in net income for fiscal 1990 and 1991, respectively.
LIQUIDITY AND CAPITAL RESOURCES
The Company's liquidity needs arise primarily from the funding of the
Company's capital expenditures, working capital requirements, ongoing expansion
program, and debt service on indebtedness incurred in connection with the 1989
Transaction and the subsequent refinancings thereof.
Orchard Supply's funded debt obligations include (i) up to $40.0 million of
revolving credit availability under the Financing Agreement (with an $8.0
million sublimit for guarantees of letters of credit) of which no borrowings
and $4.5 million of guarantees of letters of credit were outstanding as of
October 31, 1993, and of which $20.0 million was borrowed on November 15, 1993
to finance the Expansion and (ii) $21.5 million outstanding under the Store
Mortgage Facility (as defined under "Terms of Continuing Debt Instruments"),
(iii) $13.7 million aggregate principal amount of the Warehouse Mortgage Notes
(as defined under "Terms of Continuing Debt Instruments"), (iv) $30.0 million
aggregate principal amount of the Old Senior Notes and (v) $19.3 million
aggregate principal amount of 14.5% Subordinated Notes. Orchard Supply's debt
instruments contain financial and operating covenants including, among other
things, requirements that the Company maintain certain financial ratios and
satisfy certain financial tests and limitations on the Company's ability to
make capital expenditures, to incur other indebtedness, and to pay dividends.
As of October 31, 1993, the Company and Orchard Supply were in compliance with
all covenants contained in such debt instruments. See "Terms of Continuing Debt
Instruments."
The Company intends to use the net proceeds of the Preferred Stock Offering
to redeem the 14.5% Subordinated Notes at their stated redemption price of
107.25% of their principal amount, resulting in a call premium of $1.4 million
which will be paid with available cash from operations. As a result of the
redemption of the 14.5% Subordinated Notes, the Company's cash interest expense
will be reduced by approximately $2.8 million on an annual basis. The Company
expects to incur extraordinary charges of approximately $0.5 million and $1.4
million in the period the 14.5% Subordinated Notes are redeemed, which will
consist of a loss on extinguishment of debt resulting from the write-off of
deferred financing costs and the payment of the call premium, respectively. The
Company's dividend requirements on the Preferred Stock will be $1.2 million per
year.
The estimated net proceeds from this Offering will be applied as follows: (i)
approximately $30.9 million to retire the Old Senior Notes at their stated
redemption price of 103.0% of the principal amount thereof, (ii) $20.0 million
to repay additional borrowings under the Financing Agreement used to finance
the Expansion, (iii) $35.0 million to fund additional investments required to
open the nine Expansion stores and (iv) the
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<PAGE>
remainder for general corporate purposes. Assuming the Company successfully
completes the Preferred Stock Offering and this Offering, the Company estimates
that cash interest expense for borrowings for the fiscal years 1994, 1995 and
1996 will be approximately $13.9 million, $13.3 million and $13.1 million,
respectively (assuming (i) the interest rate for borrowings under the Notes,
the Store Mortgage Facility, the Warehouse Mortgage Notes and the Financing
Agreement is 9.375%, 10.1%, 10.64%, and 7.5%, respectively, (ii) an average
outstanding balance under the Financing Agreement of $0.8 million and (iii)
only scheduled amortization payments on the Warehouse Mortgage Notes and the
Store Mortgage Facility are made during this period). Aggregate scheduled
principal repayments for fiscal 1994, 1995 and 1996 will be $0.7 million, $1.7
million and $2.0 million, respectively. Assuming that the Company successfully
completes the Preferred Stock Offering and the Offering, the Company believes
that funds from operations, together with borrowings under the Financing
Agreement and financings through operating leases, will be adequate to fund the
Company's operating requirements and capital expenditure program and meet its
debt and dividend obligations through at least fiscal 2000.
The Company's business strategy requires that it maintain broad product lines
and large inventories, however, the effect of this strategy on working capital
is somewhat minimized through the receipt of trade credit. The Company's
working capital is also affected by accounts receivable arising from its
proprietary credit card which had an average monthly balance for fiscal 1992 of
$11.6 million. The Company will fund its working capital needs through a
combination of funds from operations and borrowings under the Financing
Agreement. The Financing Agreement permits borrowings based on percentages of
the Company's eligible inventory and accounts receivable and is to be used for
working capital and general corporate purposes. As of October 31, 1993, Orchard
Supply had no outstanding borrowings and $4.5 million in letter of credit
guarantees and had additional borrowing capacity under the Financing Agreement
of $15.5 million. On November 15, 1993 the Company increased availability under
the Financing Agreement to $40.0 million and borrowed $20.0 million to provide
initial financing for the Expansion. The Financing Agreement remains effective
for the two-year period ending October 29, 1995. Upon the repayment of the
$20.0 million in borrowings to finance the Expansion with a portion of the
proceeds from this Offering, the Company plans to reduce its credit line under
the Financing Agreement to $20.0 million.
Orchard Supply has historically financed its store capital expenditures
through cash flow from operations and through operating leases. Total capital
expenditures for fiscal years 1990, 1991 and 1992 were $11.0 million, $19.7
million and $4.3 million, respectively, which amounts include capital
expenditures for the new warehouse facility for fiscal 1990 and 1991 of $5.1
million and $14.3 million, respectively. Capital expenditures for the new
warehouse were originally funded through borrowings under the former senior
credit facility and were subsequently refinanced by the Warehouse Mortgage
Notes.
In connection with Orchard's expansion plans, the Company anticipates capital
expenditures of approximately $900,000 for furniture, fixtures and equipment
for each new store opened, a portion of which may be leased under operating
leases. The Company expects that pre-opening expenses for the nine Expansion
stores (approximately $6.8 million in the aggregate) will average approximately
$850,000 for the six metropolitan Los Angeles stores and $550,000 for the
remaining stores. The Company expects that for its subsequent metropolitan Los
Angeles stores, pre-opening expenses will average approximately $600,000
(compared to $450,000 in its Northern and Central California markets). The
initial inventory requirement for new stores net of trade credit is estimated
at $900,000 per store. In the event that the Company is responsible for the
renovation or remodeling of the existing space to be leased, the Company
anticipates incurring additional capital expenditures of approximately $500,000
to $1,200,000 per store. If the Company elects to purchase the real estate, the
capital expenditure would range from approximately $2,500,000 for owned store
improvements constructed on leased land to $4,000,000-$6,000,000 if the entire
property were to be owned by the Company. The Company's capital expenditure
plan for fiscal 1994 assumes three purchased stores, 10 leased stores and the
construction of one store on a ground lease.
The Company's three-year capital expenditure plan for fiscal 1993 through
1995 provides for annual capital expenditures of $37.0 million, $16.5 million
and $10.9 million to $12.8 million (depending on the
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<PAGE>
actual number of stores opened during the period), respectively. The capital
expenditure plan for fiscal 1993 includes the $19.7 million purchase price for
the nine Expansion store sites. The 1993 and 1994 plans include approximately
$9.0 million for furniture, fixtures and equipment and $10.0 million for tenant
improvements for all the Expansion stores combined. This capital expenditure
plan includes the expenditures of approximately $2.0 million to $2.5 million
annually for the maintenance of existing facilities. The remainder of the
annual budgeted amounts will be used primarily for the opening of other planned
new stores, including new store fixtures and leasehold improvements with
respect to the new stores, and computer equipment. Since the 1989 Transaction,
the Company has financed some of its equipment through operating leases, and
expects to be able to procure such financings in the future. The inability of
the Company to procure such financing for its capital expenditure program may
have a negative impact on the ability of the Company to make capital
expenditures.
Assuming that the Company successfully completes the Preferred Stock Offering
and the Offering, the Company believes that funds from operations, together
with borrowings under the Financing Agreement and financings through operating
leases, will be adequate to fund the Company's operating requirements and
capital expenditure program and meet its debt and dividend obligations through
at least fiscal 2000. Any material shortfalls of operating cash flow could
require the Company to reduce its expansion plans.
As a result of the Initial Public Offering, the Company's ability to utilize
its Federal income tax net operating loss carryforwards is limited.
Accordingly, the income taxes payable by the Company may increase. See Note 10
to Consolidated Financial Statements.
EFFECT OF INFLATION
The effect of inflation on the Company's results of operations has not been
material in the periods discussed.
IMPACT OF RECENT ACCOUNTING PRONOUNCEMENTS
The Company does not provide post-retirement benefits other than through the
benefit plans discussed in Note 5 to Consolidated Financial Statements.
Accordingly, Statement of Financial Accounting Standard ("SFAS") No. 106
"Accounting for Post-Retirement Benefits Other Than Pensions" will not impact
the Company. The Company generally does not provide benefits for periods after
employment but prior to retirement. Accordingly, SFAS No. 112 "Employers'
Accounting for Postemployment Benefits" will have an immaterial impact.
The Company adopted the provisions of SFAS No. 109 "Accounting for Income
Taxes" in its fiscal year beginning February 1, 1993. The effect of the
adoption was not material. See Note 4 to the Condensed Consolidated Financial
Statements as of October 31, 1993 and for the nine months then ended included
elsewhere in this Prospectus.
31
<PAGE>
BUSINESS
GENERAL
Orchard operates 43 hardware superstores which average approximately 40,000
square feet of interior and exterior selling space. All of the Company's
current stores are located in Northern and Central California, but in November
1993 the Company announced its intention to enter the metropolitan Los Angeles
market through its acquisition of six store locations. See "--Expansion
Strategy." Orchard primarily targets the "fix-it" homeowner focused on repair
and maintenance projects and is positioned in a unique niche between small,
high-priced independent hardware retailers and large warehouse home center
chains. Orchard strives to offer the service and convenience of a "mom and pop"
hardware store and a greater depth and breadth of "fix-it" products in its core
product categories than the large warehouse home center chains.
The first Orchard Supply Hardware store was opened by 30 Santa Clara Valley
orchardists in 1931 as a farmers' cooperative. As the population of the Santa
Clara Valley increased and the cooperative grew to 2,500 members, Orchard's
merchandise line was expanded to include nonagricultural products. The
Company's roots as a purveyor of orchard and farm supplies are reflected in its
emphasis on garden and nursery products. From 1979 to 1986, under the ownership
of W.R. Grace & Co., Orchard expanded from 8 stores to 21 stores. Under Wickes'
ownership from 1986 to 1989, the Company's store base increased to 31, and
since the 1989 Transaction, the Company has grown to 43 stores.
INDUSTRY
The home improvement industry caters primarily to homeowners interested in
performing repairs, maintenance and minor remodeling projects on their homes.
Retail sales of home improvement products have grown from $55.9 billion in 1981
to $105.8 billion in 1992. The industry is highly fragmented and competitive
and is comprised primarily of local independent retailers (those with five or
fewer stores), traditional home improvement centers and warehouse home center
chains. Local independent retailers compete on the basis of service and
convenience, but typically offer small stores and relatively high prices. While
home centers (which include warehouse home center chains with average store
sizes in excess of 90,000 square feet and smaller traditional home improvement
centers) target the customer involved in major remodeling and project-oriented
home improvements, Orchard targets shoppers for "fix-it" products with its
40,000 square foot hardware superstores. This difference in business focus is
evidenced by the fact that approximately one third of the sales of a major
warehouse competitor are building materials, lumber and floor and wall
coverings as opposed to the less than 5% of Orchard's sales being attributable
to these products.
BUSINESS STRATEGY
Orchard's business strategy is to provide a broad merchandise selection,
outstanding service, convenient, well organized stores and fair everyday
pricing, thereby encouraging its customers to perceive Orchard as the primary
destination for their "fix-it" needs.
Broad Selection. Orchard offers a wide selection of brand name and private
label merchandise, including many products not carried by its competitors, in
its core areas of hardware, plumbing, electrical and garden and nursery.
Orchard's stores carry approximately 45,000 SKUs and maintain a high in stock
position (98% on average) to ensure the availability of its merchandise to
customers. This breadth of selection contrasts with the Company's warehouse
competitors, which typically carry only 25,000 to 33,000 SKUs.
The following table sets forth the Company's percentage of sales by product
category for fiscal 1992, which the Company believes will not change
substantially in fiscal 1993:
<TABLE>
<S> <C>
Hardware............................................................ 22.2%
Plumbing............................................................ 15.3
Electrical.......................................................... 11.4
Garden and Nursery.................................................. 26.6
Other............................................................... 24.5
-----
Total Sales....................................................... 100.0%
=====
</TABLE>
32
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Hardware. Orchard carries a wide line of hardware products, including
fasteners, power tools, hand tools and accessories. The Company stocks over
3,000 SKUs of nuts, bolts, screws and other fasteners, many of which are not
carried by its competitors. Orchard offers these fasteners for sale in a
variety of quantities, repackaging bulk shipments from its vendors at the
Tracy, California distribution center for sale in smaller, more profitable unit
counts. The Company also carries over 150 brand name power tools, including
Black & Decker, Skil, Makita, Freud, Milwaukee, Bosch, Delta, DeWalt, Dremel,
Wissota, Campbell Hausfeld, Homelite, McCulloch, Echo and Coleman Power Mate.
Orchard offers over 1,200 different power tool accessories, such as drill bits
and saw blades, which generate high gross margins and increase shopping
frequency due to their consumable nature. Orchard further stocks an extensive
selection of handtools, including 30 and 150 SKUs of pipe wrenches and hammers,
respectively, and also offers replacement products for these tools, including
handles.
Plumbing. Orchard distinguishes itself from its competitors by carrying a
broad selection of repair and maintenance plumbing parts. The Company stocks
over 1,300 different PVC, ABS, galvanized, copper, brass, polystyrene and cast
iron fittings, as well as over 1,250 faucet, toilet and sink repair parts
including hard-to-find parts for discontinued faucets and toilets. Orchard also
offers a variety of faucets, toilets and sinks. In addition, Orchard's
selection of nearly 400 sprinkler and drip irrigation SKUs appeals to both
homeowners and commercial landscapers.
Electrical. Orchard stocks nearly 300 different light bulbs and 150 types of
extension cords. With over 350 different lamp parts, repair and maintenance is
emphasized. Orchard is also well equipped in basic electrical components and
stocks a broad selection of electric boxes, wire and circuit breakers commonly
used in residential and commercial construction.
Garden and Nursery. Garden and nursery products are a strong focus of
Orchard's business, reflecting Orchard's heritage as a farmers' cooperative.
Orchard offers both the price and convenience of a mass merchant and the
selection, quality and expertise of an independent nursery. It carries a broad
selection of landscape container and bedding plants, most of which are contract
grown to the Company's specifications. Orchard's nurseries carry more than 30
varieties of ground cover, over twice as many as are offered by its major
competitors. Orchard has the largest display of Ames and Corona garden tools in
the United States. Orchard also offers a wide selection of tank sprayers,
liquid and dry fertilizers, weed killers, insecticides, hoses and hose-end
products. In addition, the Company supplies a variety of organic bag goods,
including bark, mulch, soil conditioners, potting soils, planting mixes and
peat moss.
Other. In addition to the "fix-it" items above, the Company carries an
extensive selection of housewares, paint, paint supplies and automotive
supplies, as well as certain destination items such as bottled water. The
Company also offers a unique merchandise selection of impulse items which
captures incremental sales from its frequent customer base and further
differentiates Orchard from its competition.
High Levels of Customer Service. The Company is committed to furnishing
outstanding levels of customer service through knowledgeable, well trained
personnel. Orchard seeks to hire personnel with prior repair and "fix-it"
experience and provides its employees with extensive training. The Company
requires all of its employees to pass written tests in their respective
departments as a condition of employment and requires ongoing testing in other
departments in order to be eligible for advancement. For example, the Company
provides compensation incentives to its garden and nursery employees to become
certified California Nurserymen. This certification, awarded by the California
Association of Nurserymen, is based on completing 3,120 hours of relevant work
experience and passing a test which displays proficiency in plant
identification, landscape design and insect and weed control. The Company
currently employs 36 certified California Nurserymen. In addition, Orchard
provides its customers with the following value-added services which the
Company believes create high customer loyalty.
Pick-Up Stations. All Orchard stores operate convenient pick-up stations for
hard-to-handle items. A customer may purchase oversized items by simply taking
a pull-tag located at the product display rack within
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<PAGE>
the store, checking out at the register and driving to the pick-up station,
where an Orchard employee loads the product into the customer's vehicle.
OSH Credit Card. Orchard offers a proprietary credit card to its retail and
commercial customers to build customer loyalty. The Company had an average of
42,000 active accounts in fiscal 1992, which comprised approximately 16% of the
Company's sales in that year. Approximately 80% of those credit card sales were
attributable to commercial customers. The Company also offers its commercial
customers added services such as the ability to selectively restrict their
employee purchases and detailed descriptions of all purchases on a monthly
basis.
"How-To" Fairs. The Company conducts two annual "how-to" fairs in its
existing market areas in Northern and Central California. These fairs are
designed to provide customers with DIY information through vendor booths and
specialized classes. Management estimates that its Santa Clara County "how-to"
fair in February 1993, which featured Norm Abrams from "This Old House" and
"The New Yankee Workshop" shown on PBS, attracted approximately 150,000 people.
ZIP Service. Orchard offers added convenience and fast pick-up through its
"ZIP" service for commercial customers, which enables them to place orders over
the phone and have them pre-assembled for immediate pick-up at no additional
charge.
Custom Cutting. Orchard will custom cut to a customer's specifications
products such as pipe, electrical wire, shade cloth, rope, chain, tubing and
screening.
Eager Beaver Engine Shop. Orchard offers customers repair and maintenance
service for power driven equipment such as lawn mowers, chain saws and edgers
through its factory authorized service facility located at its Tracy,
California distribution center. Customers can drop off the equipment to be
repaired at their local Orchard store and pick it up typically within seven
days.
Convenient, Well Organized Stores. To encourage ease of shopping, Orchard's
stores are designed in a conventional supermarket format with low profile
shelving as opposed to warehouse racking. This allows customers to view the
entire store upon entering in order to easily and quickly find the products
they need. Every store is organized so that related departments are located
adjacent to one another, and most SKUs are displayed according to centrally
developed plan-o-grams designed to optimize space utilization. Product labels
and descriptive signs assist customers in easy identification of merchandise,
and efficient check-out stations minimize customer lines at the cash register.
The Company's stores follow a standard merchandise layout and maintain a
consistent appearance. In addition, all stores have ample parking facilities
and wide aisles. These features provide customers with an attractive shopping
environment and the ability to get in and out of the store quickly.
Value Pricing. The Company provides the customer with value through a
combination of broad merchandise selection, outstanding service, convenient,
well organized stores and fair everyday pricing. Fair everyday pricing entails
competitive pricing on high visibility, high volume products and higher margins
on other products which in many cases are not carried by competitors. In
addition, the Company seeks to increase its margins by concentrating on non-
commodity products and through the selective use of private label merchandise
and in-house repackaging of bulk shipments into smaller, more profitable unit
counts.
This strategy of providing value, together with the Company's broad market
presence achieved by operating more stores than any of its competitors within
its markets, has resulted in strong name identification in its Northern and
Central California markets. Management believes that the average customer
purchase is approximately $17.
EXPANSION STRATEGY
The Company's expansion strategy is to increase market share in existing
markets and to open stores in attractive new markets. Building on its current
43 store base, the Company intends to open 14 stores in fiscal
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<PAGE>
1994, including the nine Expansion stores, six of which will be located in
metropolitan Los Angeles. The remaining five new stores for fiscal 1994 will be
located in Northern and Central California. Management believes that the
metropolitan Los Angeles market, which is one of the largest DIY markets in the
United States, presents an attractive opportunity for the broad selection, high
service Orchard format, particularly in light of the recent liquidation of the
Builders Emporium chain which operated approximately 40 DIY stores in
metropolitan Los Angeles. In fiscal year 1995, the Company plans to open five
to ten new stores, the majority of which are expected to be in metropolitan Los
Angeles. The Company believes it has the potential to expand to a total of 70
stores in Northern and Central California and 45 stores in metropolitan Los
Angeles and Orange County.
Consistent with this expansion strategy, on November 9, 1993 the Company
announced its plans to acquire nine former Builders Emporium store sites. The
Company completed the acquisition of six of these sites (Pasadena, Burbank, Van
Nuys and Hollywood in metropolitan Los Angeles, and Pismo Beach and Redding in
Central and Northern California, respectively) on November 16, 1993 and
completed the acquisition of the remaining three sites (South Pasadena and West
Los Angeles in metropolitan Los Angeles and Goleta in Central California) on
December 22, 1993. All nine Expansion stores will be converted into the Orchard
format and are expected to open in the second quarter of fiscal 1994. Three of
the new stores (Van Nuys, Hollywood and Pismo Beach) are owned, and the
remainder are leased.
The $19.7 million purchase price for the nine Expansion store sites was
financed through $18.7 million in additional borrowings under the Financing
Agreement and the assumption of $1.0 million in outstanding mortgage debt. The
Company expects to refinance the additional borrowings under the Financing
Agreement and to finance the $35.0 million additional investment required to
open the stores with a portion of the proceeds from the issuance of the Notes.
See "Use of Proceeds" and "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Liquidity and Capital Resources."
The Expansion store sites are proven retail hardware locations and include
seven of the top eight sales volume stores in the Builders Emporium chain. The
Company has in the past successfully converted former Builders Emporium stores
to the Orchard format. Based on the historical sales volume in the Expansion
stores, management believes that the stores located in metropolitan Los Angeles
will have average mature store sales in excess of the average mature store
sales of the Company's existing stores. Six of the Expansion store sites also
provide a unique opportunity to enter the metropolitan Los Angeles market with
immediate market presence. However, because the Los Angeles media market is
more expensive than the Northern and Central California market and Orchard will
initially lack the store concentration it enjoys in its existing markets, the
Company's advertising and marketing expenses will increase as a percent of
sales. The Company expects to execute its standard print advertising campaign
in metropolitan Los Angeles, but will initially make only limited use of
electronic media.
The Company expects to service all the acquired Expansion stores in
metropolitan Los Angeles and Goleta from its warehouse and distribution center
located in Tracy, California using an independent common carrier. Due to the
distance of the Los Angeles metropolitan market from the Tracy warehouse,
management expects transportation expenses as a percent of sales for these
Expansion stores to be higher than its other stores. The Company expects to
open an additional warehouse to service the metropolitan Los Angeles stores
after approximately 15 stores are open in that area.
In order to achieve the desired economies in distribution and advertising and
to establish critical market presence, management believes it is necessary to
open more stores in metropolitan Los Angeles in addition to the six Expansion
stores. Entering into a new market area, particularly one as large and complex
as Los Angeles, presents significant risks to the Company. See "Investment
Considerations--Expansion Program."
35
<PAGE>
1994 STORE OPENING SCHEDULE*
<TABLE>
<CAPTION>
INTERIOR AND
ANTICIPATED FISCAL 1994 EXTERIOR SELLING
STORE LOCATIONS OPENING SQ. FOOTAGE
---------------------------------- ----------------------- ----------------
<S> <C> <C>
Van Nuys+......................... Second Quarter 42,971
Burbank+.......................... Second Quarter 59,709
Hollywood+........................ Second Quarter 24,832
Pasadena+......................... Second Quarter 34,054
West Los Angeles+................. Second Quarter 26,338
South Pasadena+................... Second Quarter 40,096
Pismo Beach++..................... Second Quarter 34,208
Goleta++.......................... Second Quarter 32,929
Redding++......................... Second Quarter 34,775
Sonora............................ Second Quarter 33,148
Merced............................ Second Quarter 35,611
Petaluma.......................... Second Quarter 33,500
San Luis Obispo................... Third or Fourth Quarter 30,600
Hanford........................... Third or Fourth Quarter 33,240
</TABLE>
- --------
* This schedule represents management's current estimate with respect to
anticipated store openings; however, there is no assurance that the Company
will be able to achieve its expansion plan, including the 1994 store
openings detailed above, or that the new stores will be profitable. See
"Investment Considerations--Expansion Program."
+ Metropolitan Los Angeles Expansion store location.
++ Expansion store location.
COMPETITION
The Company competes with warehouse home center chains, traditional home
improvement centers and local independent retailers, including neighborhood
hardware stores and garden and nursery centers. Management believes that the
Company's "fix-it" orientation, broad merchandise selection, convenient
locations, value-added services and high name recognition in Northern and
Central California distinguish it from its competitors, including larger
warehouse home center chains and independent hardware stores.
Management believes that the warehouse home center chains, including HomeBase
and Home Depot, are its primary competitors. Since 1984 when the first
warehouse home center was opened in Orchard's markets, HomeBase and Home Depot
have opened and currently operate 12 and 21 stores, respectively, in the
Company's Northern and Central California markets. As of October 31, 1993, the
Company estimates that 32 Orchard stores faced competition from warehouse
operators. Despite this warehouse competition, the Company's operating income
has increased from $14.6 million in fiscal 1988 to $20.7 million in fiscal
1992. Since late October 1993, Home Depot has opened five competing stores. The
Company believes Home Depot will open two to four stores in fiscal 1994 in the
Company's Northern and Central California markets. HomeBase is expected to open
one store in the first quarter of calendar year 1994. Management believes this
is the only store opening in the Company's Northern and Central California
markets announced by HomeBase since 1991. If the anticipated Home Depot and
HomeBase store openings occur and the Company's fiscal 1994 expansion plan
takes place on schedule, then following fiscal 1994, HomeBase and Home Depot
will operate 37 stores in the Company's Northern and Central California markets
and 33 Orchard stores will face competition from warehouse competitors in these
markets.
Management believes that the competitive situation in metropolitan Los
Angeles is substantially similar to the highly competitive environment of
Orchard's existing Northern and Central California markets. Management believes
that HomeBase and Home Depot currently operate approximately 12 and 17 stores,
36
<PAGE>
respectively, in metropolitan Los Angeles and that three of the six
metropolitan Los Angeles Expansion stores will be in direct competition with
two HomeBase stores and two Home Depot stores.
ADVERTISING AND MARKETING
Consistent with its emphasis on building a concentrated market presence in
its Northern and Central California markets, Orchard utilizes advertising and
marketing campaigns across three major media categories: newspaper, circulars
and broadcasting. These campaigns are currently centered around Easter,
Memorial Day, July 4th, Labor Day and Christmas. The Company uses a significant
portion of its advertising and marketing allowance, which it obtains from
vendors that participate in the Company's co-operative advertising program, to
offset the costs of these campaigns, particularly television advertising
expenses. Co-operative advertising is the rebate received by the Company from a
merchandise vendor in return for featuring that vendor's product in the
Company's advertising media. The Company also maximizes the efficiency of its
advertising program in its Northern and Central California markets by spreading
these costs over a large number of stores contained in a concentrated
geographical area. In addition to the seasonal advertising campaigns, Orchard
regularly places newspaper ads and circulars in its Northern and Central
California markets and conducts an institutional image-building television and
radio campaign. Another major part of the Company's advertising program is its
"how-to" fairs which are held annually in two of the Company's major markets.
Each fair attracts approximately 150,000 potential customers and over 350
vendors, which purchase booths where they perform product demonstrations and
distribute discount coupons which are redeemable only at Orchard stores.
The Los Angeles media market is more expensive than Northern and Central
California, and Orchard will initially lack the store concentration it enjoys
in its existing markets. Accordingly, the Company expects to experience an
increase in marketing costs as a percentage of sales as a result of its fiscal
1994 openings in metropolitan Los Angeles. The Company expects to execute its
standard print advertising campaign in the Los Angeles market, but will
initially make only limited use of electronic media. As a new entrant into a
large and complex advertising market, there can be no assurances that the
Company will be able to achieve the same level of name recognition as in its
current Northern and Central California markets. See "Investment
Considerations--Expansion Program."
PURCHASING
Orchard's computerized point-of-sale systems automatically generate store
merchandise orders and track inventory by SKU. The majority of Orchard's
merchandise is purchased directly from the manufacturer and is shipped to the
Company's central warehouse located in Tracy, California. Orchard stores have
no significant storage space and rely on the warehouse for a majority of their
merchandise. The merchandising department controls inventory flow through a
purchase order management ("POM") system which tracks SKU levels and generates
reorder quantities for replenishment. This new warehouse facility stocks
approximately 25,000 SKUs, accounting for approximately 70% of the total dollar
sales. Moving to the new warehouse has allowed Orchard to add approximately
4,500 new items which can be carried at enhanced gross margins in the warehouse
relative to direct shipments to the stores from distributors and manufacturers.
Of the remaining 30% of the total dollar sales of the stores, 3% is obtained
through pool consolidation orders, which are received at the warehouse and
immediately shipped to the individual stores, and 27% is obtained through
direct shipments from distributors and manufacturers to the stores. Orchard
buys goods from approximately 1,000 different vendors. The Company's top 10
suppliers account for less than 18% of its total purchases, with no single
supplier accounting for more than 6% of the total. As its expansion rate
increases in fiscal 1994, the Company expects to benefit from greater volume
discounts created by growing sales volume generated by new stores.
DISTRIBUTION
Orchard's new warehouse facility, which commenced operations in February
1992, was designed to improve the in-stock position in the Company's stores by
increasing the amount of warehouse delivered
37
<PAGE>
merchandise versus vendor delivered merchandise, improving inventory management
and leveraging the Company's fixed cost structure as it expands its store base.
The 350,000 square foot warehouse facility is situated on approximately 28.5
acres of land in Tracy, California and replaced the Company's warehouse located
in San Jose, California, which was reaching its full capacity. The centrally
located warehouse is within a one day round trip (approximately a 300 mile
radius) of each Northern and Central California store. Management estimates
that the new warehouse will be able to support, with additional shifts, at
least 68 stores. The building was designed to be expanded by approximately
100,000 square feet at an estimated cost of $2.5 million. The warehouse allows
the Company to continue with its store expansion plans and maintain its ability
to process orders within 24 hours, thereby ensuring high in-stock levels (98%
on average). By removing the need for in-store storage space, Orchard maximizes
the selling space available in its stores, increases the stock level on each
store's shelves and reduces overall inventory requirements, thereby increasing
Orchard's high in-stock position.
Metropolitan Los Angeles is approximately 350 miles from the Company's
distribution center, which will result in significantly higher transportation
costs than in its current Northern and Central California markets. Management
expects to outsource the delivery of merchandise to the new stores south of
Santa Maria by use of an independent common carrier. As a result, management
expects transportation expenses as a percent of sales to be approximately 1.3%
higher for the metropolitan Los Angeles stores. The Company plans to process
orders from its metropolitan Los Angeles stores within 24 hours. The Company
expects to open an additional warehouse to service the metropolitan Los Angeles
stores after approximately 15 stores are open in that area. While the
additional warehouse will reduce transportation costs, it will initially have a
higher operating cost than the existing warehouse in Tracy, California. These
costs as a percentage of sales will be reduced as more stores are opened in the
metropolitan Los Angeles and Orange County markets.
Orchard operates a fleet of 29 tractors and 118 trailers, which are driven
and maintained by a non-union work force. The Company will be required to
expand its fleet of tractors and trailers when it opens a new distribution
center in metropolitan Los Angeles.
OPERATIONS
Orchard manages its operations on a centralized basis. Its headquarters staff
is responsible for all pricing, purchasing, advertising and promotional
programs, new site selection and administrative functions such as accounting,
payroll and management information systems. The Company's stores are operated
by store managers who report to one of five regional managers, four for the
Northern and Central California regions and one who will be responsible for
metropolitan Los Angeles. Orchard's store managers, who average in excess of 10
years of service with the Company, are responsible for day-to-day store
operations, subject to operating procedures established at headquarters.
The Company expects to add approximately 108 clerical and 17 management
workers to staff the Expansion stores. All management employees will undergo a
12 week training program and all other employees will undergo an eight week
training program prior to the Expansion store openings.
Orchard stores are open seven days a week. Depending on the size and sales
volume of the facility, the total number of personnel per store varies from 57
to 130, 25 to 49 of whom are full-time employees. A typical store is staffed
with a store manager, one first assistant manager, three assistant managers and
12 department managers.
MANAGEMENT INFORMATION SYSTEMS
Orchard's information systems have been designed and developed to sustain
growth through increased productivity and address a wide range of functions
that include sales analysis, merchandise ordering and processing, merchandise
management and presentation, management of human resources and financial
management. The Company's management is provided with concise relevant
information on performance
38
<PAGE>
that includes the daily individual store and department information necessary
for financial and merchandising decisions and periodic results reporting for
strategic planning and analysis.
Sales analysis reporting includes daily and periodic store sales results
detailed by department, classification and SKU movement. Merchandise ordering
is supported by the POM system which employs forecasting to calculate item
suggested order quantities for warehouse inventory replenishment. Purchase
orders are reviewed or created on-line and are electronically transmitted to
suppliers that participate in the hardware industry's "Eagle" Electronic Data
Interchange ("EDI") system. Price change control is an integral part of the POM
system.
The Store Order system is tightly coupled with the POM system and processes
daily transmitted store orders and produces warehouse pick tickets, shipping
manifests, "pool" (cross dock) distribution reports and productivity reports.
On-line capability of the system provides the warehouse with real-time
inventory data such as purchase order receiving, processing manifest exceptions
and updating inventory levels. This system is linked to the Retail Stock Ledger
financial system for store accounting.
The Point-of-Sale system is a fully integrated store sales, credit, inventory
and data collection system. The system provides automatic price look-up and
Orchard and bank card credit authorization at point-of-sale; sales audit
reporting; advertised item reporting; item sales performance and history; daily
computer review; and forecast and order generation of all warehouse replenished
items as well as suggested order quantities for items ordered directly from
vendors. The system provides improved customer service, reduces store operating
expense and provides disciplined inventory management. The Company expects to
install bar code scanning capabilities in all of its stores by the end of
fiscal 1993 and plans to install a UNIX based system in fiscal 1994.
Financial management is addressed by the retail stock ledger, accounts
payable, general ledger, fixed assets, bank card transmission, accounts
receivable and credit systems. These systems are traditional retail financial
control and operational systems with the exception of having on-line capability
wherever feasible in order to enhance productivity.
Management believes its systems are excellent and a key component to the
Company's ability to evaluate and respond to its markets and customers.
EMPLOYEES
As of October 31, 1993, Orchard had 3,857 total employees of whom 2,885 were
full time.
Management believes that its relationship with its employees is good. The
Company has never experienced a material interruption of business caused by
labor disputes. All of Orchard's employees are non-union.
PROPERTIES
Of the Company's 43 stores, eight are owned and 35 are leased under long-term
ground or building arrangements with various renewal options. All of these 35
leases are scheduled to expire after 2000 (including options to renew). See
Note 4 to Consolidated Financial Statements.
Orchard completed the acquisition of six former Builders Emporium stores on
November 16, 1993 and the acquisition of three former Builders Emporium stores
on December 22, 1993. Six of these stores are located in metropolitan Los
Angeles (Pasadena, South Pasadena, Burbank, Van Nuys, Hollywood and West Los
Angeles) and three of these stores are in new single-store markets previously
targeted for entry (Redding, Goleta and Pismo Beach). Orchard purchased three
of these stores (Van Nuys, Hollywood and Pismo Beach) and is leasing the
remainder. All but one of the Expansion store leases will expire after 2000
(including options to renew).
39
<PAGE>
The Company owns its new 350,000 square foot warehouse which commenced
operations in February 1992 and is located on 28.5 acres (including acreage
reserved for warehouse expansion) in Tracy, California. The Company also owns
its former San Jose warehouse which consists of several buildings totalling
282,000 square feet located on 17.4 acres. The Company has listed this facility
for sale at an asking price of $5.9 million and, in the alternative, is seeking
to enter into a long-term lease. The Company has also listed 11 acres it owns
adjacent to its distribution center in Tracy, California for $1.0 million.
The Company's corporate offices are located in a 75,761 square foot building
of which the Company leases 58,180 square feet. The Company's lease terminates
in November 1999, subject to the Company's option to renew the lease for a
five-year term at 90% of the market rate at the time of renewal. In addition,
the Company has a right of first refusal to lease the remaining space in 1997,
or earlier in the event that the space is vacated by the current tenant. The
Company believes that the facility is adequate for its present needs and that
the adjacent property subject to the right of first refusal will be available
to accommodate further expansion if needed.
LEGAL PROCEEDINGS
There are no material legal proceedings pending or, to the knowledge of
management of the Company, threatened against the Company.
40
<PAGE>
MANAGEMENT
EXECUTIVE OFFICERS AND DIRECTORS
The following table sets forth certain information concerning each person who
is an executive officer, Director or significant employee of the Company:
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<C> <C> <S>
Maynard Jenkins....... 51 President, Chief Executive Officer and Director
Brad R. Tukey......... 47 Executive Vice President
Stephen M. Hilberg.... 50 Vice President-Finance, Chief Financial Officer and
Director
William G. Collard.... 56 Vice President-Distribution
Joseph A. DiRocco..... 43 Vice President-Marketing
Robert A. Lewis....... 48 Vice President-Purchasing and General Merchandise
Manager
Carolyn J. McInnes.... 49 Vice President-Human Resources
Lee Nemechek.......... 60 Vice President-Stores
Bradford M. Freeman*+. 51 Director
Morton Godlas*+....... 70 Director
J. Frederick Simmons*. 39 Director
Ronald P. Spogli*+.... 45 Director
William E. Walsh...... 62 Director
William M. Wardlaw+... 47 Director
</TABLE>
- --------
*Member of the Compensation Committee.
+Member of the Audit Committee.
Each executive officer and Director of the Company serves in the same
capacity with Orchard Supply.
Mr. Jenkins has served as President of the Company and a Director since May
1989 and as Chief Executive Officer since 1986. Mr. Jenkins has over twenty-
five years of retail experience. Before joining the Company, Mr. Jenkins served
as the President and Chief Operating Officer of Pay 'n Save drug stores, where
he was responsible for operations, merchandising and advertising of the 108-
store chain with sales in excess of $500 million. Mr. Jenkins serves on the
advisory board of Malsham Group, Inc. ("Malsham"), a Canadian subsidiary of
Molson Companies, Ltd. Malsham operates the Aikenhead chain of warehouse home
centers and a chain of retail lumber yards and traditional home centers.
Mr. Tukey has served as Executive Vice President since July 1993. Prior to
joining Orchard, he served in senior management positions at several retailers,
including Standard Brands Paint Company, HomeBase and Handyman Home Centers,
Inc. Merchandising, marketing, real estate and store planning report to Mr.
Tukey.
Mr. Hilberg has served as Chief Financial Officer and Vice President-Finance
of the Company since 1981 and as a Director since May 1989. Until 1978, Mr.
Hilberg worked for Touche Ross & Co. where he advanced to the position of Audit
Manager and specialized in retail and distribution industries. From 1978 to
1981, Mr. Hilberg served as the Corporate Controller of Franklin Stores.
Mr. Collard has served as Vice President-Distribution of the Company since
1986. Mr. Collard joined the Company in 1979 and has over 30 years of
warehousing and distribution experience. Prior to joining the Company, Mr.
Collard served for seven years as the Operations Supervisor for Fleming Foods
and for nine years as the Warehouse Foreman for Louis Stores. Mr. Collard is
currently responsible for the Company's warehouse and distribution activities.
41
<PAGE>
Mr. DiRocco has served as Vice President-Marketing of the Company since 1986.
From 1983 to May 1986, Mr. DiRocco worked in the marketing and advertising
departments of the Company. Mr. DiRocco joined the Company in 1983 and has over
15 years of marketing experience in the retail industry.
Mr. Lewis has served as Vice President-Purchasing and General Merchandise
Manager of the Company since 1986. Mr. Lewis began his career at the Company in
1961 and is responsible for all aspects of the Company's merchandising and
buying program.
Ms. McInnes has served as Vice President-Human Resources of the Company since
1986. Ms. McInnes joined the Company in 1979 as Director of Training. She is
responsible for all of the Company's training, personnel, wage and benefits
related matters.
Mr. Nemechek joined the Company in March 1987 as a Regional Manager and was
promoted to Vice President-Stores in July 1990. Prior to joining Orchard, Mr.
Nemechek had over 30 years of experience in grocery and general merchandise
retailing. Mr. Nemechek is responsible for all aspects of store operations.
Mr. Freeman is a founding partner of FS&Co. Mr. Freeman became a Director of
the Company in connection with the 1989 Transaction. Mr. Freeman is also a
member of the Board of Directors of Duff & Phelps Corporation and Buttrey Food
and Drug Stores Company.
Mr. Godlas became a Director of the Company in July 1993 and is a management
consultant with more than 45 years of retail experience. Since 1982, Mr. Godlas
has been President and Chief Executive Officer of M. Godlas, Inc. From 1978 to
1982, Mr. Godlas was Corporate Senior Vice President-General Merchandise at
Lucky Stores, Inc. and served as President of GEMCO/MEMCO membership department
stores from 1976 to 1978. From 1976 to 1982, Mr. Godlas was a director of the
International Mass Retailing Association.
Mr. Simmons joined FS&Co. in 1986 and became a general partner in January
1991. Mr. Simmons became a Director of the Company in connection with the 1989
Transaction. Mr. Simmons is also a member of the Board of Directors of Buttrey
Food and Drug Stores Company, Purity Supreme, Inc. and EnviroSource, Inc.
Mr. Spogli is a founding partner of FS&Co. Mr. Spogli became a Director of
the Company in connection with the 1989 Transaction. Mr. Spogli is the Chairman
of the Board and a Director of EnviroSource, Inc. Mr. Spogli also serves on the
Board of Directors of Mac Frugal's Bargains . Close-Outs Inc., Buttrey Food and
Drug Stores Company and Purity Supreme, Inc. and on the Board of
Representatives of Brylane, L.P.
Mr. Walsh became a Director of the Company in July 1993 and is currently Head
Coach of the Stanford University football team. As head coach of the San
Francisco 49ers from 1979 to 1988, he led the team to three Super Bowl
championship titles. In addition to the numerous coaching positions he has held
since 1957, Mr. Walsh has also served as Executive Vice President for football
operations for the San Francisco 49ers and as a football analyst for NBC
television. He was elected to the Pro Football Hall of Fame in 1993. Mr. Walsh
is also a member of the Board of Directors of American Building Maintenance,
Inc.
Mr. Wardlaw joined FS&Co. in March 1988 and became a general partner in
January 1991. From 1984 to 1988, Mr. Wardlaw was a principal of the law firm of
Riordan & McKinzie. Mr. Wardlaw became a Director of the Company in connection
with the 1989 Transaction. Mr. Wardlaw is also a member of the Board of
Directors of Buttrey Food and Drug Stores Company, Purity Supreme, Inc. and
EnviroSource, Inc.
Each Director is elected to hold office until the next annual meeting of
stockholders and until his respective successor is elected and qualified.
Officers serve at the discretion of the Board of Directors. Non-employee
Directors not affiliated with FS&Co. receive $2,500 for each regular Board
meeting attended and $1,500 for each special Board meeting attended. All
Directors are reimbursed for their out-of-pocket expenses in serving on the
Board of Directors. See "--1993 Non-Employee Directors Stock Option Plan."
42
<PAGE>
EXECUTIVE COMPENSATION
The following table sets forth the cash compensation paid or accrued by the
Company to the President and Chief Executive Officer and to each of the four
additional most highly compensated executive officers for each of the fiscal
years in the three-year period ended January 31, 1993:
<TABLE>
<CAPTION>
LONG TERM
COMPENSATION
------------------
ANNUAL COMPENSATION AWARDS PAYOUTS
------------------------------------- ------- ----------
OTHER ALL
ANNUAL OPTIONS LTIP OTHER
NAME AND PRINCIPAL POSITIONS YEAR SALARY(1) BONUS(1)(2) COMPENSATION(3) (#)(4) PAYOUTS(5) COMPENSATION(3)
- ---------------------------- ---- --------- ----------- --------------- ------- ---------- ---------------
<S> <C> <C> <C> <C> <C> <C> <C>
Maynard Jenkins.......... 1992 $299,578 $286,747 -- 12,045 -- $4,723
President and Chief Ex-
ecutive 1991 293,000 -- -- --
Officer 1990 285,000 170,655 -- $206,300
Stephen M. Hilberg....... 1992 117,484 39,287 -- -- -- 2,182
Vice President-Finance
and 1991 115,000 -- -- --
Chief Financial Officer 1990 110,000 54,770 -- --
Robert A. Lewis.......... 1992 101,923 34,623 -- -- -- 1,903
Vice President-Purchas-
ing and 1991 100,000 -- -- --
General Merchandise Man-
ager 1990 95,000 47,400 -- --
John K. Self(6).......... 1992 97,692 28,223 -- -- -- 411
Vice President-Store
Planning 1991 99,000 -- -- --
1990 94,000 47,848 -- --
Joseph A. DiRocco........ 1992 92,704 31,860 -- -- -- 1,789
Vice President-Marketing 1991 91,000 -- -- --
1990 86,000 42,920 -- --
</TABLE>
- --------
(1) Amounts shown include compensation earned and received by executive
officers as well as amounts earned but deferred at the election of those
officers.
(2) Represents payments made to executive officers pursuant to the Company's
Performance Bonus Plan and a $100,000 bonus paid to Maynard Jenkins for
fiscal 1992 pursuant to his employment agreement. See "--Employment
Agreement."
(3) In accordance with the transitional provisions of the new executive
compensation disclosure rules adopted by the Securities and Exchange
Commission (the "Commission"), amounts of Other Annual Compensation and All
Other Compensation for fiscal 1990 and 1991 are excluded from this table.
(4) Represents options to purchase 12,045 shares of Common Stock made outside
the Option Plan (as defined below) to Maynard Jenkins on April 15, 1992
pursuant to a Nonqualified Stock Option Agreement.
(5) Represents a payment made pursuant to a discontinued long-term incentive
plan.
(6) Mr. Self resigned his position as Vice President-Store Planning and left
the Company in April 1993.
EMPLOYMENT AGREEMENT
Mr. Jenkins is party to an employment agreement which provides for a base
annual salary of not less than $275,000 per year and bonuses and fringe
benefits determined from time to time by the Company. In April 1992, Mr.
Jenkins' employment agreement was amended to provide for an additional $100,000
bonus to be paid to him annually. Upon termination of employment for death or
disability, Mr. Jenkins is entitled to a severance payment equal to six months
of his salary. Upon termination of employment other than for cause, death or
disability, Mr. Jenkins is entitled to a severance payment consisting of two
years' base salary, the target bonus applicable to the earning year in progress
at the date of termination and the $100,000 bonus for the year in progress at
the date of termination. See "--Performance Bonus."
43
<PAGE>
AMENDED 1989 NONQUALIFIED STOCK OPTION PLAN
Officers and certain employees, including Directors who are officers or
employees, of the Company who are chosen by the Compensation Committee of the
Company (the "Compensation Committee") are eligible to participate in the
Amended 1989 Nonqualified Stock Option Plan (the "Option Plan"). Only officers
and employees who do not own capital stock possessing more than 10% of the
total combined voting power or value of all classes of capital stock of the
Company are eligible to receive grants of options under the Option Plan. Under
the Option Plan, the participants may be granted nonqualified options (the
"Options") to purchase shares of the Company's Common Stock at a purchase price
determined by the Company's Compensation Committee. In no event shall such
purchase price be less than the fair market value of the underlying shares at
the time the Option is granted. The Options are not intended to qualify for
treatment as incentive stock options under Section 422 of the Internal Revenue
Code of 1986, as amended. Up to 60,000 shares of the Company's Common Stock may
be issued under the Option Plan upon the exercise of Options granted
thereunder. As of November 18, 1993, Options covering 43,741 shares of Common
Stock were outstanding under the Option Plan, and Options to purchase 6,945
shares of Common Stock had been exercised.
The following table sets forth information concerning options granted to each
of the named executive officers during fiscal 1992:
<TABLE>
<CAPTION>
POTENTIAL REALIZABLE
VALUE AT ASSUMED
INDIVIDUAL GRANTS ANNUAL RATES
------------------------------------------------------ OF STOCK
% OF TOTAL EXERCISE PRICE APPRECIATION
OPTIONS GRANTED TO OR BASE FOR OPTION TERM
EMPLOYEES IN PRICE EXPIRATION ---------------------
NAME OPTIONS GRANTED FISCAL YEAR ($/SH) DATE 5% 10%
---- --------------- ------------------ -------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Maynard Jenkins......... 12,045(1) 100% $8.33 05/15/02 $ 174,346 $ 337,048
Stephen M. Hilberg...... -- -- N/A N/A N/A N/A
Robert A. Lewis......... -- -- N/A N/A N/A N/A
John K. Self(2)......... -- -- N/A N/A N/A N/A
Joseph A. DiRocco....... -- -- N/A N/A N/A N/A
</TABLE>
- --------
(1) This option was granted outside the Option Plan pursuant to a Nonqualified
Stock Option Agreement and is only exercisable upon the occurrence of
certain mergers, consolidations, business combinations, asset sales, tender
offers, exchange offers or liquidations involving the Company (an
"Extraordinary Corporate Event").
(2) Mr. Self resigned his position as Vice President-Store Planning and left
the Company in April 1993.
The Options granted or to be granted under the Option Plan terminate at the
earliest to occur of (i) 90 days after the participant's termination of
employment by the Company (unless such termination results from the
participant's death or disability, or the participant dies within 90 days after
such termination of employment, in which case, the Option shall terminate 180
days after the date of the participant's termination of employment); (ii) ten
years from the date of grant; or (iii) on the effective date of a dissolution,
liquidation or sale of all of the business, properties and assets of the
Company or upon certain reorganizations, mergers or consolidations.
The Options vest and become exercisable in annual installments of 20% per
year over five years. Upon the occurrence of certain events constituting an
Extraordinary Corporate Event, the vesting of any outstanding Option will be
accelerated and each outstanding Option (and any portion thereof) will become
immediately and fully exercisable. Upon the occurrence of any event other than
an Extraordinary Corporate Event, the Compensation Committee may, in its sole
discretion, elect to accelerate the vesting of all or any portion of the
Options then outstanding.
44
<PAGE>
Under the Option Plan, any time prior to four years after the date of grant
of an Option, the Company has the option to repurchase all of the shares of
Common Stock acquired by the participant upon the exercise of such Option for a
period of 90 days after the date of termination of the participant due to
retirement, voluntary resignation, or dismissal, with or without cause (but
excluding death or disability). The purchase price for such repurchased shares
shall equal the greater of $8.33 or their fair market value. In addition, the
Company has a right of first refusal in the event a participant proposes to
sell any shares purchased upon exercise of such participant's Options. After
the termination of a participant's employment, the Options may be exercised
only with respect to that number of shares of Common Stock which could have
been purchased upon exercise of the Options at the time of the termination of
such employment.
The following table sets forth information concerning options held by each of
the named executive officers.
<TABLE>
<CAPTION>
NUMBER OF UNEXERCISED VALUE OF UNEXERCISED
OPTIONS AT IN-THE-MONEY OPTIONS AT
1992 FY-END 1992 FY-END
SHARES ACQUIRED ------------------------- -------------------------
NAME ON EXERCISE VALUE REALIZED EXERCISABLE/UNEXERCISABLE EXERCISABLE/UNEXERCISABLE
---- --------------- -------------- ------------------------- -------------------------
<S> <C> <C> <C> <C>
Maynard Jenkins......... -- -- 6,313/16,254 $35,795/$23,865
Stephen M. Hilberg...... -- -- 3,157/ 2,105 17,900/ 11,935
Robert A. Lewis......... -- -- 3,157/ 2,105 17,900/ 11,935
John K. Self(1)......... -- -- 2,104/ 1,403 11,930/ 7,955
Joseph A. DiRocco....... -- -- 3,157/ 2,105 17,900/ 11,935
</TABLE>
- --------
(1) Mr. Self resigned his position as Vice President-Store Planning and left
the Company in April 1993.
1993 NON-EMPLOYEE DIRECTORS STOCK OPTION PLAN
Non-employee Directors of the Company, excluding Directors who are affiliated
with FS&Co., are eligible to participate in the 1993 Non-Employee Directors
Stock Option Plan (the "Non-Employee Directors Plan"). Under the Non-Employee
Directors Plan, the Options are not intended to qualify for treatment as
incentive stock options under Section 422 of the Internal Revenue Code of 1986,
as amended. Participants in the Non-Employee Directors Plan may be granted
Options to purchase shares of the Company's Common Stock at a purchase price
determined by the Compensation Committee. In no event shall such purchase price
be less than 85% of the fair market value of the underlying shares at the time
the Option is granted, or less than 110% of the fair market value in the case
of any participant who owns capital stock possessing more than 10% of the total
combined voting power or value of all classes of capital stock of the Company
or its subsidiaries. The Options vest and become exercisable in annual
installments of 20% per year over five years. Up to 10,000 shares of the
Company's Common Stock may be issued under the Non-Employee Directors Plan upon
the exercise of Options granted thereunder. As of November 19, 1993, Options
covering 10,000 shares of Common Stock had been granted under the Non-Employee
Directors Plan, and no Options to purchase shares of Common Stock had been
exercised.
1993 STOCK OPTION PLAN
Officers and certain employees, including Directors who are officers or
employees, of the Company who are chosen by the Compensation Committee are
eligible to participate in the 1993 Stock Option Plan (the "1993 Plan"). Only
officers and employees who do not own capital stock possessing more than 10% of
the total combined voting power or value of all classes of capital stock of the
Company or its subsidiaries are eligible to receive grants of options under the
1993 Plan. Under the 1993 Plan, options may be intended to qualify for
treatment as incentive stock options under Section 422 of the Internal Revenue
Code of 1986, as amended. Participants in the 1993 Plan may be granted
incentive stock options or nonqualified stock options to purchase shares of the
Company's Common Stock at a purchase price determined by the Compensation
Committee. In no event shall such purchase price of incentive stock options be
less than the fair market value
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<PAGE>
of the underlying shares at the time the incentive stock option is granted. The
options vest as determined by the Compensation Committee. Up to 350,000 shares,
plus an annual increase equal to 1% of the total issued and outstanding shares
on the first day of each calendar year, of the Company's Common Stock may be
issued under the 1993 Plan upon the exercise of options granted thereunder. As
of November 19, 1993, options covering 95,000 shares of Common Stock had been
granted under the 1993 Plan, which grants were subject to stockholder approval
at the Company's annual meeting to be held in the spring of 1994.
EMPLOYEE STOCK SUBSCRIPTION PLAN
In connection with the 1989 Transaction in May 1989, the Board of Directors
adopted the 1989 Employee Stock Subscription Plan, as amended on August 7, 1989
and June 11, 1991 (as amended, the "Subscription Plan") pursuant to which an
aggregate of 97,200 shares of Series A Preferred Stock and 58,320 shares of
Common Stock were issued, at a purchase price of $10.00 and $8.33 per share,
respectively, to management and certain other key employees of the Company.
Pursuant to the Reclassification, all shares of Series A Preferred Stock were
converted into shares of Common Stock. All of the shares were purchased
pursuant to the Subscription Agreements which provide that one-fifth of the
shares of Common Stock purchased were deemed "vested" upon purchase, with the
remainder vesting in four equal annual installments. All of the shares of
Series A Preferred Stock were deemed vested upon purchase. If a purchaser's
employment with the Company is terminated prior to the fourth anniversary of
the date of purchase, the Company retains the right to repurchase all unvested
shares at their original purchase price. Except for certain permitted transfers
to family members, upon death or pursuant to a registered public offering, no
shares may be sold or transferred prior to the fourth anniversary of the date
of purchase. As of November 18, 1993, an aggregate of 147,169 shares of Common
Stock were outstanding under the Subscription Plan.
Members of management and employees may elect to pay a portion of the
purchase price for their shares purchased under the Subscription Plan through
the delivery of five-year, full recourse promissory notes, bearing interest at
the rate designated by Bankers Trust Company as its prime rate, as adjusted
from time to time. Accrued interest on the promissory notes is payable
quarterly, and the principal balance of, including all accrued and unpaid
interest on, the promissory notes is payable in full at maturity. For the
participants electing to deliver promissory notes, their shares are pledged to
the Company to secure payment of the notes. As of November 18, 1993, promissory
notes in the aggregate amount of $175,080 remained outstanding to the Company
by management and employees.
After giving effect to the Reclassification, the following executive officers
of the Company have acquired the number of shares of Common Stock set forth
after their names pursuant to the Subscription Plan: Maynard Jenkins, 35,920
shares of Common Stock; Stephen M. Hilberg, 17,960 shares of Common Stock; John
K. Self, 11,972 shares of Common Stock; Joseph A. DiRocco, 17,960 shares of
Common Stock; Robert A. Lewis, 17,960 shares of Common Stock; Carolyn J.
McInnes, 11,972 shares of Common Stock; William G. Collard, 11,972 shares of
Common Stock; and Lee Nemechek, 2,394 shares of Common Stock. For Messrs.
Hilberg, Self, DiRocco and Nemechek and Ms. McInnes, $50,000, $50,000, $75,000,
$10,000 and $30,000 of their purchase price, respectively, was financed through
the delivery of promissory notes. After giving effect to the Reclassification,
in addition to the preceding eight executive officers, 83 other employees of
the Company acquired 55,880 shares of Common Stock of the Company pursuant to
the Subscription Plan.
SALARY DEFERRAL AND PROFIT SHARING PLAN
All of Orchard's salaried and hourly employees over 21 years of age are
eligible to participate in the Company's Your Employee Savings Plus Plan, or
YES Plus Plan, after one year of employment. The YES Plus Plan allows eligible
employees to invest up to 6% of their pre-tax compensation and an additional 6%
of after-tax compensation. All amounts contributed by the employee are
immediately fully vested. Orchard matches 50% of employee contributions to the
YES Plus Plan up to a maximum employee contribution of 3% of the employee's
compensation. In addition, the Company may, in its discretion, contribute
amounts to a profit sharing pool which is then allocated to the accounts of all
eligible employees based on their covered
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<PAGE>
earnings. This contribution is determined yearly based on the Company's
performance and profitability. The Company's contributions only vest after two
years of service at which time such contributions are 40% vested. Thereafter,
the contributions vest at a rate of 20% for each year so that the Company's
contributions are fully vested after five years of service. Notwithstanding the
foregoing, the Company's contributions immediately vest when the employee
reaches 55 or upon the death or permanent disability of the employee while so
employed.
PERFORMANCE BONUS
The Company has instituted a bonus plan (the "Performance Bonus Plan")
covering senior management (the President and seven Vice Presidents) which
provides for annual bonus payments based upon the Company's performance against
annually established target levels of "EBDIT" (earnings before depreciation,
amortization of deferred charges, interest and income taxes) and "Free Cash
Flow" (EBDIT minus capital expenditures and plus or minus the change in working
capital). The amounts awarded each year are based on specified percentages of
each person's salary upon the Company's attaining such target levels. In
addition, if performance exceeds the target levels, senior management receives
a percentage of the excess amount.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Ronald P. Spogli, J. Frederick Simmons and Maynard Jenkins, the President and
Chief Executive Officer of the Company, served on the Compensation Committee
during fiscal 1992. Mr. Jenkins resigned from the Compensation Committee on
February 26, 1993. In April 1992, the Company and Maynard Jenkins entered into
an amendment to Mr. Jenkins' existing employment agreement. In addition, the
Company granted a nonqualified stock option outside of the Option Plan to Mr.
Jenkins. See "--Employment Agreement" and "--Amended 1989 Nonqualified Stock
Option Plan."
CERTAIN TRANSACTIONS
The Company has entered into an agreement to sell to FS Equity Partners III,
L.P., an affiliate of FS&Co. ("FSEP III"), 800,000 shares of Preferred Stock
with an aggregate liquidation preference of $20.0 million, resulting in
aggregate net proceeds to the Company of $19.3 million (net of $150,000 of
transaction costs). The Preferred Stock Agreement contains certain customary
conditions to closing which will be eliminated upon the closing of the
Offering, at which time the purchase of the Preferred Stock will become
unconditional. The purchase of the Preferred Stock will be consummated not
later than the time the proceeds are needed to fund the redemption of the 14.5%
Subordinated Notes. See "Principal Stockholders" and "Description of Capital
Stock--Preferred Stock."
Immediately following consummation of the Initial Public Offering, borrowings
under the Financing Agreement were used to pay $2.5 million of the accrued and
unpaid dividends on the Series A Preferred Stock, which was owned by FS Equity
Partners II, L.P., an affiliate of FS&Co. ("FSEP II"), and management
(including the executive officers set forth in the table under the caption
"Management"). The remainder of the accrued and unpaid dividends totalling
$10.8 million were paid in additional shares of Series A Preferred Stock. After
payment of the Series A Preferred Stock dividends, the Company completed the
Reclassification by amending its Certificate of Incorporation on the closing
date of the Initial Public Offering to reclassify its Series A Preferred Stock
into shares of Common Stock.
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<PAGE>
PRINCIPAL STOCKHOLDERS
The following table sets forth certain information regarding beneficial
ownership of the Company's capital stock as of December 1, 1993 (i) by each
person who is known by the Company to own beneficially more than 5% of Common
Stock, (ii) by certain of the Company's executive officers and each of the
Company's Directors and (iii) by all executive officers and Directors of the
Company as a group.
<TABLE>
<CAPTION>
DIRECTORS, OFFICERS AND 5% STOCKHOLDERS(1) SHARES PERCENT
------------------------------------------ --------- -------
<S> <C> <C>
Freeman Spogli & Co.(2).......................................... 2,693,023 38.9%
Maynard Jenkins(3)............................................... 44,338 *
Stephen M. Hilberg(4)............................................ 18,170 *
Robert A. Lewis.................................................. 32,170 *
John K. Self(5).................................................. -- --
Joseph A. DiRocco................................................ 6,000 *
Bradford M. Freeman(2)........................................... -- --
Morton Godlas.................................................... 500 *
J. Frederick Simmons(2).......................................... -- --
Ronald P. Spogli(2).............................................. -- --
William E. Walsh................................................. -- --
William M. Wardlaw(2)............................................ -- --
Directors and Executive Officers as a Group (15 persons)(2)(6)... 2,822,813 40.6%
</TABLE>
- --------
* Less than 1%.
(1) The persons named in this table have sole voting power and investment power
with respect to all shares of capital stock shown as beneficially owned by
them, subject to community property laws where applicable and the
information contained in this table and these notes.
(2) All shares are held of record by FSEP II. As general partner of FSEP II,
FS&Co. has the sole power to vote and dispose of such shares. Messrs.
Freeman, Simmons, Spogli and Wardlaw, each of whom is a Director of the
Company, and John M. Roth are general partners of FS&Co., and as such may
be deemed to be the beneficial owners of the shares of the Company's
capital stock indicated as beneficially owned by FS&Co. The business
address of FS&Co., its general partners and FSEP II is 11100 Santa Monica
Boulevard, Suite 1900, Los Angeles, California 90025. The Company has
entered into an agreement to sell 800,000 shares of Preferred Stock to FSEP
III. Assuming full conversion of the Preferred Stock, FS&Co. through its
affiliates will own approximately 48.4% of the outstanding Common Stock and
the Directors and executive officers as a group will own approximately
49.8% of the outstanding Common Stock. See "Certain Transactions" and
"Description of Capital Stock--Preferred Stock."
(3) Mr. Jenkins is a Director of the Company. 35,920 shares of Common Stock are
held by Maynard L. Jenkins, Jr. and Susan M. Jenkins, Co-Trustees under the
Living Trust dated November 10, 1988. The amount stated includes 8,418
shares of Common Stock covered by Options which are exercisable within the
next sixty days.
(4) Mr. Hilberg is a Director of the Company. Includes 4,210 shares of Common
Stock covered by Options which are exercisable within the next sixty days.
(5) Mr. Self resigned from the Company in April 1993.
(6) The amount of shares of Common Stock stated includes 23,012 shares of
Common Stock covered by Options which are exercisable within the next sixty
days.
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<PAGE>
DESCRIPTION OF NOTES
The Notes will be issued under an indenture (the "Indenture") dated as of
January 15, 1994, among Orchard Supply, Orchard Holding, as Guarantor, and U.S.
Trust Company of California, N.A., as trustee (the "Trustee"). The terms of the
Notes will include those stated in the Indenture and those made part of the
Indenture by reference to the Trust Indenture Act of 1939 (the "Trust Indenture
Act"), as in effect on the date of the Indenture. The Notes will be subject to
all such terms, and prospective investors are referred to the Indenture and the
Trust Indenture Act for a statement of such terms.
The statements under this caption relating to the Notes and the Indenture are
summaries and do not purport to be complete. Such summaries make use of certain
terms defined in the Indenture and are qualified in their entirety by express
reference to the Indenture, a copy of which is filed as an exhibit to the
Registration Statement of which this Prospectus is a part.
GENERAL
The Notes will bear interest from the date the Notes are first issued under
the Indenture at the rate shown on the cover page of this Prospectus, payable
semiannually on February 15 and August 15 of each year, commencing August 15,
1994, to holders of record at the close of business on February 1 or August 1
immediately preceding each such interest payment date. The Notes will be due on
February 15, 2002 and will be issued only in registered form, without coupons,
in denominations of $1,000 and integral multiples thereof.
The Notes will be senior obligations of Orchard Supply limited to an
aggregate amount of $100 million. The Notes will be senior to all subordinated
indebtedness of Orchard Supply and will rank pari passu in right of payment
with all senior indebtedness of Orchard Supply. At October 31, 1993, on an
adjusted basis after giving effect to the offering of the Notes and the
Preferred Stock and the application of the estimated net proceeds therefrom,
Orchard Supply would have had $39.7 million of indebtedness outstanding other
than the Notes. The ability of Orchard Supply and its Subsidiaries to incur
additional indebtedness will be limited by the "Limitations on Indebtedness"
covenant of the Indenture, and the ability of Orchard Supply and its
Subsidiaries to incur additional secured indebtedness will be limited by the
"Limitations on Liens" covenant of the Indenture.
PARENT GUARANTEE
Under the terms of the Indenture and subject to the provisions thereof,
Orchard Holding will unconditionally guarantee to the holders of the Notes from
time to time the due and punctual payment of the principal of, and premium and
interest on and any other Obligation of Orchard Supply with respect to, the
Notes when and as they shall become due and payable, whether at maturity, by
acceleration, redemption, repayment or otherwise, in accordance with the terms
of the Notes and the Indenture. In the event of a default in the payment of
principal, premium or interest or other Obligation by Orchard Supply, whether
at maturity, upon acceleration, redemption, repayment or otherwise, Orchard
Holding agrees to cause such payment to be made as if such payment were to be
made by Orchard Holding directly and the Indenture provides that the Trustee
may proceed directly against the Guarantor without first proceeding against
Orchard Supply. Orchard Holding is a holding company. The only material asset
of Orchard Holding is the capital stock of Orchard Supply.
REDEMPTION
Optional Redemption. The Notes may not be redeemed prior to February 15,
1998, except as provided below. On or after February 15, 1998, Orchard Supply
may, at its option, redeem the Notes in whole or in part, from time to time, at
the following redemption prices (expressed in percentages of the principal
amount thereof), in each case together with accrued interest, if any, to the
date of redemption.
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<PAGE>
If redeemed during the twelve-month period beginning February 15,
<TABLE>
<CAPTION>
YEAR PERCENTAGE
---- ----------
<S> <C>
1998.......................... 103.125%
1999.......................... 101.563
2000.......................... 100.000
2001.......................... 100.000
</TABLE>
Selection and Notice of Redemption. In the event that less than all of the
Notes are to be redeemed at any time, selection of Notes or portions thereof
for redemption will be made by the Trustee pro rata, by lot or by any other
method the Trustee shall deem fair and reasonable; provided, however, that no
Notes of $1,000 or less shall be redeemed in part. Notice of redemption to the
holders of the Notes to be redeemed in whole or in part shall be given by
mailing notice of such redemption by first-class mail, postage prepaid, at
least 30 days and not more than 60 days prior to the date fixed for redemption
to such holders of the Notes at their addresses as they shall appear upon the
registry books. On and after the redemption date, interest ceases to accrue on
the Notes or portions thereof called for redemption.
Sinking Fund. There will be no sinking fund for the Notes.
CERTAIN COVENANTS OF ORCHARD SUPPLY
The following is a summary of certain covenants that will be contained in the
Indenture. Such covenants will be applicable (unless waived or amended as
permitted by the Indenture) so long as any of the Notes are outstanding.
Reports to Holders of the Notes. So long as any of the Notes remain
outstanding, Orchard Holding will continue to remain subject to the periodic
reporting requirements of the Exchange Act, and will continue to furnish the
information required thereby to the Commission and to the Trustee. If Orchard
Supply files periodic reports under the Exchange Act, Orchard Supply will
furnish such reports to the Trustee.
Repurchase of Notes Upon Change of Control. In the event that there shall
occur a Change of Control, each holder of the Notes shall have the right, at
the holder's option, to require Orchard Supply to purchase all or any part of
such holder's Notes on the date (the "Repurchase Date") that is no later than
60 days after notice of the Change of Control, at 101% of the principal amount
thereof, plus accrued interest to the Repurchase Date.
On or before the thirtieth day after the Change of Control, Orchard Supply is
obligated to mail, or cause to be mailed, to all holders of record of such
Notes a notice regarding the Change of Control and the repurchase right. The
notice shall state the Repurchase Date, the date by which the repurchase right
must be exercised, the price for such Notes and the procedure which the holder
must follow to exercise such right. Substantially simultaneously with mailing
of the notice, Orchard Supply shall cause a copy of such notice to be published
in a newspaper of general circulation in the Borough of Manhattan, The City of
New York. To exercise such right, the holder of such Note must deliver at least
ten days prior to the Repurchase Date written notice to Orchard Supply (or an
agent designated by Orchard Supply for such purpose) of the holder's exercise
of such right, together with the Note with respect to which the right is being
exercised, duly endorsed for transfer; provided, that, if mandated by
applicable tender offer rules and regulations a holder may be permitted to
deliver such written notice nearer to the Repurchase Date as may be specified
by Orchard Supply.
Orchard Supply will comply with all applicable tender offer rules and
regulations, including Section 14(e) of the Exchange Act and the rules
thereunder, if Orchard Supply is required to give a notice of right of
repurchase as a result of a Change of Control.
"Change of Control" means (i) any sale, lease or other transfer (in one
transaction or a series of transactions) of all or substantially all of the
assets of Orchard Supply to any Person (other than a Wholly
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<PAGE>
Owned Subsidiary of Orchard Supply); (ii) Orchard Holding fails to own,
beneficially and of record, 100% of the Capital Stock of Orchard Supply; (iii)
a "person" or "group" (within the meaning of Sections 13(d) and 14(d)(2) of the
Exchange Act (other than FS&Co. or its Affiliates)) becomes the "beneficial
owner" (as defined in Rule 13d-3 under the Exchange Act) of Capital Stock of
Orchard Holding representing 50% or more of the voting power of the Capital
Stock of Orchard Holding; (iv) the Common Stock of Orchard Holding is no longer
registered under Section 12 of the Exchange Act; (v) Continuing Directors of
Orchard Holding or Orchard Supply cease to constitute at least a majority of
the Board of Directors of Orchard Holding or Orchard Supply, respectively; or
(vi) the stockholders of Orchard Holding or Orchard Supply approve any plan or
proposal for the liquidation or dissolution of Orchard Holding or Orchard
Supply; provided, however, that in the event that Orchard Holding is merged
into Orchard Supply in compliance with the terms of the Indenture and the
beneficial owners of the Capital Stock of Orchard Holding immediately prior to
such transaction beneficially own all the Capital Stock of Orchard Supply
immediately after such transaction, the provisions of clause (vi) above shall
not apply to such transaction and thereafter clause (ii) above shall no longer
be applicable and all references in this definition of Change of Control to
Orchard Holding shall be deemed to refer to Orchard Supply.
"Continuing Director" means a director who either was a member of the Board
of Directors of a Person on the date of the Indenture or who became a director
of the Person subsequent to such date and whose election, or nomination for
election by the Person's stockholders, was duly approved by a majority of the
Continuing Directors then on the Board of Directors of the Person, either by a
specific vote or by approval of the proxy statement issued by the Person on
behalf of the entire Board of Directors of the Person in which such individual
is named as nominee for director.
With respect to the disposition of assets, the phrase "all or substantially
all" as used in the Indenture (including as set forth under "Limitations on
Mergers, Consolidations and Sales of Assets" below) varies according to the
facts and circumstances of the subject transaction, has no clearly established
meaning under New York law (which governs the Indenture) and is subject to
judicial interpretation. Accordingly, in certain circumstances there may be a
degree of uncertainty in ascertaining whether a particular transaction would
involve a disposition of "all or substantially all" of the assets of Orchard
Supply, and therefore it may be unclear as to whether a Change of Control has
occurred and whether the holders have the right to require Orchard Supply to
repurchase Notes.
None of the provisions relating to a repurchase upon a Change of Control are
waivable by the Board of Directors of Orchard Supply. Orchard Supply could, in
the future, enter into certain transactions, including certain
recapitalizations of Orchard Supply, that would not constitute a "Change of
Control" with respect to the Change of Control purchase feature of the Notes,
but would increase the amount of indebtedness outstanding at such time.
The Indenture will require the payment of money for Notes or portions thereof
validly tendered to and accepted for payment by Orchard Supply pursuant to a
Change of Control offer. If a Change of Control were to occur, there can be no
assurance that Orchard Supply would have sufficient funds to pay the purchase
price for all Notes that Orchard Supply is required to repurchase. See
"Investment Considerations--Exercise of Change of Control Rights."
Failure by Orchard Supply to purchase the Notes when required upon a Change
of Control will result in an Event of Default with respect to the Notes.
These provisions could have the effect of deterring hostile or friendly
acquisitions of Orchard Supply or Orchard Holding where the person attempting
the acquisition views itself as unable to finance the purchase of the principal
amount of Notes which may be tendered to Orchard Supply upon the occurrence of
a Change of Control.
Limitations on Indebtedness. Orchard Supply will not, and will not permit any
of its Subsidiaries, directly or indirectly, to, create, incur, assume, become
liable for or guarantee the payment of (collectively,
51
<PAGE>
an "incurrence") any Indebtedness (including Acquired Indebtedness); provided
Orchard Supply may incur Indebtedness, including Acquired Indebtedness, and may
permit any Subsidiary of Orchard Supply to incur Acquired Indebtedness, if (i)
at the time of such event and after giving effect thereto, on a pro forma
basis, the Consolidated Fixed Charge Coverage Ratio of Orchard Supply would
have been greater than 2.0 to 1.0, and (ii) no Default or Event of Default
shall have occurred and be continuing at the time of or occur as a consequence
of the incurrence of such Indebtedness.
The foregoing limitations will not apply to the incurrence of (i) Permitted
Indebtedness, (ii) Refinancing Indebtedness and (iii) additional Indebtedness
of Orchard Supply the aggregate principal amount of which does not exceed $20.0
million outstanding at any one time.
Limitations on Preferred Stock of Subsidiaries. Orchard Supply will not
permit any of its Subsidiaries to issue any Preferred Stock (other than to
Orchard Supply or a Wholly Owned Subsidiary of Orchard Supply).
Limitations on Restricted Payments. Orchard Supply will not, and will not
permit any of its Subsidiaries to, directly or indirectly, make any Restricted
Payment unless:
(i) no Default or Event of Default shall have occurred and be continuing
at the time of or after giving effect to such Restricted Payment;
(ii) immediately after giving effect to such Restricted Payment, Orchard
Supply could incur at least $1.00 of Indebtedness (other than Permitted
Indebtedness) pursuant to the first paragraph of the "Limitations on
Indebtedness" covenant; and
(iii) immediately after giving effect to such Restricted Payment, the
aggregate amount of all Restricted Payments (the fair market value of any
such Restricted Payment if other than cash as determined in good faith by
Orchard Supply's Board of Directors and evidenced by a resolution of such
Board) declared or made after the Issue Date does not exceed the sum of (a)
50% of the Consolidated Net Income of Orchard Supply on a cumulative basis
during the period (taken as one accounting period) from and including the
first full fiscal quarter of Orchard Supply commencing after the Issue Date
and ending on the last day of Orchard Supply's last fiscal quarter ending
prior to the date of such Restricted Payment (or in the event such
Consolidated Net Income shall be a deficit, minus 100% of such deficit),
plus (b) 100% of the aggregate net cash proceeds of, and the fair market
value of marketable securities (as determined in good faith by Orchard
Supply's Board of Directors and evidenced by a resolution of such Board)
received by Orchard Supply from (1) a contribution of capital after the
Issue Date; (2) the issue or sale after the Issue Date of Capital Stock of
Orchard Supply (other than the issue or sale of (a) Disqualified Stock or
(b) Capital Stock of Orchard Supply to any Subsidiary of Orchard Supply);
and (3) the issue or sale after the Issue Date of any Indebtedness or other
securities of Orchard Supply convertible into or exercisable for Capital
Stock (other than Disqualified Stock) of Orchard Supply which has been so
converted or exercised, as the case may be.
The foregoing clauses (ii) and (iii) will not prohibit: (a) the payment of
any dividend within 60 days of its declaration if such dividend could have been
made on the date of its declaration without violation of the provisions of the
Indenture; (b) the repurchase, redemption or retirement of any shares of
Capital Stock of Orchard Supply in exchange for, or in an amount not in excess
of the net proceeds of the substantially concurrent sale (other than to a
Subsidiary of Orchard Supply) of, other shares of Capital Stock (other than
Disqualified Stock) of Orchard Supply; (c) the repurchase, redemption or
retirement of subordinated Indebtedness of Orchard Supply in exchange for, by
conversion into, or in an amount not in excess of the net proceeds of, a
substantially concurrent (x) issue or sale of Capital Stock (other than
Disqualified Stock) of Orchard Supply, (y) capital contribution to Orchard
Supply or (z) incurrence of Refinancing Indebtedness with respect to such
subordinated Indebtedness; (d) the making of Restricted Payments to Orchard
Holding for the purpose of paying the quarterly dividends accrued by Orchard
Holding on the outstanding 6% Cumulative Convertible Preferred Stock of Orchard
Holding; and (e) the making of Restricted Payments to Orchard Holding to cover
administrative expenses payable by Orchard Holding not exceeding $250,000 in
the aggregate in any 12-month period; provided, that, each Restricted Payment
described in clauses (a) through (e) (other than subclause (z) of clause (c))
of this sentence shall be taken into account for purposes
52
<PAGE>
of computing the aggregate amount of all Restricted Payments pursuant to clause
(iii) of the immediately preceding paragraph.
Limitations on Transactions with Affiliates. So long as any of the Notes
remain outstanding, Orchard Supply will not, and will not permit any of its
Subsidiaries to, make any loan, advance, guarantee or capital contribution to,
or for the benefit of, or sell, lease, transfer or otherwise dispose of any of
its properties or assets to, or for the benefit of, or purchase or lease any
property or assets from, or enter into or amend any contract, agreement or
understanding with, or for the benefit of, any Affiliate of Orchard Supply or
any Affiliate of any of Orchard Supply's Subsidiaries or any holder of 10% or
more of any class of Capital Stock of Orchard Supply (including any Affiliates
of such holders) (each, an "Affiliate Transaction") except for any Affiliate
Transaction the terms of which are at least as favorable as the terms which
could be obtained by Orchard Supply or such Subsidiary, as the case may be, in
a comparable transaction made on an arm's length basis with Persons who are not
such a holder, an Affiliate of such holder or an Affiliate of Orchard Supply or
any of Orchard Supply's Subsidiaries; provided that the payments described in
clauses (a), (d) and (e) of the last paragraph under the heading "Limitations
on Restricted Payments" above and in clauses (a) and (b) of the proviso in the
definition of Restricted Payment will not be deemed Affiliate Transactions.
In addition, Orchard Supply will not, and will not permit any Subsidiary of
Orchard Supply to, enter into an Affiliate Transaction, or any series of
related Affiliate Transactions, unless (i) with respect to such Transaction or
Transactions involving or having a value of more than $700,000, Orchard Supply
has (x) obtained the approval of a majority of the Board of Directors of
Orchard Supply in the exercise of their fiduciary duties and (y) either
obtained the approval of a majority of Orchard Supply's disinterested directors
or obtained an opinion of an independent financial advisor of national
recognition to the effect that such Transaction or Transactions are fair to
Orchard Supply or such Subsidiary, as the case may be, from a financial point
of view and (ii) with respect to such Transaction or Transactions involving or
having a value of more than $10 million, Orchard Supply has (x) obtained the
approval of a majority of the Board of Directors of Orchard Supply in the
exercise of their fiduciary duties and (y) delivered to the Trustee an opinion
of an independent financial advisor of national recognition to the effect that
such Transaction or Transactions are fair to Orchard Supply or such Subsidiary,
as the case may be, from a financial point of view.
Limitations on Dispositions of Assets of Orchard Supply. The Indenture will
provide that (i) Orchard Supply will not, and will not permit any of its
Subsidiaries to, make any Asset Disposition unless (x) Orchard Supply (or its
Subsidiary, as the case may be) receives consideration at the time of such sale
or other disposition at least equal to the fair market value thereof (as
determined in good faith by Orchard Supply's Board of Directors and evidenced
by a resolution of such Board), and (y) not less than 75% of the consideration
received by Orchard Supply (or its Subsidiary, as the case may be) is in the
form of cash, and (ii) the Net Cash Proceeds of such an Asset Disposition shall
be within 360 days, at Orchard Supply's election, (a) invested in the business
or businesses of Orchard Supply or a Subsidiary as of the Issue Date or any
related business, or (b) to the extent not so invested, applied to make a Net
Cash Proceeds Offer to purchase the Notes (on a pro rata basis if the amount
available for such repurchase is less than the principal amount of the Notes
tendered in such Net Cash Proceeds Offer plus accrued interest to the date of
repurchase) at a purchase price of 100% of the principal amount thereof plus
accrued interest to the date of repurchase. The provisions of clause (y) above
shall not apply to a sale of Orchard Supply's existing warehouse in San Jose,
California. Notwithstanding the foregoing, Orchard Supply and its Subsidiaries
will not be required to apply such Net Cash Proceeds to the repurchase or
repayment of the Notes in accordance with clause (ii) above except to the
extent that such Net Cash Proceeds, together with the aggregate Net Cash
Proceeds of prior Asset Dispositions, which have not been applied in accordance
with this provision, exceed $5 million, provided that when any non-cash
consideration is converted into cash, such cash shall constitute Net Cash
Proceeds and be subject to clause (ii) of the preceding sentence. The 75%
limitation of clause (y) above shall not apply to any Asset Disposition in
which the cash portion of the consideration received therefor is equal to or
greater than what the net after-tax proceeds would have been had such Asset
Disposition complied with the
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aforementioned 75% limitation if Orchard Supply shall have received an opinion
of independent tax counsel confirming the appropriateness of the tax treatment
of such Asset Disposition.
Limitations on Liens. Orchard Supply will not, and will not permit any
Subsidiary of Orchard Supply to, issue, assume, guarantee or suffer to exist
any Indebtedness secured by a Lien (other than a Permitted Lien) upon any
Property of Orchard Supply or any Subsidiary of Orchard Supply or any shares of
stock or debt of any Subsidiary of Orchard Supply, whether such Property is
owned at the date of the Indenture or thereafter acquired, without making
effective provision whereby the Notes shall be secured by such Lien equally and
ratably with such Indebtedness, so long as such Indebtedness shall be so
secured.
Limitations on Sale and Leaseback Transactions. Orchard Supply will not, and
will not permit any Subsidiary of Orchard Supply to, enter into any sale and
leaseback transaction with respect to any Property (whether now owned or
hereafter acquired) unless (i) if the sale or transfer of the Property to be
leased does not occur within 180 days after the acquisition of such Property,
Orchard Supply complies with the requirements of the "Limitations on
Dispositions of Assets of Orchard Supply" covenant and (ii) Orchard Supply or
such Subsidiary would be entitled under the "Limitations on Indebtedness"
covenant to incur at least $1.00 of Indebtedness after giving effect to such
sale and leaseback transaction on a pro forma basis; provided that this clause
(ii) shall not be applicable with respect to the premises owned by the Company
located in Pismo Beach, California and San Rafael, California if a sale and
leaseback transaction is consummated with respect thereto within the time
periods specified in the Indenture.
Limitations on Dividend and Other Payment Restrictions Affecting
Subsidiaries. Orchard Supply will not, and will not permit any of its
Subsidiaries to, directly or indirectly, create or otherwise cause or suffer to
exist or become effective any consensual encumbrance or restriction on the
ability of any Subsidiary of Orchard Supply to (i) (a) pay dividends or make
any other distributions on its Capital Stock, or any other interest or
participation in or measured by its profits, owned by Orchard Supply or any
other Subsidiary of Orchard Supply, or (b) pay any Indebtedness owed to Orchard
Supply or any other Subsidiary of Orchard Supply, (ii) make loans or advances
to Orchard Supply or a Subsidiary of Orchard Supply or (iii) transfer any of
its properties or assets to Orchard Supply or any other Subsidiary of Orchard
Supply, except for Permitted Liens and such other encumbrances or restrictions
existing under or by reason of (a) any restrictions, with respect to a
Subsidiary that is not a Subsidiary of Orchard Supply on the Issue Date, under
any agreement in existence at the time such Subsidiary becomes a Subsidiary of
Orchard Supply (unless such agreement was entered into in connection with, or
in contemplation of, such entity becoming a Subsidiary of Orchard Supply on or
after the Issue Date), (b) any restrictions under any agreement evidencing any
Acquired Indebtedness of a Subsidiary of Orchard Supply incurred pursuant to
the provisions of the "Limitations on Indebtedness" covenant; provided that
such restrictions shall not restrict or encumber any assets of Orchard Supply
or its Subsidiaries other than such Subsidiary, (c) terms relating to the
nonassignability of any operating lease, (d) customary provisions restricting
assignment of any contract (or any rights thereunder), (e) any encumbrance or
restriction existing under any agreement that refinances or replaces the
agreements containing restrictions described in clauses (a)-(d), provided that
the terms and conditions of any such restrictions are no less favorable to the
holders of the Notes than those under the agreement so refinanced or replaced,
or (f) any encumbrance or restriction due to applicable law.
Limitations on Mergers, Consolidations and Sales of Assets. Orchard Supply
will not consolidate or merge with or into, or sell, lease, convey or otherwise
dispose of all or substantially all of its assets (as an entirety or
substantially an entirety in one transaction or a series of related
transactions, including by way of liquidation or dissolution) to, any Person
unless: (i) the entity formed by or surviving any such consolidation or merger
(if other than Orchard Supply), or to which sale, lease, conveyance or other
disposition shall have been made (the "Surviving Entity"), is a corporation
organized and existing under the laws of the United States, any state thereof
or the District of Columbia; (ii) the Surviving Entity assumes by supplemental
indenture all of the obligations of Orchard Supply on the Notes and under the
Indenture; (iii) immediately after giving effect to such transaction, no
Default or Event of Default shall have occurred and be continuing; (iv)
immediately after giving effect to such transaction and the use of any net
proceeds therefrom on a pro
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forma basis, the Consolidated Tangible Net Worth of Orchard Supply or the
Surviving Entity, as the case may be, would be at least equal to the
Consolidated Tangible Net Worth of Orchard Supply immediately prior to such
transaction; and (v) immediately after giving effect to such transaction and
the use of any net proceeds therefrom on a pro forma basis, Orchard Supply or
the Surviving Entity, as the case may be, could incur at least $1.00 of
Indebtedness (other than Permitted Indebtedness) pursuant to the first
paragraph of the "Limitations on Indebtedness" covenant. Notwithstanding the
foregoing, any Wholly Owned Subsidiary may merge with or into the Company so
long as (a) all of the conditions specified above, except for clause (v), are
satisfied, and (b) the Company is the surviving entity.
CERTAIN DEFINITIONS
Set forth below is a summary of certain of the defined terms used in the
Indenture. Reference is made to the Indenture for the full definition of all
such terms as well as any other capitalized terms used herein for which no
definition is provided.
"Acquired Indebtedness" means (i) with respect to any Person that becomes a
Subsidiary of Orchard Supply (or is merged into Orchard Supply or any of its
Subsidiaries) after the Issue Date, Indebtedness of, or Preferred Stock issued
by, such Person or any of its Subsidiaries existing at the time such Person
becomes a Subsidiary of Orchard Supply (or is merged into Orchard Supply or any
of its Subsidiaries) that was not incurred in connection with, or in
contemplation of, such Person becoming a Subsidiary of Orchard Supply (or being
merged into Orchard Supply or any of its Subsidiaries) and (ii) with respect to
Orchard Supply or any of its Subsidiaries, any Indebtedness assumed by Orchard
Supply or any of its Subsidiaries or Non-recourse Indebtedness to which
Property acquired by Orchard Supply or any of its Subsidiaries is subject, in
each case in connection with the acquisition of any assets from another Person
(other than Orchard Supply or any of its Subsidiaries), which Indebtedness was
not incurred by such other Person in connection with, or in contemplation of,
such acquisition. Notwithstanding the foregoing, in no event will Preferred
Stock of Orchard Supply be deemed Acquired Indebtedness.
"Affiliate" means, when used with reference to a specified Person, any Person
directly or indirectly controlling or controlled by or under direct or indirect
common control with the Person specified. For the purposes of this definition,
"control," when used with respect to any Person, means the power to direct the
management and policies of such Person, directly or indirectly, whether through
the ownership of voting securities, by contract or otherwise; and the terms
"controlling" and "controlled" have meanings correlative to the foregoing.
Notwithstanding the foregoing, the term "Affiliate" shall not include, (i) with
respect to Orchard Supply, any Subsidiary of Orchard Supply, or (ii) with
respect to any Subsidiary of Orchard Supply, Orchard Supply or any other
Subsidiary of Orchard Supply.
"Asset Disposition" means, any sale, transfer, conveyance, lease or other
disposition (including, without limitation, by way of merger, consolidation or
sale and leaseback or sale of shares of Capital Stock in any Subsidiary) (each,
a "transaction") by Orchard Supply or any of its Subsidiaries to any Person
(other than (i) a transaction between Orchard Supply and a Wholly Owned
Subsidiary of Orchard Supply or a transaction between Wholly Owned Subsidiaries
of Orchard Supply; provided, that, if such sale, transfer, conveyance, lease or
other disposition is to a Wholly Owned Subsidiary, and the fair market value of
the assets that are the subject thereof is $1,000,000 or greater, such Wholly
Owned Subsidiary shall, in order for such transaction not to be deemed an
"Asset Disposition", enter into a supplemental indenture wherein such Wholly
Owned Subsidiary shall unconditionally guarantee all of the obligations of
Orchard Supply under the Indenture and the Notes and (ii) a transaction in the
ordinary course of business (including such a transaction with a Wholly Owned
Subsidiary)) of any Property. For purposes of this definition, the term "Asset
Disposition" shall not include any sale, transfer, conveyance, lease or other
disposition of assets and properties of Orchard Supply that is governed by the
provisions relating to "Limitations on Mergers, Consolidations and Sales of
Assets."
"Capital Stock" means, with respect to any Person, any and all shares,
interests, participations, or other equivalents (however designated) of or in
such Person's capital stock, and options, rights or warrants to purchase such
capital stock, whether now outstanding or issued after the Issue Date,
including, without limitation, all Common Stock and Preferred Stock.
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"Capitalized Lease Obligations" of any Person means the obligations of such
Person to pay rent or other amounts under a lease that is required to be
capitalized for financial reporting purposes in accordance with GAAP; and the
amount of such obligation shall be the capitalized amount thereof determined in
accordance with GAAP.
"Commodity Agreement" of any Person means any option or futures contract or
similar agreement or arrangement designed to protect such Person or any of its
Subsidiaries against fluctuations in commodity prices.
"Consolidated Cash Flow Available for Fixed Charges" of Orchard Supply for
any period means, without duplication, the amounts for such period of the sum
of (i) Consolidated Net Income, plus (ii) taxes based upon the income of
Orchard Supply with respect to the period, plus (iii) interest expense for such
period, plus (iv) all depreciation and amortization and all other non-cash
charges to earnings (excluding any such non-cash charge constituting an
extraordinary item of loss or any non-cash charge that requires an accrual of
or a reserve for cash charges for any future period), minus (v) all non-cash
items increasing Consolidated Net Income; all as determined on a consolidated
basis for Orchard Supply and its Subsidiaries in accordance with GAAP.
Consolidated Cash Flow Available for Fixed Charges for any period shall be
adjusted to give pro forma effect (to the extent applicable) to (i) any
Investment by Orchard Supply or a Subsidiary of Orchard Supply from the
beginning of such period through the applicable determination date (the
"Reference Period") in any Person which, as a result of such Investment,
becomes a Subsidiary of Orchard Supply or, in the acquisition of assets from
any Person which constitutes substantially all of an operating unit or business
of such Person, but only if the financial statements of such Person or
operating unit or business used in calculating such pro forma effect shall have
been audited by independent accountants and (ii) the sale or other disposition
of any assets (including capital stock) of Orchard Supply or a Subsidiary of
Orchard Supply, other than in the ordinary course of business, during the
Reference Period as if such Investment or sale or disposition of assets by
Orchard Supply or a Subsidiary of Orchard Supply occurred on the first day of
the Reference Period.
"Consolidated Fixed Charge Coverage Ratio" of Orchard Supply means, with
respect to any determination date, the ratio of (i) Consolidated Cash Flow
Available for Fixed Charges of Orchard Supply for the prior four full fiscal
quarters for which financial results have been reported immediately preceding
such determination date; to (ii) Consolidated Fixed Charges which Orchard
Supply shall accrue during the next succeeding four full fiscal quarters for
which financial results will be reported immediately following such
determination date, such Consolidated Fixed Charges to be calculated on the
basis of the amount of Orchard Supply's Indebtedness (on a consolidated basis)
outstanding on the determination date and reasonably anticipated by the Board
of Directors of Orchard Supply to be outstanding from time to time during such
period.
"Consolidated Fixed Charges" of Orchard Supply for any period means the sum
of: (i) the aggregate amount of interest which, in conformity with GAAP, would
be set forth opposite the caption "interest expense" or any like caption on a
consolidated income statement for Orchard Supply and its Subsidiaries
(including, but not limited to, imputed interest included on Capitalized Lease
Obligations, all commissions, discounts and other fees and charges owed with
respect to letters of credit and banker's acceptance financing, the net costs
associated with Commodity Agreements, Currency Agreements and Interest
Protection Agreements, amortization of other financing fees and expenses, the
interest portion of any deferred payment obligation, amortization of discount
premium, if any, and all other non-cash interest expense other than interest
amortized to cost of sales), plus (ii) interest incurred during the period and
capitalized by Orchard Supply and its Subsidiaries, on a consolidated basis in
accordance with GAAP, plus (iii) the amount of Preferred Stock dividends
accrued by Orchard Holding or any of Orchard Supply's Subsidiaries on any
Preferred Stock (other than Preferred Stock dividends payable to Orchard Supply
or any Wholly Owned Subsidiary) whether or not paid during such period;
provided that, in making such computation, the Consolidated Fixed Charges
attributable to interest on any Indebtedness computed on a pro forma basis and
bearing a floating interest rate shall be computed as if the rate in effect on
the date of computation will be the applicable rate for the entire period.
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"Consolidated Net Income" of Orchard Supply for any period means the net
income (or loss) of Orchard Supply and its Subsidiaries for such period,
determined on a consolidated basis in accordance with GAAP; provided that there
shall be excluded from the computation of net income (loss) (to the extent
otherwise included therein) without duplication: (i) the net income (or loss)
of any Person (other than a Subsidiary of Orchard Supply) in which any Person
other than Orchard Supply or any of its Subsidiaries has an ownership interest,
except to the extent that any such income has actually been received by Orchard
Supply or any of its Subsidiaries in the form of dividends or similar
distributions during such period; (ii) the net income (or loss) of any Person
that accrued prior to the date that (a) such Person becomes a Subsidiary of
Orchard Supply or is merged into or consolidated with Orchard Supply or any of
its Subsidiaries or (b) the assets of such Person are acquired by Orchard
Supply or any of its Subsidiaries, except for purposes of a pro forma
calculation pursuant to clause (i) of the second sentence of the definition of
Consolidated Cash Flow Available for Fixed Charges, the net income (or loss) of
such Person shall be taken into account for the full four-quarter period for
which the calculation is being made; (iii) the net income of any Subsidiary of
Orchard Supply to the extent that (but only as long as) the declaration or
payment of dividends or similar distributions by such Subsidiary of that income
is not permitted by operation of the terms of its charter or any agreement,
instrument, judgment, decree, order, statute, rule or governmental regulation
applicable to the Subsidiary during such period; (iv) any gain or loss,
together with any related provisions for taxes on any such gain or loss,
realized during such period by Orchard Supply or any of its Subsidiaries upon
(a) the acquisition of any securities, or the extinguishment of any
Indebtedness, of Orchard Supply or any of its Subsidiaries or (b) any Asset
Disposition by Orchard Supply or any of its Subsidiaries; (v) any extraordinary
gain or loss, together with any related provision for taxes on any such
extraordinary gain or loss, realized by Orchard Supply or any of its
Subsidiaries during such period; (vi) in the case of a successor to Orchard
Supply by consolidation, merger or transfer of its assets, any earnings of the
successor prior to such merger, consolidation or transfer of assets, except for
purposes of a pro forma calculation pursuant to clause (v) under "Certain
Covenants of Orchard Supply--Limitations on Mergers, Consolidations and Sales
of Assets" above; and (vii) amortization of debt discount and other debt
issuance costs relating to the issuance of the Notes; and provided further,
that there shall be included in such net income (to the extent not otherwise
included therein) the net income of any Subsidiary of Orchard Supply to the
extent such net income is actually received by Orchard Supply or a Subsidiary
of Orchard Supply in the form of cash dividends or other cash distributions
from such Subsidiary.
"Consolidated Tangible Net Worth" means, with respect to any Person, the
consolidated stockholder's equity (including any Preferred Stock that is
classified as equity under GAAP, other than Disqualified Stock) of such Person
and its Subsidiaries, as determined in accordance with GAAP, less the book
value of all Intangible Assets reflected on the consolidated balance sheet of
Orchard Supply and its Subsidiaries as of such date.
"Credit Agreement" means the Financing Agreement, dated October 29, 1992, as
amended as of July 29, 1993, November 12, 1993 and November 24, 1993, between
Orchard Supply and The CIT Group/Business Credit, Inc., as the same may be
amended hereafter from time to time and any subsequent agreement or agreements
constituting a refinancing, extension, modification or substitution thereof in
whole or in part.
"Currency Agreement" of any Person means any foreign exchange contract,
currency swap agreement of other similar agreement or arrangement designed to
protect such Person or any of its Subsidiaries against fluctuations in currency
values.
"Disqualified Stock" means any Capital Stock that, by its terms (or by the
terms of any security into which it is convertible or for which it is
exchangeable), or upon the happening of any event (other than a change in
control which would not occur prior to a Change of Control under the
Indenture), (i) matures or is mandatorily redeemable, pursuant to a sinking
fund obligation or otherwise, or is redeemable at the option of the holder
thereof, in whole or in part, on or prior to the final maturity date of the
Notes or (ii) is convertible into or exchangeable for (whether at the option of
the issuer or the holder thereof) (a) debt securities or (b) any Capital Stock
referred to in (i) above, in each case, at any time prior to the final maturity
date of the Notes.
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"GAAP" means generally accepted accounting principles set forth in the
opinions and pronouncements of the Accounting Principles Board of the American
Institute of Certified Public Accountants and statements and pronouncements of
the Financial Accounting Standards Board or in such other statements by such
other entity as may be approved by a significant segment of the accounting
profession of the United States, as in effect on the Issue Date.
"Indebtedness" of any Person means, without duplication, (i) any liability of
such Person (a) for borrowed money, or under any reimbursement obligation
relating to a letter of credit, (b) evidenced by a bond, note, debenture or
similar instrument (including a purchase money obligation) given in connection
with the acquisition of any business, properties or assets of any kind or with
services incurred in connection with capital expenditures, or (c) in respect of
Capitalized Lease Obligations, (ii) any Indebtedness of others that such person
has guaranteed or that is otherwise its legal liability, (iii) to the extent
not otherwise included, obligations under Currency Agreements, Commodity
Agreements or Interest Protection Agreements, and (iv) all Indebtedness of
others secured by a Lien on any asset of such Person, whether or not such
Indebtedness is assumed by such Person, provided that Indebtedness shall not
include accounts payable (including, without limitation, accounts payable to
such Person by any of its Subsidiaries or to any such Subsidiary by such Person
or any of its other Subsidiaries, in each case, in accordance with customary
industry practice) or liabilities to trade creditors of such Person arising in
the ordinary course of business. The amount of Indebtedness of any Person at
any date shall be (a) the outstanding balance at such date of all unconditional
obligations as described above, (b) the maximum liability of such Person for
any contingent obligations under clause (ii) above at such date and (c) in the
case of clause (iv) above, the lesser of (1) the fair market value of any asset
subject to a Lien securing the Indebtedness of others on the date that the Lien
attaches and (2) the amount of the Indebtedness secured.
"Intangible Assets" of any Person means all unamortized debt discount and
expense, unamortized deferred charges, goodwill, patents, trademarks, service
marks, trade names, copyrights, write-ups of assets over their prior carrying
values (other than write-ups which occurred prior to the Issue Date and other
than, in connection with the acquisition of an asset, the write-up of the value
of such asset (within one year of its acquisition) to its fair market value in
accordance with GAAP), and all other items which would be treated as
intangibles on the consolidated balance sheet of Orchard Supply and its
Subsidiaries prepared in accordance with GAAP.
"Interest Protection Agreement" of any Person means any interest rate swap
agreement, interest rate collar agreement, option or future contract or other
similar agreement or arrangement designed to protect such Person or any of its
Subsidiaries against fluctuations in interest rates.
"Investment" of any Person means (i) all investments by such Person in any
other Person in the form of loans, advances or capital contributions, (ii) all
guarantees of Indebtedness or other obligations of any other Person by such
Person, (iii) all purchases (or other acquisitions for consideration) by such
Person of Indebtedness, Capital Stock or other securities of any other Person
and (iv) all other items that would be classified as investments (including,
without limitation, purchases of assets outside the ordinary course of
business) on a balance sheet of such Person prepared in accordance with GAAP.
"Issue Date" means the date on which the Notes are originally issued under
the Indenture.
"Lien" means, with respect to any Property, any mortgage, easement, lien,
lease, pledge, charge, security interest or encumbrance of any kind in respect
of such Property. For purposes of this definition, Orchard Supply shall be
deemed to own subject to a Lien any Property which it has acquired or holds
subject to the interest of a vendor or lessor under any conditional sale
agreement, capital lease or other title retention agreement relating to such
Property.
"Net Cash Proceeds" means with respect to an Asset Disposition, cash payments
received (including any cash payments received by way of deferred payment of
principal pursuant to a note or installment receivable or otherwise (including
any cash received upon sale or disposition of such note or receivable), but
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only as and when received), excluding any other consideration received in the
form of assumption by the acquiring Person of Indebtedness or other obligations
relating to the Property disposed of in such Asset Disposition or received in
any other non-cash form unless and until such non-cash consideration is
converted into cash therefrom, in each case, net of all legal, title and
recording tax expenses, commissions and other fees and expenses incurred, and
all federal, state, provincial, foreign and local taxes paid or required to be
accrued as a liability under GAAP as a consequence of such Asset Disposition,
and in each case net of a reasonable reserve for the after-tax cost of any
indemnification payments (fixed and contingent) attributable to the seller's
indemnities to the purchaser undertaken by Orchard Supply or any of its
Subsidiaries in connection with such Asset Disposition (but excluding any
payments, which by the terms of the indemnities will not, under any
circumstances, be made during the term of the Notes), and net of all payments
made on any Indebtedness which is secured by such Property, in accordance with
the terms of any Lien upon or with respect to such Property, or which must by
its terms or by applicable law be repaid out of the proceeds from such Asset
Disposition, and net of all distributions and other payments made to minority
interest holders in Subsidiaries or joint ventures as a result of such Asset
Disposition.
"Permitted Indebtedness" means (i) Indebtedness of Orchard Supply and its
Subsidiaries outstanding immediately following the offering of the Notes and
the application of the proceeds therefrom in the manner set forth under "Use of
Proceeds"; (ii) Indebtedness under the Credit Agreement, provided that (a)
during a period of 30 consecutive days during each fiscal year of Orchard
Supply, the amount of borrowings outstanding under the Credit Agreement,
excluding obligations under the Credit Agreement relating to letters of credit,
does not exceed $20.0 million and (b) the maximum amount of Indebtedness
permitted under this clause (ii) shall not exceed at any time 40% of the
aggregate amount of Orchard Supply's accounts receivable and inventory (as
determined in accordance with GAAP); (iii) any guarantee of the Notes by a
Subsidiary of Orchard Supply; (iv) Indebtedness in respect of obligations of
Orchard Supply to the Trustee under the Indenture; (v) intercompany debt
obligations (including intercompany notes and guarantees by Orchard Supply of
Indebtedness of its Subsidiaries) of Orchard Supply and each of its
Subsidiaries; provided, however, that the obligations of Orchard Supply to any
of its Subsidiaries or other Persons with respect to such Indebtedness shall be
subject to a subordination agreement providing for the subordination of such
obligations in right of payment from and after such time as all Notes issued
and outstanding shall become due and payable (whether at stated maturity, by
acceleration or otherwise) to the payment and performance of Orchard Supply's
obligations under the Indenture and the Notes; provided further, that any
Indebtedness of Orchard Supply or any of its Subsidiaries owed to any other
Subsidiary of Orchard Supply that ceases to be such a Subsidiary shall be
deemed to be incurred and shall be treated as an incurrence for purposes of the
first paragraph of the covenant described under "Limitations on Indebtedness"
at the time the Subsidiary in question ceased to be a Subsidiary of Orchard
Supply; and (vi) Indebtedness of Orchard Supply or its Subsidiaries under any
Currency Agreements, Commodity Agreements or Interest Protection Agreements.
"Permitted Liens" means (i) Liens existing on the Issue Date, (ii) Liens on
the Company's accounts receivable and inventory (and related general
intangibles and proceeds) securing Indebtedness under the Credit Agreement,
(iii) Liens securing Indebtedness collateralized by Property of, or any shares
of stock of or debt of, any corporation existing at the time such corporation
becomes a Subsidiary of Orchard Supply or at the time such corporation is
merged into Orchard Supply or any of its Subsidiaries, provided that such Liens
are not incurred in connection with, or in contemplation of, such corporation
becoming a Subsidiary of Orchard Supply or merging into Orchard Supply or any
of its Subsidiaries, (iv) Liens securing Refinancing Indebtedness used to
refund, refinance or extend Indebtedness, provided that any such Lien does not
extend to or cover any Property or class of Property, shares or debt other than
the Property or class of Property, shares or debt securing the Indebtedness so
refunded, refinanced or extended, (v) Liens in favor of Orchard Supply or any
of its Subsidiaries, (vi) Liens on Property of Orchard Supply or any of its
Subsidiaries acquired after the Issue Date in favor of governmental bodies to
secure progress or advance payments relating to such Property, (vii) Liens on
Property of Orchard Supply or any of its Subsidiaries acquired after the Issue
Date securing industrial revenue or pollution control bonds issued in
connection with the acquisition or refinancing of such Property, (viii) Liens
to secure certain Indebtedness that is otherwise permitted under the Indenture
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and that is used to finance the cost of Property of Orchard Supply or any of
its Subsidiaries acquired after the Issue Date, provided that (a) any such Lien
is created solely for the purpose of securing Indebtedness representing, or
incurred to finance, refinance or refund, the cost (including sales and excise
taxes, installation and delivery charges and other direct costs of, and other
direct expenses paid or charged in connection with, such purchase or
construction) of such Property, (b) the principal amount of the Indebtedness
secured by such Lien does not exceed 100% of such cost, (c) the Indebtedness
secured by such Lien is incurred by Orchard Supply or its Subsidiary within 180
days of the acquisition of such Property by Orchard Supply or its Subsidiary,
as the case may be, and (d) such Lien does not extend to or cover any Property
other than such item of Property and any improvements on such item, (ix) Liens
to secure Indebtedness that is otherwise permitted under the Indenture the
aggregate principal amount of which does not exceed $5 million outstanding at
any one time, (x) Liens or deposits incidental to the conduct of business or
the ownership of properties and assets (including Liens or deposits in
connection with worker's compensation, unemployment insurance and other like
laws, statutory landlords', carriers', warehouseman's, mechanics', suppliers',
materialmen's, repairmen's or similar Liens) and Liens or deposits to secure
the performance of bids, tenders or trade contracts, or to secure statutory
obligations, surety or appeal bonds or other Liens or deposits of like general
nature incurred in the ordinary course of business and with respect to amounts
which are not yet delinquent or are being contested in good faith by
appropriate proceedings, and if a reserve or other appropriate provision, if
any, as shall be required in conformity with GAAP shall have been made
therefor, (xi) Liens arising by reason of any judgment, decree or order of any
court so long as such Liens are being contested in good faith by appropriate
proceedings and the execution or other enforcement of such Liens is effectively
stayed, (xii) Liens for taxes, assessments or governmental charges not yet
delinquent or which are being contested in good faith by appropriate
proceedings and for which adequate reserve or other appropriate provision has
been made in accordance with GAAP; (xiii) easements, reservations, licenses,
rights of way, zoning restrictions and covenants and restrictions and other
similar encumbrances or title defects which, in the aggregate, do not
materially detract from the use by Orchard Supply or any Subsidiary of the
Property subject thereto, or materially interfere with the ordinary conduct of
the business of Orchard Supply or any of its Subsidiaries; and (xiv) the
interest of a lessee under any lease under which Orchard Supply or any
Subsidiary is a lessor.
"Person" means any individual, corporation, limited or general partnership,
joint venture, association, joint stock company, trust, unincorporated
organization or government or any agency or political subdivision thereof.
"Preferred Stock" of any Person means all Capital Stock of such Person which
has a preference in liquidation or a preference with respect to the payment of
dividends.
"Property" of any Person means all types of real, personal, tangible,
intangible or mixed property owned by such Person whether or not included in
the most recent consolidated balance sheet of such Person and its Subsidiaries
under GAAP.
"Refinancing Indebtedness" means Indebtedness that refunds, refinances or
extends any Indebtedness of Orchard Supply or its Subsidiaries outstanding on
the Issue Date or other Indebtedness permitted to be incurred by Orchard Supply
or its Subsidiaries pursuant to the terms of the Indenture (other than
Indebtedness referred to in clause (iii) of the second paragraph of the
"Limitations on Indebtedness" covenant), but only to the extent that (i) the
Refinancing Indebtedness is subordinated to the Notes to the same extent as the
Indebtedness being refunded, refinanced or extended, if at all, (ii) the
Refinancing Indebtedness is scheduled to mature either (a) no earlier than the
Indebtedness being refunded, refinanced or extended, or (b) after the maturity
date of the Notes, (iii) the portion, if any, of the Refinancing Indebtedness
that is scheduled to mature on or prior to the maturity date of the Notes has a
weighted average life to maturity at the time such Refinancing Indebtedness is
incurred that is equal to or greater than the weighted average life to maturity
of the portion of the Indebtedness being refunded, refinanced or extended that
is scheduled to mature on or prior to the maturity date of the Notes, (iv) such
Refinancing Indebtedness is in an aggregate principal amount that is equal to
or less than the sum of (a) the aggregate principal amount
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then outstanding under the Indebtedness being refunded, refinanced or extended,
(b) the amount of accrued and unpaid interest, if any, on such Indebtedness
being refunded, refinanced or extended and (c) the amount of customary fees,
expenses and costs related to the incurrence of such Refinancing Indebtedness,
and (v) such Refinancing Indebtedness is incurred by the same Person that
initially incurred the Indebtedness being refunded, refinanced or extended,
except that (a) Orchard Supply may incur Refinancing Indebtedness to refund,
refinance or extend Indebtedness of any Subsidiary of Orchard Supply and (b)
any Subsidiary of Orchard Supply may incur Refinancing Indebtedness to refund,
refinance or extend Indebtedness of a Subsidiary of Orchard Supply.
"Restricted Investment" means, with respect to any Person, any Investment by
such Person in (i) any of its Affiliates or in any Person that becomes an
Affiliate as a result of such Investment, (ii) any executive officer or
director of such Person or (iii) any executive officer or director of any
Affiliate of such Person; provided, that, loans not in excess of $150,000 in
the aggregate at any one time outstanding and not in excess of $50,000 to any
one individual executive officer or director of such Person will not be a
Restricted Investment if, in the case of the President of Orchard Supply, the
loan was approved by a majority of the disinterested directors and, in the case
of all other individuals, the loans were approved by the President of Orchard
Supply.
"Restricted Payment" means any of the following: (i) the declaration or
payment of any dividend or any other distribution on Capital Stock of Orchard
Supply or any Subsidiary of Orchard Supply or any payment made to the direct or
indirect holders (in their capacities as such) of Capital Stock of Orchard
Supply or any Subsidiary of Orchard Supply (other than (a) dividends or
distributions payable solely in Capital Stock (other than Disqualified Stock)
and (b) in the case of Subsidiaries of Orchard Supply, dividends or
distributions payable to Orchard Supply or to a Subsidiary of Orchard Supply);
(ii) the purchase, redemption or other acquisition or retirement for value of
any Capital Stock, or any option, warrant, or other right to acquire shares of
Capital Stock, of Orchard Supply or any of its Subsidiaries; (iii) the making
of any principal payment on, or the purchase, defeasance, repurchase,
redemption or other acquisition or retirement for value, prior to any scheduled
maturity, scheduled repayment or scheduled sinking fund payment, of any
Indebtedness which is subordinated in right of payment to the Notes other than
with the proceeds from the incurrence of Refinancing Indebtedness related
thereto; and (iv) the making of any Restricted Investment or guarantee of any
Restricted Investment in any Person; provided that, notwithstanding the
foregoing, (a) advances to employees, officers, directors, agents and
representatives for travel and other reasonable and ordinary business expenses
and (b) advances and loans to employees and officers in connection with their
relocation shall not be deemed Restricted Payments.
"Subsidiary" means, with respect of any Person, any corporation or other
entity of which a majority of the Capital Stock or other ownership interests
having ordinary voting power to elect a majority of the Board of Directors or
other persons performing similar functions are at the time directly or
indirectly owned or controlled by such Person.
"Wholly Owned Subsidiary" of any Person means, at any time, a Subsidiary all
of the Capital Stock of which (except directors' qualifying shares, if any) are
at the time owned directly or indirectly by such Person.
EVENTS OF DEFAULT AND NOTICE THEREOF
The term "Event of Default" when used in the Indenture will mean any one of
the following: (i) failure of Orchard Supply to pay interest on the Notes when
due and continuance of such failure for 30 days; (ii) failure of Orchard Supply
to pay principal of or premium on the Notes when due, whether at maturity, upon
acceleration, redemption or otherwise; (iii) failure of Orchard Supply or
Orchard Holding to perform any other covenant in the Indenture for 30 days
after notice from the Trustee or the holders of 25% in principal amount of the
Notes outstanding (except in the case of a default with respect to the "Change
of Control" and "Limitations on Mergers, Consolidations and Sales of Assets"
covenants, which will constitute Events of Default with notice but without
passage of time); (iv) failure of Orchard Supply or any of its Subsidiaries to
make any payment when due (after giving effect to any applicable grace period)
under any other senior
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Indebtedness (including, without limitation, Indebtedness under the Credit
Agreement) in excess of $5.0 million; (v) failure of Orchard Supply or any of
its Subsidiaries to perform any term, covenant, condition or provision of any
other Indebtedness in excess of $5.0 million individually or $10.0 million in
the aggregate, which failure results in the acceleration of the maturity of
such Indebtedness; (vi) a final judgment or judgments for the payment of money
not fully covered by insurance, which judgments exceed $5.0 million
individually or $10.0 million in the aggregate, is entered against Orchard
Supply or any of its Subsidiaries and is not satisfied, stayed, annulled or
rescinded within 60 days of being entered; and (vii) certain events of
bankruptcy, insolvency or reorganization of Orchard Supply or any of its
Subsidiaries.
The Indenture will provide that the Trustee shall, within 90 days after the
occurrence of any Default (the term "Default" to include the events specified
above without grace or notice) known to it, give to the holders of the Notes
notice of such Default; provided that, except in the case of a Default in the
payment of principal of or interest on any of the Notes, the Trustee shall be
protected in withholding such notice if it in good faith determines that the
withholding of such notice is in the interest of the holders of the Notes. The
Indenture will require Orchard Supply to certify to the Trustee annually as to
whether any Default occurred during such year.
In case an Event of Default (other than Event of Default described in clause
(viii) above with respect to Orchard Supply) shall occur and be continuing, the
Trustee or the holders of at least 25% in aggregate principal amount of the
Notes then outstanding, by notice in writing to Orchard Supply (and to the
Trustee if given by the holders of the Notes), may declare all unpaid principal
and accrued interest on the Notes then outstanding to be due and payable
immediately. Such acceleration may be annulled and past Defaults (except,
unless theretofore cured, a Default in payment of principal of or interest on
the Notes) may be waived by the holders of a majority in principal amount of
the Notes then outstanding, upon the conditions provided in the Indenture. If
an Event of Default described in clause (vii) above occurs with respect to
Orchard Supply and is continuing, then the principal of, premium, if any, and
accrued interest on, all the Notes will be due and payable immediately without
any declaration or other act on the part of the Trustee or any holder of a
Note.
The Indenture will provide that no holder of a Note may pursue any remedy
under the Indenture unless the Trustee shall have failed to act after notice of
an Event of Default and request by holders of at least 25% in principal amount
of the Notes and the offer to the Trustee of indemnity satisfactory to it;
provided, however, that such provision does not affect the right to sue for
enforcement of any overdue payment on the Notes.
MODIFICATION AND WAIVER
Modification and amendment of the Indenture may be made by Orchard Supply and
the Trustee with the consent of the holders of not less than a majority in
principal amount of the outstanding Notes, provided that no such modification
or amendment may, without the consent of the holder of each Note affected
thereby, (i) reduce the rate, or change the time or place for payment, of
interest on any Note, or reduce any amount payable on the redemption thereof or
upon a Change of Control, (ii) reduce the principal, or change the fixed
maturity or place of payment, of any Note, (iii) change the currency of payment
of principal of or interest on any Note, (iv) impair the right to institute
suit for the enforcement of any payment on or with respect to any Note, (v)
reduce the principal amount of outstanding Notes necessary to modify or amend
the Indenture, (vi) modify any of the provisions under the "Repurchase of Notes
Upon Change of Control" covenant, or (vii) modify any of the foregoing
provisions or reduce the principal amount of outstanding Notes necessary to
waive any covenant or past Default. Holders of not less than a majority in
principal amount of the outstanding Notes may waive certain past Defaults. See
"--Events of Default and Notice Thereof."
The Indenture or the Notes may be amended or supplemented, without the
consent of any holder of the Notes, (i) to cure any ambiguity, defect or
inconsistency, (ii) to evidence the succession of another Person to Orchard
Supply or any Subsidiary of Orchard Supply and the assumption by any such
successor of the covenants of Orchard Supply or such Subsidiary, as the case
may be, (iii) to evidence the release and discharge
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of the obligations of any Subsidiary of Orchard Supply the Capital Stock of
which has been sold or otherwise disposed of in accordance with the applicable
provisions of the Indenture or (iv) to make any other change that does not have
a material adverse effect on the rights of any holder of the Notes.
DEFEASANCE OR COVENANT DEFEASANCE OF INDENTURE
Orchard Supply may, at its option and at any time, elect to have the
obligations of Orchard Supply and Orchard Holding discharged in accordance with
the provisions set forth below with respect to the outstanding Notes. Such
defeasance means that Orchard Supply and Orchard Holding shall be deemed to
have paid and discharged the entire indebtedness represented by the outstanding
Notes and to have satisfied all their other obligations under the Notes and the
Indenture, except for (i) the rights of holders of outstanding Notes to receive
payments in respect of the principal of, premium, if any, and interest on such
Notes when such payments are due, (ii) Orchard Supply's obligations with
respect to the Notes concerning issuing temporary Notes, registration of Notes,
mutilated, destroyed, lost or stolen Notes and the maintenance of an office or
agency for payment and money for security payments held in trust, (iii) the
rights, powers, trusts, duties and immunities of the Trustee, and (iv) the
defeasance provisions of the Indenture. In addition, Orchard Supply may, at its
option and at any time, elect to have the obligations of Orchard Supply
released with respect to certain covenants that are described in the Indenture
("covenant defeasance") and any omission to comply with such obligations shall
not constitute a Default or an Event of Default with respect to the Notes. In
the event covenant defeasance occurs, certain events (not including non-
payment, bankruptcy and insolvency events) described under "Events of Default
and Notice Thereof" will no longer constitute an Event of Default with respect
to the Notes.
In order to exercise either defeasance or covenant defeasance, (i) Orchard
Supply or Orchard Holding must irrevocably deposit with the Trustee, in trust,
for the benefit of the holders of the Notes, cash in U.S. dollars, U.S.
Government Obligations (as defined in the Indenture), or a combination thereof,
in such amounts as will be sufficient, in the opinion of a nationally
recognized firm of independent public accountants, to pay the principal of,
premium, if any, and interest on the outstanding Notes on the stated maturity
of such principal or installment of principal or interest; (ii) in the case of
defeasance, Orchard Supply shall have delivered to the Trustee an opinion of
counsel in the United States stating that (a) Orchard Supply has received from,
or there has been published by, the Internal Revenue Service a ruling or (b)
since the date of the Indenture, there has been a change in the applicable
federal income tax law, in either case to the effect that, and based thereon
such opinion of counsel shall confirm that, the holders of the outstanding
Notes will not recognize income, gain or loss for federal income tax purposes
as a result of such defeasance and will be subject to federal income tax on the
same amounts, in the same manner and at the same times as would have been the
case if such defeasance had not occurred; (iii) in the case of covenant
defeasance, Orchard Supply shall have delivered to the Trustee an opinion of
counsel in the United States to the effect that the holders of the outstanding
Notes will not recognize income, gain or loss for federal income tax purposes
as a result of such covenant defeasance and will be subject to federal income
tax on the same amounts, in the same manner and at the same times as would have
been the case if such covenant defeasance had not occurred; (iv) no Default or
Event of Default shall have occurred and be continuing on the date of such
deposit; (v) such defeasance or covenant defeasance shall not result in a
breach or violation of, or constitute a default under, the Indenture or any
other material agreement or instrument to which Orchard Supply or Orchard
Holding is a party or by which it is bound; (vi) in the case of defeasance or
covenant defeasance, Orchard Supply shall have delivered to the Trustee an
opinion of counsel to the effect that after the 91st day following the deposit,
the trust funds will not be subject to the effect of any applicable bankruptcy,
insolvency, reorganization or similar laws affecting creditors' rights
generally; (vii) Orchard Supply and Orchard Holding shall have delivered to the
Trustee officers' certificates stating that the deposit was not made by Orchard
Supply or Orchard Holding with the intent of preferring the holders of Notes
over the other creditors of Orchard Supply or Orchard Holding with the intent
of defecting, hindering, delaying or defrauding creditors of Orchard Supply,
Orchard Holding or others; and (viii) Orchard Supply and Orchard Holding shall
have delivered to
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the Trustee officers' certificates and opinions of counsel, each stating that
all conditions precedent provided for relating to either the defeasance or the
covenant defeasance, as the case may be, have been complied with.
SATISFACTION AND DISCHARGE
The Indenture will cease to be of further effect (except as to surviving
rights of registration of transfer or exchange of the Notes, as expressly
provided for in the Indenture) as to all outstanding Notes when (i) either (a)
all such Notes theretofore authenticated and delivered (except lost, destroyed
or wrongfully taken Notes which have been replaced or paid) have been delivered
to the Trustee for cancellation or (b) all such Notes not theretofore delivered
to the Trustee for cancellation have become due and payable or will become due
and payable within one year and Orchard Supply or Orchard Holding has
irrevocably deposited or caused to be deposited with the Trustee funds in an
amount sufficient to pay and discharge the entire indebtedness for principal
of, premium, if any and interest to the date of deposit (in the case of the
Notes that have become due and payable) or to maturity or the redemption date
on the Notes not theretofore delivered to the Trustee for cancellation; (ii)
Orchard Supply or Orchard Holding has paid all other sums payable under the
Indenture by Orchard Supply or Orchard Holding; and (iii) Orchard Supply has
delivered to the Trustee an officers' certificate and an opinion of counsel
each stating that (a) all conditions precedent under the Indenture relating to
the satisfaction and discharge of the Indenture have been complied with and (b)
such satisfaction and discharge will not result in a breach or violation of, or
constitute a default under, the Indenture or any other material agreement or
instrument to which Orchard Supply or Orchard Holding is a party or by which it
is bound.
CONCERNING THE TRUSTEE
The Indenture will contain certain limitations on the rights of the Trustee,
should it become a creditor of Orchard Supply, to obtain payment of claims in
certain cases, or to realize on certain property received in respect of any
such claim as security or otherwise. The Trustee will be permitted to engage in
other transactions; provided, however, if it acquires any conflicting interest
(as defined in Section 310(b) of the Trust Indenture Act), it must eliminate
such conflict or resign.
The holders of a majority in principal amount of all outstanding Notes will
have the right to direct the time, method and place of conducting any
proceeding for exercising any remedy or power available to the Trustee,
provided that such direction does not conflict with any Rule of law or with the
Indenture.
In case an Event of Default shall occur (and shall not be cured or waived),
the Trustee will be required to exercise its powers with the degree of care and
skill of a prudent person in the conduct of his own affairs. Subject to such
provisions, the Trustee will be under no obligation to exercise any of its
rights or powers under the Indenture at the request of any of the holders of
Notes, unless they shall have offered to the Trustee security and indemnity
satisfactory to it.
TERMS OF CONTINUING DEBT INSTRUMENTS
The following summary of Orchard Supply's debt instruments which will be
outstanding following the Preferred Stock Offering and the Offering does not
purport to be complete and is subject to the detailed provisions of, and
qualified in its entirety by reference to, the definitive agreements and
instruments governing such indebtedness, copies of which are available upon
request to the Company. Capitalized terms used herein which are not otherwise
defined shall have the meaning assigned to them in the definitive agreements
and instruments governing such indebtedness.
DESCRIPTION OF THE FINANCING AGREEMENT
General. Under the Financing Agreement, The CIT Group/Business Credit, Inc.
(the "Lender") provides a revolving credit facility to Orchard Supply. As
amended in connection with the Expansion to
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provide for an additional $20.0 million in availability, the Financing
Agreement provides for a total credit facility of up to $40.0 million, with a
$8.0 million sublimit for guarantees of letters of credit, and is comprised of
(i) a $20.0 million revolving credit facility (the "Revolving Credit Facility")
to be used for working capital and general corporate purposes of Orchard
Supply, (ii) a letter of credit guarantee subfacility (the "Letter of Credit
Facility") to be used primarily to aid in the procurement of or to guarantee
letters of credit used by Orchard Supply to, among other things, secure the
purchase of inventory and (iii) a second revolving credit facility of $20.0
million, all of which has been borrowed to provide the original financing of
the Expansion. Following the Offering and the application of a portion of the
net proceeds therefrom to repay the $20.0 million in borrowings under the
second revolving credit facility, Orchard Supply plans to eliminate the second
revolving credit facility. The Financing Agreement is secured by present and
future Accounts, Inventory, Documents of Title and General Intangibles of
Orchard Supply (each as defined in the Financing Agreement). This description
is qualified in its entirety by reference to the Financing Agreement which has
been filed or incorporated by reference as an exhibit to the Registration
Statement of which this Prospectus forms a part. Capitalized terms used herein
and not otherwise defined shall have the meanings assigned to them in the
Financing Agreement.
The commitment of the Lender to make loans pursuant to the Financing
Agreement expires, and all amounts outstanding under the Revolving Credit
Facility must be repaid, on or after October 29, 1995, upon either party giving
60 days prior written notice of termination; provided that (i) the Lender may
terminate the Financing Agreement at any time upon the occurrence of an event
of default, and (ii) Orchard Supply may terminate the Financing Agreement at
any time upon 60 days prior written notice, provided that Orchard Supply must
pay the Lender an Early Termination Fee (as defined) if it terminates the
Financing Agreement prior to October 29, 1994. Borrowings and usage of the
Letter of Credit Facility under the Financing Agreement are permitted up to the
lesser of (i) $40.0 million and (ii) a defined borrowing base determined
according to a percentage of Orchard Supply's eligible inventory and accounts
receivable, less the sum of certain reserves. As of November 30, 1993, Orchard
Supply had $20.0 million in borrowings outstanding under the Financing
Agreement and, after giving effect to the issuance of guarantees of letters of
credit for $4.7 million, had additional borrowing capacity under the Financing
Agreement of $15.3 million. Borrowings outstanding under the Financing
Agreement bear interest, at the election of Orchard Supply, at a defined prime
rate plus 1.0% or at a defined London Interbank Offered Rate plus 2.75%.
Interest is payable monthly as of the end of each month. In addition, Orchard
Supply is required to pay the Lender a Revolving Line of Credit Fee (as
defined) on the last business day of each month and a fee equal to 1.0% per
annum, payable monthly, of the average aggregate outstanding amount of letters
of credit.
Financial Covenants. The Financing Agreement imposes on Orchard Supply
certain financial tests with respect to Orchard Supply's net worth, working
capital and ability to make capital expenditures and with respect to Orchard
Supply's fixed charge coverage and leverage ratios which require that Orchard
Supply (i) have on the last day of each fiscal quarter an Effective Net Worth
(as defined) not less than $85.0 million less the carrying value of the
Company's old San Jose warehouse, (ii) have on the last day of each fiscal
quarter Working Capital (as defined) of not less than $35.0 million, (iii) not
make capital expenditures in an aggregate amount in excess of $40.0 million for
the fiscal year ended January 1994, $20.0 million for the fiscal year ended
January 1995 and $9.0 million for each fiscal year thereafter, (iv) maintain a
Fixed Charge Coverage Ratio (as defined) at levels increasing from 1.00 to 1
for the quarter ended January 31, 1993, 1.1 to 1 for the two quarters ended May
2, 1993, 1.2 to 1 for the three quarters ended August 1, 1993 and 1.35 to 1 for
the four quarters ended January 30, 1994 and for any four quarters thereafter,
and (v) have on the last day of each fiscal quarter a Leverage Ratio (as
defined) of not more than 0.9 to 1.
Other Covenants. The Financing Agreement contains certain additional
restrictive covenants which, among other things, limit (subject to certain
exceptions) Orchard Supply with respect to (a) the incurrence of indebtedness;
(b) the existence of liens; (c) the payment of dividends or repurchases of
capital stock of Orchard Supply; (d) the making of investments, loans and
advances; (e) mergers, consolidations, liquidations and sales of assets; (f)
the incurrence of capital expenditures or the entering into of operating
leases; and (g)
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transactions with affiliates. Orchard Supply and the Lender have entered into
an amendment to the Financing Agreement to permit Orchard Supply to pay
dividends to Orchard Holding to provide the funds necessary to pay regularly
scheduled quarterly dividends on the Preferred Stock, subject in each case to
there not being at the time each such dividend is paid any default or event of
default under the Financing Agreement. Orchard Supply has obtained an amendment
from the Lender to permit the incurrence of indebtedness in the Offering and
certain related changes.
Guarantee. Orchard Holding has guaranteed the obligations of Orchard Supply
under the Financing Agreement.
Events of Default. The Financing Agreement contains a change of control
(defined as the transfer or encumbrance of a majority of the stock of Orchard
Holding held by FS&Co.) and a minimum adjusted operating earnings event of
default, as well as other customary events of default.
DESCRIPTION OF STORE MORTGAGE FACILITY
Orchard Supply entered into the Store Mortgage Facility in 1990 with an
insurance company lender. The Store Mortgage Facility provides for a twelve-
year, $21.8 million facility. The obligations under the Store Mortgage Facility
mature in 2002 and are secured by eight of Orchard Supply's owned and one
leased store locations. This description is qualified in its entirety by
reference to the Store Mortgage Facility and the amendment thereto which have
been incorporated by reference as an exhibit to the Registration Statement of
which this Prospectus is a part. Capitalized terms used herein and not
otherwise defined shall have the meanings assigned to them in the Store
Mortgage Facility.
Interest. Amounts outstanding under the Store Mortgage Facility bear interest
(i) at a fixed rate of 10.1% per annum to and including the last day of the
fifth Loan Year (as hereinafter defined), and (ii) at an adjusted rate for each
of the sixth through twelfth Loan Years equal to 275 basis points above the
average imputed yield on one year United States Treasury securities effective
on the first day of each such Loan Year. For purposes of the Store Mortgage
Facility, "Loan Year" means each successive period of twelve calendar months,
the first of which such period commenced April 1, 1990.
Payments. Interest is payable on the first day of each month. Mandatory
monthly payments of principal commence at the beginning of the fourth Loan Year
and are based on a twenty year amortization schedule with a final balloon
payment of $13.9 million on March 31, 2002 (the end of the twelfth Loan Year).
Prepayment. Orchard Supply may not prepay the principal amount outstanding
under the Store Mortgage Facility in whole or in part prior to the first day of
the fourth Loan Year (except in the case of a sale of any of the properties
encumbered under the Store Mortgage Facility in accordance with the terms
thereof.) Except as set forth therein, all prepayments, including those after
the first day of the fourth Loan Year, are subject to a Note Prepayment Fee (as
defined). Orchard Supply may not make any partial prepayments of the principal
balance under the Store Mortgage Facility (other than the prepayments made in
connection with the sale of any of the Properties (as defined) in accordance
with the terms thereof) which, in the aggregate throughout the term thereof,
exceed 25% of the original principal amount of the Store Mortgage Facility.
Covenants. The Store Mortgage Facility contains a number of restrictive
financial and other covenants including the following:
Minimum Net Worth. Orchard Supply must maintain an Adjusted Net Worth (as
defined) at the end of each fiscal quarter of at least $65.0 million. In the
event that Orchard Supply fails to satisfy the Adjusted Minimum Net Worth
requirement for any fiscal quarter, Orchard Supply is obligated to offer to
prepay (a "Prepayment Offer") an amount equal to 25% of the original principal
balance of the Store Mortgage Facility. Any prepayment will include payment of
the applicable Note Prepayment Fee (as defined). Failure of Orchard Supply to
satisfy the minimum Adjusted Net Worth requirement for any single fiscal
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quarter will not constitute a breach and will not constitute an Event of
Default provided that (i) Orchard Supply timely complies with all obligations
regarding the making of the Prepayment Offer; (ii) there has not occurred and
is not continuing any other Event of Default under the Store Mortgage Facility
and there does not exist any uncured breach or default under the Store Mortgage
Facility with respect to which the Mortgage Lender has given notice; and (iii)
the Adjusted Net Worth requirement is satisfied for the immediately following
fiscal quarter.
Additional Covenants. The Store Mortgage Facility contains certain
--------------------
additional covenants which impose limitations (subject to certain exceptions)
on Orchard Supply with respect to, among other things (a) selling, leasing or
disposing of more than 40% of Orchard Supply's assets other than in the
ordinary course of business; (b) creating, incurring or assuming indebtedness
or contingent obligations; (c) declaring dividends with respect to, or
repurchases of, shares of capital stock of Orchard Supply and Orchard Holding;
(d) certain transactions with affiliates; (e) material changes in Orchard
Supply's business operations; (f) liens on the Properties; (g) mergers,
consolidations or amalgamation; (h) making investments; (i) change of control;
and (j) certain acquisitions and asset transfers. Orchard Supply, Orchard
Holding and the lender have entered into an amendment to the Store Mortgage
Facility to permit Orchard Supply to pay dividends to Orchard Holding to
provide the funds necessary to pay regularly scheduled quarterly dividends on
the Preferred Stock, subject in each case to there not being at the time each
such dividend is paid any default or event of default under the Store Mortgage
Facility.
Events of Default. The Store Mortgage Facility contains customary events of
default, including a change of control default (defined as (i) any change in or
transfer of the legal beneficial ownership of Orchard Supply or any pledge,
hypothecation, grant or creation of a security interest in Orchard Supply's
stock by Orchard Holding or (ii) the acquisition by any person or related
persons (other than FS&Co. and the present and future executive management
employees of Orchard Supply or FS&Co.) of the power to elect, appoint or cause
the election or appointment of at least a majority of the board of directors of
Orchard Supply or Orchard Holding).
DESCRIPTION OF WAREHOUSE MORTGAGE NOTES
Orchard Supply issued approximately $13.7 million principal amount of
Warehouse Mortgage Notes pursuant to the terms of a Note Agreement (the "Note
Agreement") dated May 15, 1992 among Orchard Supply, Orchard Holding and the
holder thereof. The Warehouse Mortgage Notes mature on May 31, 2002 and are
secured by a deed of trust on Orchard Supply's warehouse located in Tracy,
California. This description is qualified in its entirety by reference to the
Note Agreement which has been incorporated by reference as an exhibit to the
Registration Statement of which this prospectus is a part. Capitalized terms
used herein and not otherwise defined shall have the meanings assigned to them
in the Note Agreement.
Interest. The Warehouse Mortgage Notes bear interest at a fixed rate of
10.64% per annum.
Payments. Interest is payable on the last day of each month. Mandatory annual
payments of principal commence on May 31, 1995 (the "Initial Payment") and on
each May 31 thereafter (each a "Subsequent Payment") with a final balloon
payment due on May 31, 2002. Principal payments shall be in an amount of $1.0
million for the Initial Payment increasing by $250,000 for each Subsequent
Payment and shall include interest accrued to the payment date.
Prepayment. The Warehouse Mortgage Notes are redeemable, in whole or in part
(in integral multiples of $1.0 million), at the option of Orchard Supply at any
time at a redemption price equal to the principal amount of Warehouse Mortgage
Notes to be redeemed, plus accrued interest to the redemption date and a Make-
Whole Premium (as defined). At any time on or after May 31, 1995, upon the
occurrence of a Change In Control (as defined) Orchard Supply may, at its
option, prepay all Warehouse Mortgage Notes then
67
<PAGE>
outstanding at the principal amount thereof, plus accrued interest and a Change
In Control Prepayment Premium (as defined).
In the event of a Change In Control or a proposed Change In Control, Orchard
Supply is obligated to offer to prepay the Warehouse Mortgage Notes at 101% of
the principal amount thereof, plus accrued interest, subject to the actual
occurrence of a Change In Control.
Further, in the event of a Total Destruction (as defined) or a Total Taking
(as defined), Orchard Supply must prepay the Warehouse Mortgage Notes.
Covenants. The Warehouse Mortgage Notes contain certain covenants which
impose limitations (subject to certain exceptions) on Orchard Holding, Orchard
Supply and their subsidiaries with respect to, among other things (a) the
making of investments, loans and advances; (b) creating, incurring or assuming
any debt, contingent obligations or leases; (c) declaring dividends with
respect to shares of capital stock of Orchard Supply or Orchard Holding and
repurchases of capital stock of Orchard Supply; (d) certain transactions with
affiliates; (e) fundamental changes in Orchard Supply's business operations;
(f) the creation of liens; (g) mergers, consolidations, liquidations or sales
of assets; (h) change of control; (i) sale lease-back transactions; (j)
purchases of 14.5% Subordinated Notes; and (k) amendments to the Subordinated
Debt Documents (as defined). In addition, Orchard Holding and its subsidiaries
are subject to certain financial tests with respect to leverage, fixed charge
coverage and net worth. These covenants require that Orchard Holding and its
subsidiaries (i) maintain a ratio of Consolidated Effective Net Worth (as
defined) during each fiscal quarter at certain specified levels which begin at
1.61 to 1.00 for the fiscal quarter ending January, 1992 and which decrease
thereafter to .83 to 1.00 for the fiscal quarter ending October, 1996 and each
fiscal quarter thereafter; (ii) maintain a fixed charge coverage ratio as
determined as of the end of each fiscal quarter at certain specified levels
which begin at 1.04 to 1.00 for the fiscal quarter ending January, 1992 and
which increase thereafter to 1.20 to 1.00 for the fiscal quarter ending July,
1996 and each fiscal quarter thereafter; and (iii) maintain a Consolidated
Effective Net Worth (as defined) during each fiscal quarter at specified
amounts which begin at $54.0 million for the fiscal quarter ending January,
1992 and which increase thereafter to $69.0 million for the fiscal quarter
ending January, 1997 and each fiscal quarter thereafter. Orchard Supply,
Orchard Holding and the holder of the Warehouse Mortgage Notes have entered
into an amendment to the Note Agreement (i) to permit Orchard Supply to pay
dividends to Orchard Holding to provide the funds necessary to pay regularly
scheduled quarterly dividends on the Preferred Stock and (ii) to permit Orchard
Holding to redeem the shares of Preferred Stock upon a Change In Control,
subject in each case to there not being at the time each such dividend is paid
or such Change In Control occurs any default or event of default under the
Store Mortgage Facility.
Events of Default. The Warehouse Mortgage Notes contain customary events of
default. In the event of a default by Orchard Supply pursuant to the terms of
the Note Agreement, the outstanding Warehouse Mortgage Notes will be entitled
to receive, in addition to principal and accrued interest on the Warehouse
Mortgage Notes, a Make-Whole Premium (as defined).
68
<PAGE>
DESCRIPTION OF CAPITAL STOCK
Orchard Supply's authorized capital stock consists of 5,000 shares of common
stock, $.01 par value, of which 2,000 shares were outstanding and held by
Orchard Holding as of December 1, 1993. Orchard Holding's authorized capital
stock consists of 8,000,000 shares of Common Stock, $.01 par value, and
2,000,000 shares of preferred stock, $.01 par value.
COMMON STOCK
As of November 19, 1993, there were 6,929,973 shares of Common Stock
outstanding held of record by 276 stockholders, excluding shares issuable upon
the exercise of outstanding Warrants (as discussed below) to purchase an
aggregate of 79,669 shares of Common Stock held by six Warrant holders and
outstanding options to purchase an aggregate of 160,506 shares of Common Stock
held by employees, management and Directors. See "Principal Stockholders."
PREFERRED STOCK
Orchard Holding's Certificate of Incorporation authorizes the issuance in
series of up to 2,000,000 shares of preferred stock, and permits Orchard
Holding's Board of Directors to establish the voting rights, designations,
powers, preferences and relative and other special rights and the
qualifications, limitations and restrictions of each of such series. As of the
date hereof, no shares of preferred stock are issued and outstanding.
There will be 800,000 shares of Preferred Stock outstanding upon consummation
of the Preferred Stock Offering, a portion of which shall be designated "Series
1 Preferred Stock" and a portion of which shall be designated "Series 2
Preferred Stock" (the Series 1 Preferred Stock and the Series 2 Preferred Stock
are referred to herein collectively as the "Preferred Stock"). Orchard Holding
will issue 325,000 shares of Series 1 Preferred Stock and will issue 475,000
shares of Series 2 Preferred Stock. Dividends on the Preferred Stock will
accrue at 6% per annum from the date of original issuance and will be payable
quarterly on each March 15, June 15, September 15 and December 15, commencing
March 15, 1994, when, as and if declared by the Board of Directors. The annual
cumulative dividend rate on the Series 2 Preferred Stock will increase,
retroactive to the original issue date, to 12% per annum (with the additional
6% mandatorily payable in additional shares of Series 2 Preferred Stock) if an
increase in Orchard Holding's authorized shares of Common Stock is not approved
by Orchard Holding's stockholders by June 15, 1994, and shall remain at 12%
until such increase in authorized shares is approved. FS&Co. has agreed to
cause FSEP II to vote in favor of amending Orchard Holding's Certificate of
Incorporation to increase the authorized shares of Common Stock. In the event
of any liquidation, dissolution or winding up of the Company, the holders of
Preferred Stock will be entitled to receive an amount equal to $25.00 per
share, plus all accrued but unpaid dividends, before any payment to the holders
of Common Stock. Shares of Series 1 Preferred Stock will be convertible at any
time at the option of the holder, unless previously redeemed, into Common Stock
at an initial conversion rate of 1.6 shares of Common Stock for each share of
Series 1 Preferred Stock (equivalent to a conversion price of $15.625 per share
of Common Stock), subject to adjustment upon certain circumstances. The Series
2 Preferred Stock will be convertible upon the same terms and conditions as the
Series 1 Preferred Stock after Orchard Holding's stockholders approve the
increase in Orchard Holding's authorized shares of Common Stock. Orchard
Holding may redeem the outstanding shares of Preferred Stock at any time after
December 15, 1996, in whole or in part, for cash initially at a redemption
price of $26.50 per share of Preferred Stock, and thereafter at prices
decreasing ratable annually to $25.00 per share on and after December 15, 2002,
plus accrued and unpaid dividends to the redemption date. Upon the occurrence
of an event deemed to be a Change of Control (as defined), each holder of
Preferred Stock will have the option to require Orchard Holding to redeem all
or any part of the Preferred Stock owned by such holder at $25.00 per share,
plus accrued and unpaid dividends to the redemption date. Holders of the
Preferred Stock will not be entitled to vote in the election of directors
unless dividends on the Preferred Stock are in arrears for at least six
consecutive full quarterly dividends, in which case holders of the Preferred
Stock will be entitled (voting separately as a class together with holders of
shares of any one or more other series of capital stock of
69
<PAGE>
Orchard Holding ranking on a parity with the Preferred Stock as to dividends
and having like voting rights) to elect two additional directors who shall
serve until such dividend arrearage is eliminated. Orchard Holding has obtained
waivers from the applicable lenders to permit Orchard Supply (i) to pay
dividends to Orchard Holding to provide the funds necessary to pay the
regularly scheduled quarterly dividends on the Preferred Stock, and (ii) to
redeem the Preferred Stock upon a Change of Control, subject in each case to
there not being any default or event of default under the applicable debt
instrument.
WARRANTS
As of November 19, 1993, there were Warrants outstanding to purchase up to an
aggregate of 79,669 shares of Common Stock at an exercise price of $8.33 per
share, subject to adjustment. Each Warrant contains provisions for the
adjustment of the exercise price relating thereto under certain circumstances,
including sales of Common Stock at less than the Fair Market Price (as defined
in the Warrants), stock dividends, stock splits, mergers or acquisitions, and
expires on July 1, 1999. The issuance of the Preferred Stock will not represent
a sale of Common Stock at less than Fair Market Price. Upon occurrence of a Put
Event (as defined in the Warrants), the Company is required to offer to
purchase all of the outstanding Warrants in full for an amount equal to the
Agreed Consideration (as defined in the Warrants).
UNDERWRITING
The underwriters named below (the "Underwriters") have severally agreed,
subject to the terms and conditions of the Underwriting Agreement (the form of
which is filed as an exhibit to the Registration Statement of which this
Prospectus is a part), to purchase from Orchard Supply, and Orchard Supply has
agreed to sell to the Underwriters, the principal amount of Notes set forth
opposite their respective names below:
<TABLE>
<CAPTION>
PRINCIPAL
AMOUNT
UNDERWRITERS OF NOTES
------------ ------------
<S> <C>
Lehman Brothers Inc. ............................................. $ 50,000,000
Jefferies & Company, Inc. ........................................ 35,000,000
Montgomery Securities............................................. 15,000,000
------------
Total........................................................... $100,000,000
============
</TABLE>
The Underwriting Agreement provides that the obligations of the Underwriters
to purchase Notes are subject to certain conditions, and that if any Notes are
purchased by the Underwriters pursuant to the Underwriting Agreement, all of
the Notes agreed to be purchased by the Underwriters pursuant to the
Underwriting Agreement must be so purchased.
The Company has been advised that the Underwriters propose to offer the Notes
initially at the public offering price set forth on the cover page of this
Prospectus, and to certain selected dealers (who may include Underwriters) at
such public offering price less a selling concession not to exceed 0.50% of the
principal amount of the Notes. The selected dealers may reallow a concession to
certain other dealers not to exceed 0.25% of the principal amount of the Notes.
After the initial public offering of the Notes, the public offering price, the
concession to selected dealers and the reallowance to other dealers may be
changed by the Underwriters.
The Company has agreed in the Underwriting Agreement to indemnify the
Underwriters against certain liabilities, including liabilities under the
Securities Act, and to contribute to payments that the Underwriters may be
required to make in respect thereof.
The Company has no plans to list the Notes on any securities exchange. The
Company has been advised by each Underwriter that it presently intends to make
a market in the Notes; however, the Underwriters are not obliged to do so. Any
such market-making activity may be discontinued at any time, for any reason,
without notice. If each Underwriter ceases to act as a market marker for the
Notes for any reason, there can be no assurance that another firm or person
will make a market in the Notes. There can be no assurance that an active
market for the Notes will develop or, if a market does develop, at what prices
the Notes will trade.
70
<PAGE>
LEGAL MATTERS
Certain legal matters in connection with the securities offered hereby will
be passed upon for the Company by Riordan & McKinzie, a Professional
Corporation, Los Angeles, California. Certain legal matters will be passed upon
for the Underwriters by O'Melveny & Myers. Principals and employees of Riordan
& McKinzie are limited partners in a partnership which is a limited partner of
FSEP II, the Company's principal stockholder. See "Principal Stockholders."
EXPERTS
The consolidated financial statements and schedules of the Company as of
January 26, 1992 and January 31, 1993 and for each of the three years in the
period ended January 31, 1993 included in this Prospectus have been audited by
Arthur Andersen & Co., independent public accountants, as indicated in their
reports with respect thereto, and are included herein in reliance upon the
authority of said firm as experts in giving said reports.
ADDITIONAL INFORMATION
The Company has filed a Registration Statement on Form S-1 under the
Securities Act of 1933, as amended, with the Commission with respect to the
Notes offered by this Prospectus. This Prospectus does not contain all of the
information set forth in the Registration Statement and the exhibits and
schedules thereto. Statements contained herein concerning the provisions of any
documents are not necessarily complete and, in each instance, reference is made
to the copy of such documents filed as an exhibit to the Registration
Statement, and each such statement shall be deemed qualified in its entirety by
such reference.
The Company is subject to the informational requirements of the Exchange Act
and, in accordance therewith, files reports and other information with the
Commission. A copy of the reports and other information filed by the Company in
accordance with the Exchange Act may be inspected without charge at the offices
of the Commission at Room 1024, 450 Fifth Street, N.W., Washington, D.C. 20549,
and will also be available for inspection and copying at the regional offices
of the Commission located at Suite 1400, 75 Park Place, New York, New York
10007 and at Room 3190, Northwestern Atrium Center, 500 West Madison Street,
Chicago, Illinois 60661-2511. Copies of such material may also be obtained from
the Public Reference Section of the Commission, Washington, D.C. 20549, upon
payment of the fees prescribed by the Commission. Such reports, proxy
statements and other information concerning the Company are also available for
inspection at the offices of the Nasdaq National Market, Reports Section, 1735
K Street, Washington, D.C. 20006.
71
<PAGE>
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Report of Independent Public Accountants.................................. F-2
Consolidated Balance Sheets as of January 26, 1992 and January 31, 1993... F-3
Consolidated Statements of Operations for the years ended January 27,
1991, January 26, 1992 and January 31, 1993.............................. F-5
Consolidated Statements of Stockholders' Equity for the years ended Janu-
ary 27, 1991, January 26, 1992 and January 31, 1993...................... F-6
Consolidated Statements of Cash Flows for the years ended January 27,
1991, January 26, 1992 and January 31, 1993.............................. F-7
Notes to Consolidated Financial Statements................................ F-8
- ---------------------
Report of Independent Public Accountants.................................. F-19
Condensed Consolidated Balance Sheets as of January 31, 1993 and October
31, 1993 (Unaudited)..................................................... F-20
Condensed Consolidated Statements of Operations for the three months and
nine months ended October 25, 1992 and October 31, 1993 (Unaudited)...... F-21
Condensed Consolidated Statements of Cash Flows for the nine months ended
October 25, 1992 and October 31, 1993 (Unaudited)........................ F-22
Notes to Condensed Consolidated Financial Statements (Unaudited).......... F-23
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Orchard Supply Hardware Stores Corporation:
We have audited the accompanying consolidated balance sheets of Orchard
Supply Hardware Stores Corporation (formerly Orchard Holding Corporation) and
Subsidiary as of January 31, 1993 and January 26, 1992 and the related
consolidated statements of operations, stockholders' equity and cash flows for
each of the three years in the period ended January 31, 1993. 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 in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Orchard Supply Hardware Stores
Corporation and Subsidiary as of January 31, 1993 and January 26, 1992 and the
results of its operations and its cash flows for each of the three years in the
period ended January 31, 1993 in conformity with generally accepted accounting
principles.
As explained in Note 2 to the consolidated financial statements, the Company
has restated all periods presented for the effect of the change in accounting
for inventories to the use of the first-in, first-out method.
Arthur Andersen & Co.
San Jose, California
March 5, 1993
F-2
<PAGE>
ORCHARD SUPPLY HARDWARE STORES CORPORATION AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
JANUARY 26, JANUARY 31,
1992 1993
----------- -----------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents............................ $ 5,340 $ 4,475
Accounts receivable, less allowance of $888 and
$1,267 at January 26, 1992 and January 31, 1993, re-
spectively.......................................... 12,993 13,209
Inventories.......................................... 70,727 73,858
Prepaid expenses and other........................... 3,852 4,777
Assets held for disposal............................. 7,507 6,133
-------- --------
Total current assets............................... 100,419 102,452
PROPERTY, PLANT AND EQUIPMENT, net..................... 82,371 80,779
LEASEHOLD RIGHTS, net of accumulated amortization of
$1,554 and $2,161 at January 26, 1992 and January 31,
1993, respectively.................................... 5,572 4,965
DEFERRED CHARGES, net of accumulated amortization of
$3,205 and $5,426 at January 26, 1992 and January 31,
1993, respectively.................................... 4,261 4,116
GOODWILL, net of accumulated amortization of $417 and
$573 at January 26, 1992 and January 31, 1993, respec-
tively................................................ 5,840 5,684
-------- --------
Total assets....................................... $198,463 $197,996
======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
F-3
<PAGE>
ORCHARD SUPPLY HARDWARE STORES CORPORATION AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
JANUARY 26, JANUARY 31,
1992 1993
----------- -----------
<S> <C> <C>
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Outstanding checks, not cleared by the bank.......... $ 2,897 $ 1,730
Accounts payable..................................... 25,832 27,086
Accrued payroll and related items.................... 6,754 6,481
Accrued advertising.................................. 1,722 2,436
Accrued sales taxes.................................. 4,751 5,420
Other accrued expenses............................... 3,534 3,861
Notes payable........................................ 5,642 2,649
Current portion of capital leases and long-term debt. 4,638 515
-------- --------
Total current liabilities.......................... 55,770 50,178
OTHER LIABILITIES...................................... 3,173 2,596
CAPITAL LEASES AND LONG-TERM DEBT, net of current por-
tion.................................................. 125,892 130,374
-------- --------
Total liabilities.................................. 184,835 183,148
-------- --------
STOCKHOLDERS' EQUITY:
Series A Preferred Stock, $.01 par value, aggregate
liquidating preference plus accumulated dividends of
approximately $24,377,000 and $28,505,000 at January
26, 1992 and January 31, 1993, respectively
Authorized--2,000,000 shares; issued--1,616,483
shares; outstanding-- 1,604,152 and 1,602,486
shares at January 26, 1992 and January 31, 1993,
respectively....................................... 16 16
Common Stock, $.01 par value
Authorized--3,000,000 shares; issued--1,211,118
shares; outstanding--1,205,158 and 1,207,598 shares
at January 26, 1992 and January 31, 1993,
respectively....................................... 12 12
Additional paid-in capital........................... 26,056 26,392
Less notes receivable from sale of common stock...... (370) (379)
Accumulated deficit.................................. (12,086) (11,193)
-------- --------
Total stockholders' equity......................... 13,628 14,848
-------- --------
Total liabilities and stockholders' equity......... $198,463 $197,996
======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
F-4
<PAGE>
ORCHARD SUPPLY HARDWARE STORES CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
YEAR ENDED
-----------------------------------
JANUARY 27, JANUARY 26, JANUARY 31,
1991 1992 1993
----------- ----------- -----------
<S> <C> <C> <C>
Sales...................................... $ 299,924 $ 308,562 $ 346,158
Cost of goods sold......................... 191,815 199,052 224,599
--------- --------- ---------
Gross margin............................. 108,109 109,510 121,559
Selling and other expenses................. 74,695 77,638 85,240
General and administrative expenses........ 13,749 13,658 14,704
Pre-opening expenses....................... 579 1,192 924
--------- --------- ---------
Operating income......................... 19,086 17,022 20,691
Write-down in carrying amount of asset held
for disposal.............................. -- -- 2,007
Interest expense........................... 15,160 14,773 16,725
--------- --------- ---------
Income before provision for income taxes
and extraordinary items................. 3,926 2,249 1,959
Provision for income taxes................. 1,667 971 866
--------- --------- ---------
Income before extraordinary items........ 2,259 1,278 1,093
Extraordinary items:
Realization of net operating loss
carryforwards........................... 1,667 971 438
Loss on extinguishment of debt, net of
tax benefit of $428..................... -- -- (638)
--------- --------- ---------
Net income............................... 3,926 2,249 893
Earned, but undeclared, dividends on pre-
ferred stock.............................. 3,046 3,446 4,208
--------- --------- ---------
Net income (loss) available to common
stock................................... $ 880 $ (1,197) $ (3,315)
========= ========= =========
Income per common and equivalent share:
Income (loss) before extraordinary items. $ (0.63) $ (1.74) $ (2.52)
Extraordinary items...................... 1.34 0.78 (0.16)
--------- --------- ---------
Net income (loss) per common and equiva-
lent share.............................. $ 0.71 $ (0.96) $ (2.68)
========= ========= =========
Weighted average number of common and
equivalent shares......................... 1,242 1,242 1,238
========= ========= =========
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
F-5
<PAGE>
ORCHARD SUPPLY HARDWARE STORES CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
SERIES A NOTES RETAINED
PREFERRED STOCK COMMON STOCK RECEIVABLE EARNINGS
----------------- ----------------- PAID-IN FOR CAPITAL (ACCUMULATED TOTAL
SHARES AMOUNT SHARES AMOUNT CAPITAL STOCK DEFICIT) EQUITY
--------- ------ --------- ------ ------- ----------- ------------ -------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCE, JANUARY 28,
1990................... 1,615,484 $16 1,209,319 $12 $26,205 $(473) $(18,261) $ 7,499
Payment of notes re-
ceivable from sale of
Capital Stock......... -- -- -- -- -- 5 -- 5
Repurchase of Common
Stock at $8.33 per
share................. -- -- (400) -- (4) 2 -- (2)
Repurchase of Series A
Preferred Stock at $10
per share............. (666) -- -- -- (7) 4 -- (3)
Reissuance of Common
Stock at $8.33 per
share................. -- -- 601 -- 5 (3) -- 2
Reissuance of Series A
Preferred Stock at $10
per share............. 999 -- -- -- 10 (5) -- 5
Net income............. -- -- -- -- -- -- 3,926 3,926
--------- --- --------- --- ------- ----- -------- -------
BALANCE, JANUARY 27,
1991................... 1,615,817 16 1,209,520 12 26,209 (470) (14,335) 11,432
Payment of notes re-
ceivable from sale of
Capital Stock......... -- -- -- -- -- 20 -- 20
Repurchase of Common
Stock at $8.33 per
share................. -- -- (7,002) -- (58) 28 -- (30)
Repurchase of Series A
Preferred Stock at $10
per share............. (11,665) -- -- -- (117) 57 -- (60)
Reissuance of Common
Stock at $8.33 per
share................. -- -- 2,640 -- 22 (5) -- 17
Net income............. -- -- -- -- -- -- 2,249 2,249
--------- --- --------- --- ------- ----- -------- -------
BALANCE, JANUARY 26,
1992................... 1,604,152 16 1,205,158 12 26,056 (370) (12,086) 13,628
Repurchase of Common
Stock at $8.33 per
share................. -- -- (1,279) -- (10) 1 -- (9)
Repurchase of Series A
Preferred Stock at $10
per share............. (1,666) -- -- -- (17) 1 -- (16)
Reissuance of Common
Stock at $8.33 per
share................. -- -- 3,719 -- 31 (11) -- 20
Issuance of warrants... -- -- -- -- 332 -- -- 332
Net income............. -- -- -- -- -- -- 893 893
--------- --- --------- --- ------- ----- -------- -------
BALANCE, JANUARY 31,
1993................... 1,602,486 $16 1,207,598 $12 $26,392 $(379) $(11,193) $14,848
========= === ========= === ======= ===== ======== =======
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
F-6
<PAGE>
ORCHARD SUPPLY HARDWARE STORES CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED
-----------------------------------
JANUARY 27, JANUARY 26, JANUARY 31,
1991 1992 1993
----------- ----------- -----------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income................................ $ 3,926 $ 2,249 $ 893
Non-cash adjustments to net income --
Depreciation and amortization............ 7,153 6,998 7,080
Loss on extinguishment of debt........... -- -- 1,066
Accretion of debt discount............... 2,752 3,156 1,682
Loss on asset disposals.................. 3 108 115
Write-down in carrying amount of asset
held for disposal....................... -- -- 2,007
Changes in assets and liabilities --
Increase in accounts receivable.......... (1,319) (480) (216)
Increase in inventories.................. (4,381) (8,468) (3,131)
(Increase) decrease in prepaid expenses
and other............................... 378 (920) (925)
Increase in accounts payable and other
current liabilities..................... 4,941 348 1,524
Decrease in other liabilities............ (56) (685) (577)
-------- -------- --------
Total adjustments....................... 9,471 57 8,625
-------- -------- --------
Net cash provided by operating activi-
ties.................................. 13,397 2,306 9,518
-------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property, plant and equip-
ment, net................................ (10,999) (19,675) (4,318)
Proceeds from sale of asset held for dis-
posal.................................... 635 -- --
-------- -------- --------
Net cash used in investing activities.... (10,364) (19,675) (4,318)
-------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from working capital loan........ 2,561 2,565 --
Proceeds from issuance of notes payable... 2,166 2,378 2,389
Proceeds from mortgage and construction
loans.................................... 21,759 15,700 13,721
Proceeds from Senior Notes................ -- -- 30,000
Deferred financing costs paid............. (763) -- (2,076)
Repayment of construction and working cap-
ital loans............................... -- -- (19,312)
Repayment of notes payable................ (1,789) (2,576) (1,770)
Principal payments on capital leases and
long-term debt........................... (26,876) (168) (29,012)
Repurchase of capital stock............... (11) (175) (27)
Proceeds from reissuance of capital stock. 15 22 31
Payment of notes receivable from sale of
capital stock............................ 11 105 2
Issuance of notes receivable from sale of
capital stock............................ (8) (5) (11)
-------- -------- --------
Net cash provided by (used in) financing
activities.............................. (2,935) 17,846 (6,065)
-------- -------- --------
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS............................... 98 477 (865)
CASH AND CASH EQUIVALENTS, beginning of pe-
riod...................................... 4,765 4,863 5,340
-------- -------- --------
CASH AND CASH EQUIVALENTS, end of period... $ 4,863 $ 5,340 $ 4,475
======== ======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
F-7
<PAGE>
ORCHARD SUPPLY HARDWARE STORES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JANUARY 31, 1993
1. FORMATION AND ORGANIZATION OF THE COMPANY AND BASIS OF FINANCIAL STATEMENTS:
On April 11, 1989, Orchard Supply Hardware Stores Corporation--"Company" or
"Stores," formerly Orchard Holding Corporation (a Delaware corporation) and its
wholly-owned subsidiary, Orchard Supply Hardware Corporation (a Delaware
corporation)--"Company" or "Orchard," and FS Equity Partners II, L.P. entered
into an Asset Purchase Agreement with Wickes Companies, Inc. ("Wickes") to
purchase substantially all of the assets and to assume certain liabilities of
the Orchard Supply Hardware division of Wickes. The total cost of the
acquisition was approximately $139.4 million, including approximately $130.6
million in consideration payable to Wickes, the refinancing or assumption of
approximately $3.0 million in existing Orchard indebtedness and capital lease
obligations and approximately $5.7 million of fees and expenses incurred by the
buyer related to the acquisition. The initial financing included a $25.6
million capital contribution by Orchard Holding Corporation, approximately $3.0
million of existing indebtedness, $60.0 million of Senior Subordinated
Increasing Rate Notes and approximately $51.5 million of bank debt.
This transaction was accounted for as a purchase by the Company and,
accordingly, the assets and liabilities of the Orchard Supply Hardware division
acquired from Wickes were recorded at their fair market values as of May 27,
1989. The final allocation of the purchase price, including related costs of
the acquisition, is shown below (in thousands):
<TABLE>
<S> <C>
Current assets................................................... $ 87,698
Current liabilities.............................................. (53,755)
--------
Working capital................................................ 33,943
Property, plant and equipment.................................... 70,947
Other long-term assets........................................... 5,823
Leasehold rights................................................. 6,995
Goodwill......................................................... 6,257
Other long-term liabilities...................................... (4,157)
Long-term debt................................................... (94,184)
--------
Net assets purchased........................................... $ 25,624
========
</TABLE>
The Company's 39 stores (as of January 31, 1993) are geographically located
in northern and central California.
2. SIGNIFICANT ACCOUNTING POLICIES:
Inventories--During the year ended January 31, 1993, the Company adopted the
retail first-in, first-out ("FIFO") method which requires the restatement of
the financial statements for all periods presented; accordingly, all periods
present inventories accounted for at the lower of cost or market using the FIFO
method. Previously, inventories were valued at the lower of cost or market
using the retail dollar-value last-in, first-out ("LIFO") method.
The change in accounting method was made because (i) the Company manages its
business using FIFO inventory amounts, (ii) it will not expose the Company to
earnings fluctuations associated with the LIFO estimates required to be made by
the Company on a quarterly basis and (iii) it will provide comparability with
the Company's primary competitors.
Property, Plant and Equipment--Property, plant and equipment are stated at
cost and are depreciated primarily on the straight-line basis over the
estimated useful lives of the assets. Leasehold improvements are
F-8
<PAGE>
ORCHARD SUPPLY HARDWARE STORES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
amortized over the lesser of the lease term or the estimated useful life of the
improvements. The range of estimated useful lives used by the Company is as
follows:
<TABLE>
<S> <C>
Buildings.................................... 25-40 years
Leasehold improvements....................... 14-25 years or life of lease
Land improvements............................ 15 years or life of lease
Machinery and equipment...................... 3-10 years
</TABLE>
All development costs related to the new warehouse have been capitalized
during the construction period, including interest and property taxes incurred
on the project. The Company capitalized interest costs of $87,000, $1,013,000
and $28,000 in the years ended January 27, 1991, January 26, 1992, and January
31, 1993, respectively.
Leasehold Rights--Leasehold rights represent the difference between the fair
market value of the Company's lease rentals and the stated rental rates at the
time of acquisition. Leasehold rights are amortized over the lives of the lease
terms ranging from 5 to 35 years.
Pre-Opening Expenses--Costs of setting up new stores are expensed as
incurred.
Cash and Cash Equivalents--All highly liquid debt instruments with an
original maturity of three months or less are included in cash and cash
equivalents. "Outstanding checks, not cleared by bank" included in current
liabilities consists of checks outstanding against zero balance accounts.
Deferred Charges--Deferred charges relate primarily to deferred financing
costs which are being amortized over the lives of the respective debt
instruments.
Consolidation--The consolidated financial statements include the accounts of
Orchard Supply Hardware Stores Corporation and its wholly-owned subsidiary,
Orchard Supply Hardware Corporation. All intercompany accounts and transactions
have been eliminated in consolidation.
Assets Held for Disposal--Assets held for disposal represent the Company's
former warehouse building (see Note 7 regarding the new warehouse) and the
underlying land, and, as of January 31, 1993, a parcel of land adjacent to the
new warehouse site with a carrying amount of approximately $0.6 million which
had previously been included in property, plant and equipment, and are
currently being held for sale. The Company carries these assets at amounts not
to exceed net realizable value. Accordingly, the carrying value of the former
warehouse site was reduced by approximately $2.0 million in the year ended
January 31, 1993. These assets are not subject to depreciation.
Earnings Per Share--Net income (loss) per common and equivalent share is
computed by dividing net income (loss) available to common stock (net income
less preferred stock dividend requirements) by the weighted average number of
common and equivalent shares. Common and equivalent shares include common stock
issuable upon exercise of stock options and warrants (using the treasury stock
method). Equivalents included in the weighted average number of shares assume
the conversion of options outstanding under the Nonqualified Stock Option Plan
and the warrants, unless antidilutive. Options outstanding pursuant to the
Performance Stock Option Plan (now terminated) and the options granted to the
President are excluded from the calculation due to their contingent nature.
Pursuant to Securities and Exchange Commission Staff Accounting Bulletin No.
83, common stock issued by the Company during the 12-month period prior to the
initial public offering and stock options and warrants granted during the same
period for which a measurement date has been established have been included in
the calculation of common and common equivalent shares using the treasury stock
method and the public offering price as if they were outstanding for all
applicable periods.
F-9
<PAGE>
ORCHARD SUPPLY HARDWARE STORES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The number of common and equivalent shares has been restated for all periods
presented to reflect the 1.2 for 1 stock split which was effected on January
28, 1993.
Reclassifications--Certain reclassifications were made to previously issued
financial statements to conform to the current presentation.
3. PROPERTY, PLANT AND EQUIPMENT:
Property, plant and equipment are summarized below (in thousands):
<TABLE>
<CAPTION>
JANUARY 26, JANUARY 31,
1992 1993
----------- -----------
<S> <C> <C>
Property, Plant and Equipment, excluding Assets Under
Capital Leases ("PP&E"):
Land................................................ $ 17,365 $ 16,723
Land improvements................................... 971 1,060
Buildings........................................... 29,276 29,534
Machinery and equipment............................. 21,561 23,923
Leasehold improvements.............................. 23,324 24,122
Construction in progress............................ 1,030 1,590
-------- --------
Gross PP&E.......................................... 93,527 96,952
Accumulated depreciation and amortization........... (12,356) (17,221)
-------- --------
Net PP&E............................................ 81,171 79,731
-------- --------
Assets Under Capital Leases:
Buildings........................................... 1,382 1,382
Machinery and equipment............................. 485 485
-------- --------
Gross assets under capital leases................... 1,867 1,867
Accumulated amortization............................ (667) (819)
-------- --------
Net assets under capital leases..................... 1,200 1,048
-------- --------
$ 82,371 $ 80,779
======== ========
</TABLE>
4. OPERATING LEASES:
Orchard has entered into certain long-term operating leases primarily for
buildings and equipment. Future annual minimum lease commitments under
noncancelable operating leases as of January 31, 1993 are as follows (in
thousands):
<TABLE>
<CAPTION>
FUTURE MINIMUM
RENTALS
YEAR ENDING
JANUARY
--------------
<S> <C>
1994........................................................ $ 10,710
1995........................................................ 10,461
1996........................................................ 9,689
1997........................................................ 9,310
1998........................................................ 8,327
Thereafter.................................................. 105,239
--------
Total minimum lease payments............................ $153,736
========
</TABLE>
F-10
<PAGE>
ORCHARD SUPPLY HARDWARE STORES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Store leases contain certain provisions for contingent rents based upon
defined percentages of the dollar value of sales at individual stores. Total
net rent expense is as follows (in thousands):
<TABLE>
<CAPTION>
TOTAL CONTINGENT
YEAR ENDED RENTALS RENTALS
---------- ------- ----------
<S> <C> <C>
January 31, 1993........................................ $10,971 $510
January 26, 1992........................................ 8,904 394
January 27, 1991........................................ 7,871 485
</TABLE>
5. BENEFIT PLANS:
Orchard maintains a profit-sharing benefit plan and a 401(k) plan covering
substantially all employees. Orchard matches 50% of employee contributions to
the 401(k) plan up to a maximum employee contribution of 3% of the employee's
compensation. Orchard may also make additional profit sharing contributions to
employee accounts at the discretion of the Board of Directors. The Company's
expenses for the 401(k) and profit-sharing plans were as follows (in
thousands):
<TABLE>
<CAPTION>
401(K) PROFIT
YEAR ENDED CONTRIBUTIONS SHARING
---------- ------------- -------
<S> <C> <C>
January 31, 1993..................................... $459 $ 763
January 26, 1992..................................... 409 858
January 27, 1991..................................... 418 1,027
</TABLE>
The Company does not provide post-retirement benefits other than those
provided through the plans discussed above. Accordingly, Statement of Financial
Accounting Standard (SFAS) No. 106 "Accounting for Post-Retirement Benefits
Other Than Pensions" will not impact the Company. The Company also anticipates
that SFAS No. 112 "Employers' Accounting for Postemployment Benefits," issued
in November 1992, will have an immaterial impact.
6. RELATED PARTY TRANSACTIONS:
Orchard reimburses an affiliate of FS Equity Partners II, L.P. for certain
direct costs incurred by it on the Company's behalf. Such costs were not
material for the periods presented in these financial statements.
7. LONG-TERM DEBT AND CREDIT ARRANGEMENTS:
Long-term debt as of January 26, 1992 and January 31, 1993 consists of the
following (in thousands):
<TABLE>
<CAPTION>
LESS
TOTAL CURRENT LONG-TERM
DEBT MATURITIES DEBT
-------- ---------- ---------
<S> <C> <C> <C>
January 26, 1992:
Senior subordinated discount notes due in 1999. $ 62,337 $ -- $ 62,337
Acquisition facility due in installments
through 1996.................................. 28,874 4,500 24,374
Construction facility due in 1993.............. 11,700 -- 11,700
Working capital facility relating to construc-
tion due in 1993.............................. 4,000 -- 4,000
Store mortgages................................ 21,759 -- 21,759
Obligations under capital leases............... 1,860 138 1,722
-------- ------ --------
$130,530 $4,638 $125,892
======== ====== ========
January 31, 1993:
Senior subordinated discount notes due in 1999. $ 64,000 $ -- $ 64,000
Senior notes................................... 29,687 -- 29,687
Store and warehouse mortgages.................. 35,480 428 35,052
Obligations under capital leases............... 1,722 87 1,635
-------- ------ --------
$130,889 $ 515 $130,374
======== ====== ========
</TABLE>
F-11
<PAGE>
ORCHARD SUPPLY HARDWARE STORES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The Company and Orchard have complied with the restrictive loan covenants
contained in the above obligations which provide among other things that (1)
minimum working capital and net worth levels be maintained, (2) minimum fixed
charge ratios be met, (3) capital expenditures be restricted, and (4)
additional long-term debt be limited.
SENIOR SUBORDINATED DISCOUNT NOTES
In July 1989, Orchard completed the sale of its senior subordinated discount
notes for approximately $55.2 million which are general unsecured obligations
of the Company and accreted to a full maturity value of $64 million in July
1992. The interest related to these notes was payable at 8.63% through July
1992 and together with accretion calculated using the effective interest method
yielded 14.5%. Subsequent to July 1992, the interest related to these notes is
payable at a rate of 14.5%.
Orchard is required to redeem $21 million principal amount of the securities
on July 15, 1997 and on July 15, 1998 and $22 million principal amount on July
15, 1999.
BANK FACILITY (REFINANCED DURING THE YEAR ENDED JANUARY 31, 1993)
A syndication of banks extended a credit facility to Orchard which was
secured by substantially all of the Company's non-real estate assets. As of
January 26, 1992 under the credit facility, Orchard had approximately $28.9
million outstanding under the acquisition loan, $9.1 million outstanding under
the working capital loan ($4.0 million applying to the warehouse construction
and included in "capital leases and long-term debt" and $5.1 million reflected
as "notes payable" in the financial statements) and $11.7 million outstanding
under the construction loan. In May 1992 the construction loan balance of $15.7
million was retired primarily through proceeds from the warehouse loan
discussed below. In October 1992, the bank facility was refinanced with senior
notes and a new credit facility as discussed below.
At the option of the Company, the acquisition loan, working capital loan and
construction loan bore interest as follows:
1. if a prime rate loan, then at the sum of the prime rate plus 1.50% per
annum;
2. if a Eurodollar rate loan, then at the sum of the adjusted Eurodollar
rate plus 2.50% per annum; and
3. if a CD rate loan, then at the sum of the adjusted CD rate plus 2.75%
per annum.
The following information is applicable to the working capital facility
(dollar amounts in thousands):
<TABLE>
<CAPTION>
PERIOD FROM
JANUARY 27,
1992
YEAR TO OCTOBER
ENDED 29, 1992
JANUARY (DATE OF
26, 1992 REFINANCING)
-------- ------------
<S> <C> <C>
Balance outstanding at end of year.................... $ 9,126 $ --
Average balance outstanding........................... 4,302 5,351
Maximum amount outstanding............................ 11,153 11,312
Weighted average interest rate........................ 9.48% 7.56%
Interest rate at end of period........................ 8.00% N/A
</TABLE>
The weighted average interest rate is determined by dividing total interest
costs by the average daily balance outstanding.
F-12
<PAGE>
ORCHARD SUPPLY HARDWARE STORES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
REFINANCING
On October 29, 1992 the Company, as guarantor, and Orchard, as issuer,
consummated a refinancing (the "Refinancing") of its credit facility through a
series of transactions including (i) the sale by the Company of an aggregate of
$30.0 million principal amount of 9% senior notes due July 1, 1997 and warrants
to purchase 79,669 shares of common stock of the Company and (ii) the execution
of a financing agreement between the Company and a lender providing for a
revolving credit facility of up to $20.0 million with an $8.0 million sublimit
for guarantees of letters of credit. In connection with the Refinancing, the
Company incurred a loss on extinguishment of debt resulting from the write-off
of deferred financing charges of approximately $1.1 million which was recorded
upon completion of the Refinancing on October 29, 1992.
A portion of the amount of the proceeds has been assigned to the warrants and
included in additional paid-in capital in the accompanying balance sheets. The
carrying amount of the senior notes will accrete to the principal amount
thereof over the term of the senior notes.
SENIOR NOTES
The senior notes are unsecured obligations of Orchard, mature on July 1, 1997
and interest is payable semi-annually at 9% per annum. On October 15, 1995 and
October 15, 1996 Orchard must redeem $3.0 million and $4.5 million,
respectively, and the remaining principal amount is payable at maturity.
The Company is required to exchange the senior notes with substantially
identical notes effectively registered with the Securities and Exchange
Commission prior to August 30, 1993.
REVOLVING CREDIT FACILITY
Borrowings under the revolving credit facility are included in Notes Payable
in the accompanying balance sheets and are secured by inventories, accounts
receivable, and certain intangible assets and are limited to an amount equal to
75% of eligible accounts receivable, as defined, plus 50% of eligible
inventory, as defined. Interest is payable monthly at one of two rates elected
by the Company:
1. bank base rate, as defined, plus one percent per annum, or
2. LIBOR, plus 3.25% per annum.
The revolving credit facility remains effective through October 29, 1995 at
which time it will be automatically continued unless terminated by the
Company's or lender's election.
The following summarizes activity applicable to the revolving credit facility
(dollar amounts in thousands):
<TABLE>
<S> <C>
Balance outstanding at end of year................................ $1,514
Average balance outstanding since origination..................... 2,468
Maximum amount outstanding........................................ 7,500
Weighted average interest rate.................................... 7.00%
Interest rate at end of period.................................... 7.00%
</TABLE>
Letters of credit outstanding as of January 31, 1993 totaled $4.8 million.
STORE AND WAREHOUSE MORTGAGES
In March 1990, Orchard obtained approximately $19.4 million of mortgage
financing on certain store properties. The proceeds were used to retire a then
existing mortgage debt of $0.5 million and to pay down a portion of a $20.0
million installment due in May 1990 under the bank credit facility. An
additional borrowing of $2.3 million was made in September 1990 on one other
owned property. The mortgage notes bear interest at 10.1% for the first through
fifth years and at a rate equal to the average yield imputed from one-year
United States Treasury securities, determined annually, plus 2.75% for the
sixth through twelfth years. Principal payments commence in May 1993 with a
final balloon payment due at the end of twelve years. Payments are based on a
twenty-year amortization schedule.
F-13
<PAGE>
ORCHARD SUPPLY HARDWARE STORES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
In May 1992, a life insurance company loaned Orchard approximately $13.7
million through a first mortgage loan on the new warehouse facility located in
Tracy, California. The mortgage note bears interest of 10.64% payable monthly
on the outstanding loan balance. The loan requires payments of interest only
for the first three years with the first principal payment due May 31, 1995.
The net book value of the assets mortgaged pursuant to the above mortgage
loans approximated $46.4 million at January 31, 1993.
CAPITAL LEASES
Orchard leases two stores and certain equipment under lease agreements which
are accounted for as capital leases. The leases bear interest at an implicit
rate of approximately 10%.
PRINCIPAL AND INTEREST PAYMENTS
The following summarizes the required future payments pursuant to the various
long-term debt instruments, including capital leases, discussed above (in
thousands):
<TABLE>
<CAPTION>
PRINCIPAL FUTURE MINIMUM
PAYMENTS RENTAL PAYMENTS
ON LONG- PURSUANT TO
YEAR ENDING JANUARY, TERM DEBT CAPITAL LEASES
-------------------- --------- ---------------
<S> <C> <C>
1994.............................................. $ 428 $ 255
1995.............................................. 624 253
1996.............................................. 4,606 253
1997.............................................. 27,405 253
1998.............................................. 45,402 252
Thereafter........................................ 50,702 1,629
-------- ------
129,167 2,895
Less--amount representing interest................ 1,173
------
Present value of future commitments............... 1,722
Less--current portion............................. 428 87
-------- ------
Long-term portion................................. $128,739 $1,635
======== ======
</TABLE>
Total cash paid by the Company for interest was as follows (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED
----------
<S> <C>
January 31, 1993.................................................. $13,285
January 26, 1992.................................................. 10,928
January 27, 1991.................................................. 11,352
</TABLE>
As discussed in Note 2, portions of the interest costs incurred have been
capitalized.
8. PREFERRED STOCK:
The rights, privileges and provisions of the Series A Preferred shares are as
follows:
DIVIDEND RIGHTS
The holders of Series A Preferred Stock are entitled to receive cumulative
dividends of $.40 per share on a quarterly basis plus an amount equal to 16%
annually, compounded quarterly, on any accrued but unpaid dividends. Dividends
are payable in cash or additional Series A Preferred shares at the discretion
of the Board
F-14
<PAGE>
ORCHARD SUPPLY HARDWARE STORES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
of Directors. No dividend shall be declared, paid or set aside to the holders
of outstanding shares of Common Stock unless all accrued but unpaid dividends
have been paid to the holders of outstanding shares of Series A Preferred
Stock. No dividends have been declared to date. Accumulated dividends, which
are undeclared and unpaid, total approximately $12.5 million at January 31,
1993.
EXCHANGE PROVISION
The Company, at its sole option, may require all or part of the Series A
Preferred Stock to be exchanged for junior subordinated notes (due May 30,
2001) paying interest semi-annually at a rate of 16% per annum. The exchange
rate is $10 of principal in junior subordinated notes for each share of Series
A Preferred Stock. No such exchange may be required by the Company unless all
accrued but unpaid dividends on all Series A Preferred shares, whether or not
they are to be exchanged, have been paid.
REDEMPTION PROVISION
The Company, at its sole option, may at any time redeem all or a portion of
the then outstanding shares of Series A Preferred Stock. The redemption price
shall be $10 per share plus an amount equal to all accrued but unpaid
dividends.
LIQUIDATION RIGHTS
In the event of any liquidation, dissolution or winding up of the Company,
the holders of Series A Preferred shares are entitled to be paid, out of the
assets of the Company available for distribution to its stockholders, an amount
equal to $10 per share plus an amount equal to all accrued but unpaid dividends
prior to any distribution to the holders of Common Stock.
VOTING RIGHTS
Holders of Series A Preferred shares are entitled to two votes per share of
Series A Preferred Stock.
9. COMMON STOCK:
Common stockholders are entitled to one vote per share of Common Stock. Under
the Stock Subscription Agreements between the Company and each of the employee
stockholders, common shares vested 20% at the date of purchase and vest an
additional 20% on each of the first through fourth anniversaries of the
acquisition date. Vested and unvested shares are both subject to repurchase at
the option of the Company. Holders of unvested shares are entitled to receive
an amount equal to $8.33 per share at the time of repurchase while holders of
vested shares are entitled to receive the greater of $8.33 per share or $8.33
per share plus a pro rata portion of any retained earnings for the period from
the acquisition (Note 1) to the end of the quarter preceding the repurchase of
shares.
In connection with the acquisition of Orchard Supply Hardware by the Company,
two stock option plans, the 1989 Employee Performance Stock Option Plan and the
1989 Nonqualified Stock Option Plan, were instituted to award officers of the
Company and other key employees, respectively, for services provided to the
Company. Subsequent to January 31, 1993, all holders of the 31,500 options
outstanding at January 31, 1993 tendered their options for cancellation and the
Performance Plan was terminated.
Under the 1989 Nonqualified Stock Option Plan, options may be granted to
qualified personnel of the Company to purchase shares of common stock at a
price no less than the fair market value of such shares, as determined by the
Board of Directors, at the time the option is granted. Consequently, no
compensation expense has been recognized in relation to this plan. Under the
provisions of the plan, options shall vest and become exercisable in annual
installments of 20% and shall be fully vested no later than five years from the
F-15
<PAGE>
ORCHARD SUPPLY HARDWARE STORES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
date of grant. At January 31, 1993, options covering 52,439 shares of common
stock were outstanding, of which 31,358 shares were vested under the plan. The
Board of Directors may accelerate the vesting at its discretion. Options expire
ten years after the date of grant. The Company has reserved 60,000 shares of
common stock for issuance under the plan.
Following is a detail of activity in the Nonqualified Stock Option Plan:
<TABLE>
<CAPTION>
OPTIONS OPTIONS PRICE
AVAILABLE OUTSTANDING PER SHARE
--------- ----------- ---------
<S> <C> <C> <C>
January 28, 1990.......................... 702 59,298 $8.33
Granted.................................. (526) 526 8.33
Cancelled................................ 350 (350) 8.33
----- ------
January 27, 1991.......................... 526 59,474 8.33
Granted.................................. -- -- --
Cancelled................................ 6,139 (6,139) 8.33
----- ------
January 26, 1992.......................... 6,665 53,335 8.33
Granted.................................. -- -- --
Cancelled................................ 896 (896) 8.33
----- ------
January 31, 1993.......................... 7,561 52,439 8.33
===== ======
</TABLE>
In April 1992, the Company granted a nonqualified stock option outside of the
1989 Nonqualified Stock Option Plan to its President covering 12,045 shares of
common stock at an exercise price of $8.33 per share. The option is only
exercisable upon the occurrence of certain mergers, consolidation, business
combinations, asset sales, tender offers and liquidations involving the
Company. Because of the contingent nature of the shares, no measurement date,
as defined, has been established. No compensation expense has been recorded
attributable to these options.
10. INCOME TAXES:
The provision for income taxes differs from the amount computed by applying
the statutory Federal income tax rate to income before taxes as follows:
<TABLE>
<CAPTION>
YEAR ENDED
-----------------------------------
JANUARY 27, JANUARY 26, JANUARY 31,
1991 1992 1993
----------- ----------- -----------
<S> <C> <C> <C>
Statutory Federal income
tax rate............... 34.0% 34.0% 34.0%
State income taxes, net
of Federal benefit..... 6.1 6.1 6.1
Goodwill amortization... 2.1 2.8 3.2
Other................... 0.3 0.3 0.9
---- ---- ----
42.5% 43.2% 44.2%
==== ==== ====
</TABLE>
For each of the three years in the period ended January 31, 1993, the Company
recorded an extraordinary benefit from the realization of net operating loss
carryforwards which originated in the period ended January 28, 1990. The
Company has book net operating loss carryforwards remaining of approximately
$10.0 million as of January 31, 1993.
As of January 31, 1993, for tax purposes, the Company has net operating loss
carryforwards of approximately $8.7 million for regular tax purposes available
to offset future Federal taxable income through the Company's fiscal year
ending January 2008. Differences between the Company's net operating loss
carryforwards for tax and financial reporting purposes primarily relate to
depreciation, general and administrative costs capitalizable for tax purposes,
and deductions for reserves and allowances. The Tax
F-16
<PAGE>
ORCHARD SUPPLY HARDWARE STORES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Reform Act of 1986 contains provisions which may limit the utilization of net
operating loss carryforwards in any given year upon occurrence of certain
events, including significant changes in ownership interests. Due to
limitations imposed by Section 382 of the Internal Revenue Code, as amended,
the Company's ability to utilize its Federal income tax net operating loss
carryforwards will likely be limited annually to the value of the Company's
stock immediately prior to consummation of a change in ownership multiplied by
a rate specified monthly by the IRS (currently 5.9%). In addition, any annual
limitation amount determined by this computation that is not used in the
current year increases the succeeding year's annual limitation amount. The
Company's ability to utilize net operating loss carryforwards as computed for
California income tax purposes may be similarly limited. The limitation on the
use of net operating loss carryforwards may have the effect of accelerating a
portion of the Company's income tax liability to an earlier year, and may also
result in an overall increase in income taxes payable by the Company. Whether
the Company's liability for taxes will be accelerated or increased will depend
on numerous factors, including whether and the extent to which future annual
taxable income of the Company exceeds the annual limitation, whether the
Company is paying tax based on its regular taxable income or its alternative
minimum taxable income, and whether and the extent to which California permits
corporations to deduct net operating loss carryforwards for California income
tax purposes.
The Company has made income tax payments of approximately $0.1 million, $0.3
million and $0.4 million in the years ended January 27, 1991, January 26, 1992
and January 31, 1993, respectively, primarily toward tax liabilities computed
for alternative minimum tax purposes. Such payments are recorded as prepayments
which will be applied against future liabilities computed for regular tax
purposes.
In February 1992, the Financial Accounting Standards Board issued Statement
No. 109, "Accounting for Income Taxes," which supersedes SFAS 96. The Company
is required to adopt the provisions of this statement in fiscal year 1994. The
Company expects the impact of the implementation to be immaterial.
11. DISCLOSURES ABOUT FAIR VALUES OF FINANCIAL INSTRUMENTS:
WORKING CAPITAL ACCOUNTS
The carrying amounts of cash and cash equivalents, accounts receivable and
accounts payable approximate fair value because of the short maturity of these
instruments.
LONG-TERM DEBT
Based on the borrowing rates currently available to the Company for loans
with similar terms and average maturities, the fair value of long-term debt is
approximately $137.1 million versus the carrying amount of approximately $130.9
million at January 31, 1993.
12. QUARTERLY FINANCIAL INFORMATION (UNAUDITED):
<TABLE>
<CAPTION>
INCOME (LOSS)
PER COMMON AND
INCOME EQUIVALENT SHARE
(LOSS) BEFORE BEFORE
EXTRAORDINARY NET INCOME EXTRAORDINARY
SALES GROSS MARGIN ITEMS (LOSS) ITEMS
-------- ------------ ------------- ---------- ----------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
YEAR ENDED JANUARY 26,
1992
First quarter......... $ 73,305 $ 26,290 $ (361) $ (361) $(0.96)
Second quarter........ 87,366 30,957 2,337 3,718 1.18
Third quarter......... 74,766 26,666 174 322 (0.59)
Fourth quarter........ 73,125 25,597 (872) (1,430) (1.37)
-------- -------- ------ ------- ------
Year.................. $308,562 $109,510 $1,278 $ 2,249 $(1.74)
======== ======== ====== ======= ======
</TABLE>
F-17
<PAGE>
ORCHARD SUPPLY HARDWARE STORES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
<TABLE>
<CAPTION>
INCOME (LOSS)
PER COMMON AND
INCOME EQUIVALENT SHARE
(LOSS) BEFORE BEFORE
EXTRAORDINARY NET INCOME EXTRAORDINARY
SALES GROSS MARGIN ITEMS (LOSS) ITEMS
-------- ------------ ------------- ---------- ----------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
YEAR ENDED JANUARY 31,
1993
First quarter......... $ 81,656 $ 28,510 $ 530 $ 919 $(0.35)
Second quarter........ 95,360 33,355 2,099 3,537 0.86
Third quarter(1)...... 82,349 28,169 (1,384) (2,277) (1.96)
Fourth quarter(2)..... 86,793 31,525 (152) (1,286) (1.07)
-------- -------- ------- ------- ------
Year.................. $346,158 $121,559 $ 1,093 $ 893 $(2.52)
======== ======== ======= ======= ======
</TABLE>
The following events impacted the results above:
(1) The Company recognized a write-down of $2.0 million in the carrying value
of the former warehouse (asset held for sale) in the third quarter of the
year ended January 31, 1993.
(2) Each of the quarters in fiscal 1992 and 1993 includes 13 weeks, except for
the fourth quarter of 1993 which includes 14 weeks. Management estimates
the inclusion of the additional week increased pretax income by $0.6
million.
13. SUMMARIZED FINANCIAL INFORMATION FOR ORCHARD SUPPLY HARDWARE CORPORATION:
All operations of the Company are conducted through its wholly-owned
subsidiary, Orchard Supply Hardware Corporation. The following summarizes the
financial position and results of operations for Orchard Supply Hardware
Corporation:
<TABLE>
<CAPTION>
JANUARY 26, JANUARY 31,
1992 1993
----------- -----------
<S> <C> <C>
Current assets..................................... $100,398 $102,433
Non-current assets................................. 98,044 95,544
-------- --------
198,442 197,977
======== ========
Current liabilities................................ $ 55,770 $ 50,178
Non-current liabilities............................ 129,065 132,970
-------- --------
184,835 183,148
-------- --------
Redeemable preferred stock......................... -- --
Other equity....................................... 13,607 14,829
-------- --------
13,607 14,829
-------- --------
$198,442 $197,977
======== ========
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED
-----------------------------------
JANUARY 27, JANUARY 26, JANUARY 31,
1991 1992 1993
----------- ----------- -----------
<S> <C> <C> <C>
Sales................................. $299,924 $308,562 $346,158
Gross profit.......................... 108,109 109,510 121,559
Income (loss) before provision for
taxes and extraordinary credit....... 3,879 2,253 1,944
Net income (loss)..................... 3,879 2,253 878
</TABLE>
The various debt instruments of Orchard Supply Hardware Corporation restrict
the payment of dividends to the parent.
F-18
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Orchard Supply Hardware Stores Corporation:
We have reviewed the accompanying condensed consolidated balance sheet of
Orchard Supply Hardware Stores Corporation (a Delaware corporation) as of
October 31, 1993, and the related condensed statements of operations for the
three months and nine months then ended and cash flows for the nine months then
ended. These financial statements are the responsibility of the Company's
management.
We conducted our review in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures to
financial data and making inquiries of persons responsible for financial and
accounting matters. It is substantially less in scope than an audit conducted
in accordance with generally accepted auditing standards, the objective of
which is the expression of an opinion regarding the financial statements taken
as a whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that
should be made to the financial statements referred to above for them to be in
conformity with generally accepted accounting principles.
Arthur Andersen & Co.
San Jose, California
November 21, 1993
F-19
<PAGE>
ORCHARD SUPPLY HARDWARE STORES CORPORATION AND SUBSIDIARY
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
JANUARY 31, OCTOBER 31,
1993 1993
----------- -----------
(UNAUDITED)
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents............................ $ 4,475 $ 6,199
Accounts receivable, net............................. 13,209 14,642
Inventories.......................................... 73,858 77,817
Prepaid expenses and other........................... 4,777 5,847
Assets held for disposal............................. 6,133 6,133
-------- --------
Total current assets............................... 102,452 110,638
PROPERTY, PLANT AND EQUIPMENT, net..................... 80,779 84,440
OTHER ASSETS, net...................................... 14,765 12,679
-------- --------
Total assets....................................... $197,996 $207,757
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable and accrued liabilities............. $ 47,014 $ 51,736
Notes payable........................................ 2,649 1,872
Current portion of capital leases and long-term debt. 515 748
-------- --------
Total current liabilities.......................... 50,178 54,356
OTHER LIABILITIES...................................... 2,596 2,596
CAPITAL LEASES AND LONG-TERM DEBT, net of current por-
tion.................................................. 130,374 85,173
-------- --------
Total liabilities.................................. 183,148 142,125
-------- --------
STOCKHOLDERS' EQUITY:
Common stock......................................... 12 69
Preferred stock...................................... 16 --
Additional paid-in-capital........................... 26,392 72,299
Less notes receivable from sale of common stock...... (379) (175)
Accumulated deficit.................................. (11,193) (6,561)
-------- --------
Total equity....................................... 14,848 65,632
-------- --------
Total liabilities and stockholders' equity......... $197,996 $207,757
======== ========
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
F-20
<PAGE>
ORCHARD SUPPLY HARDWARE STORES CORPORATION AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
----------------------- -----------------------
OCTOBER 25, OCTOBER 31, OCTOBER 25, OCTOBER 31,
1992 1993 1992 1993
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Sales.......................... $82,349 $88,888 $259,365 $280,455
Cost of goods sold............. 54,180 56,751 169,331 180,629
------- ------- -------- --------
Gross margin.................. 28,169 32,137 90,034 99,826
Selling, general and adminis-
trative expenses.............. 23,960 26,637 72,562 79,022
Pre-opening expenses........... 368 466 910 1,713
------- ------- -------- --------
Operating income.............. 3,841 5,034 16,562 19,091
Write-down in carrying amount
of asset held for disposal.... 2,007 -- 2,007 --
Interest expense............... 4,111 2,565 12,376 9,096
------- ------- -------- --------
Income (loss) before provision
for income taxes and
extraordinary items.......... (2,277) 2,469 2,179 9,995
Provision for income taxes..... (953) -- 934 --
------- ------- -------- --------
Income (loss) before extraor-
dinary items................. (1,324) 2,469 1,245 9,995
Extraordinary items............ (953) -- 934 (5,363)
------- ------- -------- --------
Net income (loss)............. (2,277) 2,469 2,179 4,632
Preferred stock dividends...... 1,049 -- 3,031 814
------- ------- -------- --------
Net income (loss) available to
common stock................. $(3,326) $ 2,469 $ (852) $ 3,818
======= ======= ======== ========
Income per common and equiva-
lent share:
Income (loss) before extraor-
dinary items................. $ (1.96) $ 0.35 $ (1.47) $ 1.64
Extraordinary items........... (0.79) -- 0.77 (0.96)
------- ------- -------- --------
Net income (loss)............. $ (2.75) $ 0.35 $ (0.70) $ 0.68
======= ======= ======== ========
Weighted average number of com-
mon and common
equivalent shares outstanding. 1,211 6,970 1,218 5,613
======= ======= ======== ========
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
F-21
<PAGE>
ORCHARD SUPPLY HARDWARE STORES CORPORATION AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
-----------------------
OCTOBER 25, OCTOBER 31,
1992 1993
----------- -----------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income............................................ $ 2,179 $ 4,632
Noncash adjustments to net income --
Depreciation and amortization........................ 5,383 5,062
Accretion of debt discount........................... 1,663 57
Loss on asset disposals.............................. 90 65
Write-down in carrying amount of asset held for dis-
posal............................................... 2,007 --
Write-off of deferred financing costs................ -- 1,315
Premium on repayment of subordinated debentures...... -- 4,048
Changes in assets and liabilities --
Increase in accounts receivable...................... (1,599) (1,433)
Decrease in inventories.............................. (2,709) (3,959)
Increase in prepaid expenses and other............... (768) (1,070)
Increase in noncurrent assets........................ -- (249)
Increase in accounts payable and accrued liabilities. 2,412 4,722
Decrease in noncurrent liabilities................... (590) --
------- -------
Total adjustments................................... 5,889 8,558
------- -------
Net cash provided by operating activities.......... 8,068 13,190
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property, plant and equipment, net....... (2,466) (7,704)
------- -------
Net cash used in investing activities................ (2,466) (7,704)
------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from public stock offering............... -- 48,396
Proceeds from issuance of senior notes................ 13,721 --
Proceeds from issuance of notes payable............... 2,431 737
Proceeds from sale of capital stock................... 10 58
Payment of notes receivable from sale of capital
stock................................................ 2 204
Repayment of subordinated debentures including premi-
um................................................... -- (48,726)
Repayment of construction and working capital loans... (15,700) --
Payment of preferred stock dividend................... -- (2,500)
Deferred financing costs.............................. (466) (64)
Repayment of notes payable............................ (126) (1,514)
Repurchase of capital stock........................... (25) (6)
Issuance of notes receivable from sale of capital
stock................................................ (3) --
Principal payments on capital leases and long-term
debt................................................. (4,612) (347)
------- -------
Net cash used in financing activities................ (4,768) (3,762)
------- -------
NET INCREASE IN CASH AND CASH EQUIVALENTS.............. 834 1,724
CASH AND CASH EQUIVALENTS, Beginning of Period......... 5,340 4,475
------- -------
CASH AND CASH EQUIVALENTS, End of Period............... $ 6,174 $ 6,199
======= =======
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
F-22
<PAGE>
ORCHARD SUPPLY HARDWARE STORES CORPORATION AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION:
The condensed consolidated financial statements included herein have been
prepared by the Company, without audit, pursuant to the rules and regulations
of the Securities and Exchange Commission (SEC). Certain information and
footnote disclosures normally included in financial statements prepared in
accordance with generally accepted accounting principles have been condensed or
omitted pursuant to such rules and regulations. However, the Company believes
that the disclosures are adequate to make the information presented not
misleading. These condensed consolidated financial statements should be read in
conjunction with the financial statements and the notes thereto for the year
ended January 31, 1993 included in the Company's Registration Statement on Form
S-1 (the "Registration Statement").
The unaudited condensed consolidated financial statements included herein
reflect all adjustments (which include only normal, recurring adjustments) that
are, in the opinion of management, necessary to state fairly the results for
the periods presented. The results for such periods are not necessarily
indicative of the results to be expected for the full fiscal year.
2. EARNINGS PER SHARE:
Net income (loss) per common and equivalent share is computed by dividing net
income (loss) available to common stock (net income less preferred stock
dividend requirements) by the weighted average number of common and equivalent
shares. Common and equivalent shares include common stock issuable upon
exercise of stock options and warrants (using the treasury stock method) less
shares assumed repurchased with the proceeds from the management notes.
Equivalents included in the weighted average number of shares assume the
conversion of options outstanding under the Nonqualified Stock Option Plan and
the warrants, unless antidilutive. Options outstanding pursuant to the
Performance Stock Option Plan (now terminated) and certain options granted to
the President are excluded from the calculation due to their contingent nature.
Pursuant to Securities and Exchange Commission Staff Accounting Bulletin No.
83, common stock issued by the Company during the 12-month period prior to the
initial public offering and stock options and warrants granted during the same
period for which a measurement date has been established have been included in
the calculation of common and common equivalent shares using the treasury stock
method as if they were outstanding for all applicable periods.
3. EQUITY OFFERING AND REDEMPTION OF SENIOR SUBORDINATED DEBENTURES:
On April 6, 1993, the Company consummated a series of transactions consisting
of the following:
1. Issuing 3.8 million shares of common stock in an initial public
offering (the "Offering") at a price of $14 per share.
2. Declaring dividends on preferred stock of $13.3 million equal to all
earned but undeclared dividends. Of this amount, $2.5 million was paid in
cash and funded by borrowings under the Company's revolving credit facility
(the "Financing Agreement"). The remainder was paid through the issuance of
1,915,630 additional shares of preferred stock.
3. Converting all outstanding shares of preferred stock, including those
issued pursuant to the dividends discussed above, into 3,128,028 shares of
common stock pursuant to a statutory reclassification at the market
offering price.
On April 30, 1993, the Company used the net proceeds of the Offering to
retire approximately $44.7 million of the Company's Senior Subordinated
Discount Notes due 1999 (the "Subordinated Notes"). In connection with the
early extinguishment of debt, the Company recorded an extraordinary charge of
approximately $5.4 million consisting of a prepayment premium of approximately
$4.1 million and the write-off of deferred financing charges of $1.3 million.
F-23
<PAGE>
ORCHARD SUPPLY HARDWARE STORES CORPORATION AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(UNAUDITED)
The unaudited pro forma financial data presented below have been prepared by
the Company based on certain adjustments to reflect the transactions enumerated
above. The pro forma financial data assume these transactions occurred as of
the beginning of the applicable fiscal year. The pro forma financial data do
not purport to present the financial position and results of operations of the
Company had these transactions actually occurred as of such dates nor is it
necessarily indicative of the results of operations that may be achieved in the
future. The pro forma financial data for the three and nine month periods ended
October 25, 1992 also assumes an income tax provision of zero computed under
the method of accounting adopted for the nine months ended October 31, 1993 as
discussed in Note 4.
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
----------------------- -----------------------
OCTOBER 25, OCTOBER 31, OCTOBER 25, OCTOBER 31,
1992 1993 1992 1993
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Income per common and
equivalent share before
extraordinary items....... $ (0.10) $ 0.36 $ 1.08 $ 1.67
======= ====== ====== ======
Weighted average common and
common equivalent shares
outstanding............... 6,574 6,912 6,588 6,894
======= ====== ====== ======
</TABLE>
4. INCOME TAXES:
Through January 31, 1993, the Company accounted for income taxes pursuant to
Accounting Principles Board (APB) Opinion No. 11. Effective February 1, 1993,
the Company adopted the provisions of Statement of Financial Accounting
Standard (SFAS) No. 109, "Accounting for Income Taxes." Upon adoption, the
Company elected not to restate prior periods and the effect of the cumulative
catch-up entry on the current period's balance sheet and statement of
operations is not material.
In accordance with SFAS 109, all deferred tax assets and liabilities are
quantified. Deferred tax assets include operating loss and tax credit
carryforwards. A valuation allowance against the tax assets is required to
adjust the assets to realizable amounts. Changes in the valuation allowance are
generally a component of the income tax provision. Under APB Opinion No. 11,
the realization of operating loss carryforwards was recorded as an
extraordinary item. For each of the three years in the period ended January 31,
1993, the Company recorded an extraordinary item due to the realization of
operating loss carryforwards.
The major components of deferred tax assets and liabilities are as follows
(in thousands):
<TABLE>
<CAPTION>
FEBRUARY 1, OCTOBER 31,
1993 1993
----------- -----------
<S> <C> <C>
Deferred tax assets:
Net operating losses.................................. $ 3,498 $ 2,292
AMT payments made..................................... 787 1,250
Other................................................. 1,841 2,082
------- -------
Total assets........................................ 6,126 5,624
Valuation allowance................................... (3,859) (2,683)
------- -------
Net assets............................................ 2,267 2,941
------- -------
Deferred tax liabilities:
Depreciation.......................................... 1,480 1,691
------- -------
Total liabilities................................... 1,480 1,691
------- -------
Total net deferred tax asset........................ $ 787 $ 1,250
======= =======
</TABLE>
F-24
<PAGE>
ORCHARD SUPPLY HARDWARE STORES CORPORATION AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(UNAUDITED)
As disclosed above, the valuation allowance decreased by $1.2 million during
the nine months ended October 31, 1993. The Company's tax operating loss
carryforwards as of January 31, 1993 are as follows (in thousands):
<TABLE>
<CAPTION>
EXPIRATION FEDERAL CALIFORNIA
---------- ------- ----------
<S> <C> <C>
Year ending January:
2005.................................................... $3,264 $3,006
2006.................................................... 5,975 2,809
------ ------
$9,239 $5,815
====== ======
</TABLE>
The provision for the nine month period ended October 31, 1993 is based on an
estimated annual provision of zero. The components of the provisions and the
effective rate reconciliation for the nine months ended October 25, 1992 have
not been included since the information is not significantly different from the
disclosures in the Company's Registration Statement for the year ended January
31, 1993.
5. SUBSEQUENT EVENTS:
In November, 1993, the Company acquired six store sites located in Southern
California for approximately $17.3 million. The Company owns the fee interest
in three sites and leases the other three sites. The existing improvements will
be renovated prior to the planned opening of the stores.
In October, 1993, the Company entered into an agreement to acquire the
leasehold interest in an additional three store sites in Southern California.
The transaction is expected to close in January, 1994 and the acquisition price
is $2.35 million.
In November, 1993, in connection with the acquisition of the new store sites,
the Company increased the borrowings available under the revolving credit
facility from $20.0 million to $40.0 million. The additional borrowings
available bear substantially the same terms and conditions as the original
facility.
6. STOCKHOLDERS' EQUITY (In thousands, except share data):
<TABLE>
<CAPTION>
SERIES A NOTES
PREFERRED STOCK COMMON STOCK RECEIVABLE
------------------ ----------------- PAID-IN FOR CAPITAL ACCUMULATED
SHARES AMOUNT SHARES AMOUNT CAPITAL STOCK DEFICIT
---------- ------ --------- ------ ------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, January 31,
1993................... 1,602,486 $ 16 1,207,598 $ 12 $26,392 $(379) $(11,193)
Repurchase of shares.... (333) -- (200) -- (7) -- --
Issuance of Common Stock
resulting from Initial
Public Offering and
exercise of stock op-
tions.................. -- -- 3,806,945 38 48,417 -- --
Reclassification of Se-
ries A Preferred Stock. (1,602,153) (16) 1,915,630 19 (3) -- --
Payments of cash divi-
dend on Series A Pre-
ferred Stock........... -- -- -- -- (2,500) -- --
Payments of notes
receivable............. -- -- -- -- -- 204 --
Net income.............. -- -- -- -- -- -- 4,632
---------- ---- --------- ---- ------- ----- --------
Balance, October 31,
1993................... -- $-- 6,929,973 $ 69 $72,299 $(175) $ (6,561)
========== ==== ========= ==== ======= ===== ========
</TABLE>
F-25
<PAGE>
ORCHARD SUPPLY HARDWARE STORES CORPORATION AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(UNAUDITED)
7. QUARTERLY FINANCIAL INFORMATION (in thousands, except share data):
<TABLE>
<CAPTION>
INCOME (LOSS)
PER COMMON AND
INCOME EQUIVALENT SHARE
(LOSS) BEFORE BEFORE
GROSS EXTRAORDINARY NET INCOME EXTRAORDINARY
SALES MARGIN ITEMS (LOSS) ITEMS
-------- ------- ------------- ---------- ----------------
<S> <C> <C> <C> <C> <C>
YEAR ENDED JANUARY 30,
1994
First quarter(1)...... $90,361 $31,948 $1,986 $(3,377) $0.40
Second quarter........ 101,206 35,741 5,540 5,540 0.80
Third quarter......... 88,888 32,137 2,469 2,469 0.35
-------- ------- ------ ------- -----
Year.................. $280,455 $99,826 $9,995 $ 4,632 $1.64
======== ======= ====== ======= =====
</TABLE>
- --------
(1) The net loss reflects the extraordinary charge discussed in Note 3.
8. SUMMARIZED FINANCIAL INFORMATION FOR ORCHARD SUPPLY HARDWARE CORPORATION:
All operations of the Company are conducted through its wholly-owned
subsidiary, Orchard Supply Hardware Corporation. The following summarizes the
financial position and results of operations for Orchard Supply Hardware
Corporation (In thousands):
<TABLE>
<CAPTION>
OCTOBER 31,
1993
-----------
<S> <C>
Current assets................................................. $110,663
Non-current assets............................................. 97,119
--------
$207,782
========
Current liabilities............................................ $ 54,348
Non-current liabilities........................................ 87,769
--------
142,117
--------
Redeemable preferred stock..................................... --
Other equity................................................... 65,665
--------
65,665
--------
$207,782
========
</TABLE>
<TABLE>
<CAPTION>
NINE-MONTHS ENDED
-----------------------
OCTOBER 25, OCTOBER 31,
1992 1993
----------- -----------
<S> <C> <C>
Sales............................................. $259,365 $280,455
Gross profit...................................... 90,034 99,826
Income before provision for taxes and extraordi-
nary credit...................................... 2,169 10,026
Net income........................................ 2,169 4,663
</TABLE>
The various debt instruments of Orchard Supply Hardware Corporation restrict
the payment of dividends to the parent.
F-26
<PAGE>
[THIS PAGE INTENTIONALLY LEFT BLANK]
<PAGE>
SELECTION
- --------------------------------------------------------------------------------
[PHOTO 1] [PHOTO 2] [PHOTO 3]
[PHOTO 4] [PHOTO 5] [PHOTO 6]
[COMPANY LOGO]
[PHOTO 7]
New warehouse and distribution facility
CONVENIENT, WELL
SERVICE ORGANIZED STORES
- ---------------------------------------------------- -------------------------
[PHOTO 8] [PHOTO 9] [PHOTO 10] [PHOTO 11]
Custom cutting ZIP service Drive through
pick-up station
<PAGE>
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
NO DEALER, SALESPERSON OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS NOT CONTAINED IN THIS PROSPECTUS
AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED
UPON AS HAVING BEEN AUTHORIZED BY ORCHARD SUPPLY, ORCHARD HOLDING OR ANY OF
THE UNDERWRITERS. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER OF ANY
SECURITIES OTHER THAN THOSE TO WHICH IT RELATES OR AN OFFER TO SELL, OR A
SOLICITATION OF AN OFFER TO BUY, TO ANY PERSON IN ANY JURISDICTION WHERE SUCH
AN OFFER OR SOLICITATION WOULD BE UNLAWFUL. NEITHER THE DELIVERY OF THIS
PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE
ANY IMPLICATION THAT THE INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY
TIME SUBSEQUENT TO THE DATE HEREOF.
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TABLE OF CONTENTS
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PAGE
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Prospectus Summary........................................................ 3
Investment Considerations................................................. 10
The Company............................................................... 13
Use of Proceeds........................................................... 15
Capitalization............................................................ 16
Unaudited Pro Forma Financial Data........................................ 18
Selected Consolidated Financial Data...................................... 22
Management's Discussion and Analysis of Financial Condition and Results of
Operations............................................................... 25
Business.................................................................. 32
Management................................................................ 41
Certain Transactions...................................................... 47
Principal Stockholders.................................................... 48
Description of Notes...................................................... 49
Terms of Continuing Debt Instruments...................................... 64
Description of Capital Stock.............................................. 69
Underwriting.............................................................. 70
Legal Matters............................................................. 71
Experts................................................................... 71
Additional Information.................................................... 71
Index to Consolidated Financial Statements................................ F-1
</TABLE>
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$100,000,000
LOGO
ORCHARD SUPPLY
HARDWARE
CORPORATION
9 3/8% SENIOR NOTES DUE 2002
UNCONDITIONALLY GUARANTEED BY
ORCHARD SUPPLY HARDWARE
STORES CORPORATION
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PROSPECTUS
January 20, 1994
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Lehman Brothers
Jefferies & Company, Inc.
Montgomery Securities
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<PAGE>
GRAPHICS APPENDIX LIST
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<CAPTION>
INSIDE FRONT COVER
<C> <S>
Map Map of California with symbols indicating the locations of existing
stores, the distribution center and expected 1994 store openings
Photo 1 Photograph of exterior of store and parking lot in Salinas, California
Photo 2 Photograph of check-out lines inside store
Photo 3 Photograph of plant nursery section of store
Photo 4 Photograph of store aisle containing rows of hammers
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INSIDE BACK COVER
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Photo 1 Photograph of store aisle containing rows of garden hoses
Photo 2 Photograph of store aisle of miscellaneous screws
Photo 3 Photograph of store aisle of shovels
Photo 4 Photograph of store aisle of wrenches
Photo 5 Close-up photograph of store aisle of miscellaneous screws
Photo 6 Photograph of store aisle of miscellaneous faucets
Photo 7 Photograph of exterior of distribution facility and trucks in parking
lot
Photo 8 Photograph of employee cutting hose
Photo 9 Photograph of ZIP Services center
Photo 10 Photograph of employee loading cement onto the back of a customer's
truck
Photo 11 Photograph of store interior showing how aisles are arranged
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