<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
(Mark One)
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended January 23, 1999
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
---------------------- -----------------------
Commission File Number 000-25372
U.S. OFFICE PRODUCTS COMPANY
(Exact name of registrant as specified in its charter)
Delaware 52-1906050
(State of other jurisdiction (I.R.S. Employer
incorporation or organization.) Identification No.)
1025 Thomas Jefferson Street, N.W.
Suite 600 East
Washington, D.C. 20007
(Address of principal executive offices) (Zip Code)
(202) 339-6700
(Registrant's telephone number, including area code)
N/A
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
As of MARCH 8, 1999, there were 36,629,413 shares of common stock
outstanding.
<PAGE>
<TABLE>
<CAPTION>
PAGE NO.
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PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
<S> <C>
Consolidated Balance Sheet..............................................................................3
January 23, 1999 (unaudited) and April 25, 1998
Consolidated Statement of Operations....................................................................4
For the three months ended January 23, 1999 (unaudited)
and January 24, 1998 (unaudited) and the nine months ended January
23, 1999 (unaudited) and January 24, 1998 (unaudited)
Consolidated Statement of Cash Flows....................................................................5
For the nine months ended January 23, 1999 (unaudited) and
January 24, 1998 (unaudited)
Notes to Consolidated Financial Statements (unaudited)..................................................7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations...........................................................................19
PART II - OTHER INFORMATION
Item 1. Legal Proceedings......................................................................................43
Item 6. Exhibits and Reports on Form 8-K.......................................................................43
Signatures........................................................................................................44
Exhibit Index.....................................................................................................45
</TABLE>
Page 2
<PAGE>
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
U.S. OFFICE PRODUCTS COMPANY
CONSOLIDATED BALANCE SHEET
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
JANUARY 23, APRIL 25,
ASSETS 1999 1998
------ --------------- ------------
(UNAUDITED)
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 16,435 $ 52,021
Accounts receivable, less allowance for doubtful
accounts of $11,106 and $8,639, respectively 341,445 310,527
Inventories 232,158 228,671
Prepaid expenses and other current assets 134,749 117,150
------------- -------------
Total current assets 724,787 708,369
Property and equipment, net 230,795 228,715
Intangible assets, net 919,248 923,024
Other assets 208,692 194,701
Net assets from discontinued operations:
Amounts to become receivable upon the Distributions 132,145
All other net assets 354,473
------------- -------------
Total assets $ 2,083,522 $ 2,541,427
------------- -------------
------------- -------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Short-term debt $ 25,551 $ 368,227
Accounts payable 181,996 162,718
Accrued compensation 45,650 43,013
Other accrued liabilities 103,353 81,411
------------- -------------
Total current liabilities 356,550 655,369
Long-term debt 1,192,376 382,174
Other long-term liabilities and minority interests 17,252 17,753
------------- -------------
Total liabilities 1,566,178 1,055,296
------------- -------------
Commitments and contingencies
Stockholders' equity:
Preferred stock, $.001 par value, 500,000 shares
authorized, none outstanding
Common stock, $.001 par value, 500,000,000 shares authorized, 36,795,007 and
33,460,864 shares issued, 36,629,413 and 33,460,864 shares outstanding, and
165,594 and none held in treasury, respectively 37 33
Additional paid-in capital 677,721 1,472,125
Accumulated other comprehensive loss (129,760) (112,803)
Retained earnings (accumulated deficit) (30,654) 126,776
------------- -------------
Total stockholders' equity 517,344 1,486,131
------------- -------------
Total liabilities and stockholders' equity $ 2,083,522 $ 2,541,427
------------- -------------
------------- -------------
</TABLE>
See accompanying notes to consolidated financial statements.
Page 3
<PAGE>
U.S. OFFICE PRODUCTS COMPANY
CONSOLIDATED STATEMENT OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
------------------ -----------------
JANUARY 23, JANUARY 24, JANUARY 23, JANUARY 24,
1999 1998 1999 1998
------------ ----------- ------------ -------------
<S> <C> <C> <C> <C>
Revenues $ 676,622 $ 665,959 $ 2,005,776 $ 1,930,113
Cost of revenues 482,549 476,739 1,449,000 1,390,855
----------- ----------- ------------ -----------
Gross profit 194,073 189,220 556,776 539,258
Selling, general and administrative expenses 154,042 146,497 453,508 436,037
Amortization expense 6,437 5,434 18,559 13,830
Strategic Restructuring Plan costs 97,503
Operating restructuring costs 5,034 17,229
Impaired asset write-offs 2,778 2,778
----------- ----------- ------------ -----------
Operating income (loss) 25,782 37,289 (32,801) 89,391
Interest expense 28,906 9,480 76,785 27,534
Interest income (299) (417) (1,125) (1,545)
Loss on sale of businesses 4,964 7,500
Other (income) expense 1,064 149 45 (6,369)
----------- ----------- ------------ -----------
Income (loss) from continuing operations
before provision for (benefit from) income
taxes and extraordinary items (8,853) 28,077 (116,006) 69,771
Provision for (benefit from) income taxes 3,610 12,646 (16,018) 32,535
----------- ----------- ------------ -----------
Income (loss) from continuing operations before
extraordinary items (12,463) 15,431 (99,988) 37,236
Income (loss) from discontinued operations, net
of income taxes 3,085 (1,294) 25,464
----------- ----------- ------------ -----------
Income (loss) before extraordinary items (12,463) 18,516 (101,282) 62,700
Extraordinary items - loss on early termination
of debt facilities, net of income tax benefit 269
----------- ----------- ------------ -----------
Net income (loss) $ (12,463) $ 18,516 $ (101,551) $ 62,700
----------- ----------- ------------ -----------
----------- ----------- ------------ -----------
Basic income (loss) per share data:
Income (loss) from continuing operations before
extraordinary items $ (0.34) $ 0.48 $ (2.77) $ 1.30
Income (loss) from discontinued operations 0.10 (0.03) 0.88
Extraordinary items (0.01)
----------- ----------- ----------- -----------
Net income (loss) $ (0.34) $ 0.58 $ (2.81) $ 2.18
----------- ----------- ------------ -----------
----------- ----------- ------------ -----------
Diluted income (loss) per share data:
Income (loss) from continuing operations before
extraordinary items $ (0.34) $ 0.47 $ (2.77) $ 1.27
Income (loss) from discontinued operations 0.10 (0.03) 0.87
Extraordinary items (0.01)
----------- ----------- ----------- -----------
Net income (loss) $ (0.34) $ 0.57 $ (2.81) $ 2.14
----------- ----------- ------------ -----------
----------- ----------- ------------ -----------
</TABLE>
See accompanying notes to consolidated financial statements.
Page 4
<PAGE>
U.S. OFFICE PRODUCTS COMPANY
CONSOLIDATED STATEMENT OF CASH FLOWS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
-----------------
JANUARY 23, JANUARY 24,
1999 1998
----------- -----------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) $ (101,551) $ 62,700
Adjustments to reconcile net income (loss) to net
cash provided by operating activities:
(Income) loss from discontinued operations 1,294 (25,464)
Depreciation and amortization 45,837 41,787
Strategic Restructuring Plan costs 70,380
Loss on sale of businesses 7,500
Write-off of impaired assets 2,778
Deferred income taxes (1,198) 73
Equity in net income of unconsolidated affiliate (1,054) (878)
Extraordinary loss 269
Loss (gain) on sale of assets 295 (1,059)
Changes in assets and liabilities (net of assets acquired and liabilities
assumed in business combinations):
Accounts receivable (30,111) (29,940)
Inventory (6,602) (14,417)
Prepaid expenses and other current assets (19,467) (3,909)
Accounts payable 20,289 2,245
Accrued liabilities 22,813 5,699
------------- -----------
Net cash provided by operating activities 11,472 36,837
------------- -----------
Cash flows from investing activities:
Cash paid in acquisitions, net of cash received (34,508) (33,642)
Additions to property and equipment, net of disposals (31,201) (28,200)
Investment in affiliate (40,773)
Proceeds from sale of investments 1,222 5,729
Other (179) (2,581)
------------- -----------
Net cash used in investing activities (64,666) (99,467)
------------- -----------
Cash flows from financing activities:
Proceeds from issuance of long-term debt 1,152,640 457
Repurchase of common stock in Equity Tender (1,000,000)
Proceeds from (payments of) short-term debt, net (347,486) 172,000
Proceeds from issuance of common stock, net 322,173 8,239
Payments of long-term debt (221,073) (10,647)
Net repayments by (advances to) discontinued operations 123,551 (99,213)
------------- -----------
Net cash provided by financing activities 29,805 70,836
------------- -----------
Effect of exchange rates on cash and cash equivalents 321 (3,159)
------------- -----------
Cash used in discontinued operations (12,518) (3,815)
------------- -----------
Net increase (decrease) in cash and cash equivalents (35,586) 1,232
Cash and cash equivalents at beginning of period 52,021 44,026
------------- -----------
Cash and cash equivalents at end of period $ 16,435 $ 45,258
------------- -----------
------------- -----------
</TABLE>
Page 5
<PAGE>
U.S. OFFICE PRODUCTS COMPANY
CONSOLIDATED STATEMENT OF CASH FLOWS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
(UNAUDITED)
(CONTINUED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
-----------------
JANUARY 23, JANUARY 24,
1999 1998
----------- -----------
<S> <C> <C>
Supplemental disclosures of cash flow information:
Interest paid $ 75,502 $ 26,962
Income taxes paid $ 3,187 $ 24,017
</TABLE>
The Company issued common stock and cash in connection with certain business
combinations accounted for under the purchase method for the nine months ended
January 23, 1999 and January 24, 1998. The estimated fair values of the assets
and liabilities at the dates of the acquisitions are presented as follows:
<TABLE>
<CAPTION>
NINE MONTHS ENDED
-----------------
JANUARY 23, JANUARY 24,
1999 1998
----------- -----------
<S> <C> <C>
Accounts receivable $ 3,251 $ 27,284
Inventory 3,189 18,970
Prepaid expenses and other current assets 3,929 15,806
Property and equipment 3,050 52,695
Intangible assets 29,691 371,606
Other assets 465 34,759
Short-term debt (2,586) (8,755)
Accounts payable (1,222) (20,058)
Accrued liabilities (842) (13,870)
Long-term debt (580) (20,320)
Other long-term liabilities and minority interests (3,837) (357)
------------ -------------
Net assets acquired $ 34,508 $ 457,760
------------ -------------
------------ -------------
</TABLE>
The acquisitions accounted for under the purchase method were funded as follows:
<TABLE>
<CAPTION>
NINE MONTHS ENDED
-----------------
JANUARY 23, JANUARY 24,
1999 1998
----------- -----------
<S> <C> <C>
Common stock $ $ 424,118
Cash 34,508 33,642
------------ -------------
Total $ 34,508 $ 457,760
------------ -------------
------------ -------------
</TABLE>
Non-cash transactions:
- - During the nine months ended January 23, 1999, the Company issued 2,025,185
shares of common stock in exchange for $130,989 of the 5 1/2% convertible
subordinated notes due 2001.
See accompanying notes to consolidated financial statements.
Page 6
<PAGE>
U. S. OFFICE PRODUCTS COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JANUARY 23, 1999
(IN THOUSANDS, EXCEPT RATIOS AND PER SHARE AMOUNTS)
(UNAUDITED)
NOTE 1 - BASIS OF PRESENTATION
The accompanying consolidated financial statements and related notes to
consolidated financial statements include the accounts of U.S. Office Products
Company (the "Company" or "U.S. Office Products"), and the companies acquired in
business combinations accounted for under the purchase method (the "Purchased
Companies") from their respective acquisition dates.
In June 1998, the Company completed a comprehensive restructuring plan (the
"Strategic Restructuring Plan"). The Company's Board of Directors approved the
Strategic Restructuring Plan in January 1998. The Strategic Restructuring Plan
included three principal elements: (i) the repurchase by the Company, through a
self-tender offer, of a portion of its outstanding shares (including shares
underlying employee stock options) (the "Equity Tender"); (ii) the Company's
distribution to its stockholders (the "Distributions") of the shares of four
separate companies that had been operated as divisions of the Company (together,
the "Spin-Off Companies"); and (iii) the purchase by an affiliate ("Investor")
of an investment fund managed by Clayton, Dubilier & Rice, Inc., a private
investment fund, of 24.9% of the Company's shares, plus warrants to purchase
additional shares, for a total of $270,000.
In conjunction with the Strategic Restructuring Plan, the Company also completed
several financing transactions (the "Financing Transactions") in June 1998. The
Financing Transactions consisted of the following: (i) through a tender offer,
the Company repurchased substantially all of its 5 1/2% convertible subordinated
notes due 2003 (the "2003 Notes") for a purchase price of 94.5% of the principal
amount and accrued interest on such notes; (ii) through an exchange offer, the
Company exchanged substantially all of its 5 1/2% convertible subordinated notes
due 2001 (the "2001 Notes") for shares of its common stock at an exchange rate
that represented an effective reduction in the conversion price of the 2001
Notes (the "2001 Notes Exchange"); (iii) the Company entered into a new
$1,225,000 senior secured bank credit facility (the "Credit Facility") and
terminated its former credit facility; and (iv) the Company issued and sold
$400,000 of 9 3/4% senior subordinated notes due 2008 (the "2008 Notes") in a
private placement at 99.583% of the principal amount.
For a complete description of the Strategic Restructuring Plan and the Financing
Transactions, see Note 3 of the Notes to the Company's audited consolidated
financial statements included in the Company's Annual Report on Form 10-K for
the fiscal year ended April 25, 1998.
The Company's consolidated financial statements reflect as discontinued
operations through June 9, 1998 (the effective date of the Distributions), the
results of the companies owned by the Spin-Off Companies (and thus included in
the Distributions). See Note 2, "Discontinued Operations." The Company's
continuing operations consist of its North American Office Products Group (which
includes office supply, office furniture, and office coffee, beverage, and
vending service businesses) ("NAOPG"), Mail Boxes Etc. ("MBE"), which the
Company acquired in November 1997, the Company's operations in New Zealand and
Australia (referred to herein as "Blue Star Group"), and the Company's 49%
interest in Dudley Stationery Limited ("Dudley"), a U.K. contract stationer. The
NAOPG operates primarily in the United States; it also includes three coffee and
beverage businesses located in Canada.
Page 7
<PAGE>
In the opinion of management, the information contained herein reflects all
adjustments necessary to make the results of operations for the interim periods
a fair presentation of such operations. All such adjustments are of a normal
recurring nature. Operating results for interim periods are not necessarily
indicative of results that may be expected for the year as a whole. It is
suggested that these consolidated financial statements be read in conjunction
with the Company's audited consolidated financial statements for the fiscal year
ended April 25, 1998, included in the Company's Annual Report on Form 10-K.
NOTE 2 - DISCONTINUED OPERATIONS
As a result of the Strategic Restructuring Plan, the Spin-Off Companies are
reflected as discontinued operations for all periods presented in the Company's
consolidated financial statements. The Spin-Off Companies (and their respective
lines of business) are Aztec Technology Partners, Inc. (technology solutions),
Navigant International, Inc. (corporate travel services), School Specialty, Inc.
(educational supplies), and Workflow Management, Inc (print management). The
Spin-Off Companies began operating as independent companies on June 10, 1998.
Accordingly, no statement of operations amounts have been provided for the three
months ended January 23, 1999, as the Distributions were completed on June 9,
1998.
The income (loss) from discontinued operations included in the consolidated
statement of operations represents the sum of the results of the Spin-Off
Companies for the periods they were included in the results of the Company and
is summarized as follows:
<TABLE>
<CAPTION>
CORPORATE TOTAL
PRINT TRAVEL EDUCATIONAL TECHNOLOGY DISCONTINUED
MANAGEMENT SERVICES SUPPLIES SOLUTIONS OPERATIONS
---------- --------- ----------- ----------- -------------
<S> <C> <C> <C> <C> <C>
THREE MONTHS ENDED JANUARY 24, 1998:
Revenues $ 86,730 $ 34,150 $ 49,391 $ 62,907 $ 233,178
Operating income (loss) 4,655 1,284 (3,247) 5,104 7,796
Income (loss) before provision for
income taxes 4,137 1,122 (5,058) 5,104 5,305
Provision for (benefit from) income taxes 1,851 564 (2,403) 2,208 2,220
Income (loss) from discontinued
operations, net of income taxes 2,286 558 (2,655) 2,896 3,085
NINE MONTHS ENDED JANUARY 23, 1999:
Revenues $ 41,132 $ 19,346 $ 40,785 $ 30,951 $ 132,214
Operating income (loss) (1,601) 14 1,836 403 652
Income (loss) before provision for
(benefit from) income taxes (2,043) (108) 1,069 381 (701)
Provision for (benefit from)
income taxes (732) 158 703 464 593
Income (loss) from discontinued
operations, net of income taxes (1,311) (266) 366 (83) (1,294)
NINE MONTHS ENDED JANUARY 24, 1998:
Revenues $ 260,077 $ 80,707 $ 247,880 $ 142,512 $ 731,176
Operating income 14,028 5,719 21,349 11,630 52,726
Income before provision for
income taxes 12,577 5,522 16,916 11,644 46,659
Provision for income taxes 5,629 2,794 7,734 5,038 21,195
Income from discontinued
operations, net of income taxes 6,948 2,728 9,182 6,606 25,464
</TABLE>
Page 8
<PAGE>
The results of the Spin-Off Companies include allocations of interest expense,
at U.S. Office Products' weighted average interest rates, and do not include any
allocations of corporate overhead from U.S. Office Products during the periods
presented.
The all other net assets from discontinued operations included in the Company's
consolidated balance sheet at April 25, 1998, represents the sum of the net
assets of the Spin-Off Companies as of April 25, 1998, and are summarized as
follows:
<TABLE>
<CAPTION>
CORPORATE TOTAL
PRINT TRAVEL EDUCATIONAL TECHNOLOGY DISCONTINUED
MANAGEMENT SERVICES SUPPLIES SOLUTIONS OPERATIONS
---------- --------- ----------- ----------- -------------
<S> <C> <C> <C> <C> <C>
APRIL 25, 1998:
Current assets $ 90,961 $ 21,993 $ 99,643 $ 66,835 $ 279,432
Property, plant and equipment, net 33,210 18,008 22,553 5,831 79,602
Intangible assets, net 14,014 87,590 99,613 63,829 265,046
Other assets 8,259 852 34 574 9,719
Current liabilities (57,434) (18,643) (54,642) (33,363) (164,082)
Long-term liabilities (30,250) (16,523) (63,415) (5,056) (115,244)
------------ ---------- ----------- ----------- -----------
Net assets from discontinued
operations $ 58,760 $ 93,277 $ 103,786 $ 98,650 $ 354,473
------------ ---------- ----------- ----------- -----------
------------ ---------- ----------- ----------- -----------
</TABLE>
The amounts to become receivable upon the Distributions reflected in the April
25, 1998 balance sheet were recovered from the Spin-Off Companies in connection
with the Distributions. No balance sheet amounts have been provided as of
January 23, 1999, as the Distributions were completed on June 9, 1998.
NOTE 3 - STOCKHOLDERS' EQUITY
Changes in stockholders' equity during the nine months ended January 23, 1999
were as follows:
<TABLE>
<S> <C>
Stockholders' equity balance at April 25, 1998 $ 1,486,131
Issuances (retirements) of common stock in conjunction with:
Equity investment by Investor, net of expenses 254,175
2001 Notes exchange 151,425
Exercise of stock options, including tax benefits 66,705
Employee stock purchase plan, net of expenses 1,548
Conversion of 2003 Notes 1,000
Purchase price adjustments related to acquisitions (101)
Repurchase of common stock in
Equity Tender (1,000,000)
Stock options participating in Equity Tender 57,708
Adjustments related to the Distributions (381,589)
Comprehensive loss (119,658)
-------------
Stockholders' equity balance at January 23, 1999 $ 517,344
-------------
-------------
</TABLE>
The adjustments related to the Distributions amount in the above table consists
of reductions in additional paid-in capital and retained earnings of $326,860
and $55,879, respectively, and a decrease in accumulated other comprehensive
loss of $1,150.
Page 9
<PAGE>
The Company adopted Statement of Financial Accounting Standards ("SFAS") No.
130, "Reporting Comprehensive Income," effective April 26, 1998. SFAS No. 130
requires cumulative translation adjustment, which prior to adoption was reported
separately in stockholders' equity, to be included in other comprehensive loss.
The components of other comprehensive loss are as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
------------------ -----------------
JANUARY 23, JANUARY 24, JANUARY 23, JANUARY 24,
1999 1998 1999 1998
------------ ----------- ------------ -------------
<S> <C> <C> <C> <C>
Net income (loss) $ (12,463) $ 18,516 $ (101,551) $ 62,700
Other comprehensive income (loss):
Cumulative translation adjustment 13,038 (34,954) (18,107) (107,439)
----------- ----------- ------------- -------------
Comprehensive income (loss) $ 575 $ (16,438) $ (119,658) $ (44,739)
----------- ----------- ------------- -------------
----------- ----------- ------------- -------------
</TABLE>
On June 10, 1998, the Company effected a one-for-four reverse split of its
common stock whereby each four shares of common stock were exchanged for one
share of common stock. All share and per share data appearing in these
consolidated financial statements and notes hereto have been retroactively
adjusted for this split.
On December 11, 1998, the Company completed a program in which it offered its
employees holding stock options issued by the Company the opportunity to
surrender their existing options for a smaller number of options at a lower
exercise price per share. Each employee holding options issued by the Company
was given the opportunity to have the Company (1) cancel existing options and
(2) issue to the employee a smaller number of new options with an exercise price
equal to $5 3/8, the closing price of the Company's common stock on December 11,
1998. The number of options received was equal to the number of old options
multiplied by a fraction that varied with the exercise price of old options. The
fraction ranged from .8844 for old options with an exercise price of $9.78 to
.0984 for old options with an exercise price of $54.90. Prior to the program,
options to acquire 7,546,722 shares were outstanding; after completion of the
program, options to acquire 2,618,413 shares remain issued and outstanding.
NOTE 4 - EARNINGS PER SHARE
In February 1997, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 128, "Earnings Per Share." SFAS No. 128 establishes standards for computing
and presenting earnings per share ("EPS"). SFAS No. 128 requires the dual
presentation of basic and diluted EPS on the face of the statement of
operations. Basic EPS excludes dilution and is computed by dividing income
available to common shareholders by the weighted average number of common shares
outstanding for the period. Diluted EPS reflects the potential dilution that
could occur if securities or other contracts to issue common stock were
exercised or converted into common stock. The Company adopted SFAS No. 128
during Fiscal 1998 and has restated all prior period EPS data.
The following information presents the Company's computations of basic and
diluted EPS from continuing operations before extraordinary items for the
periods presented in the consolidated statement of operations.
<TABLE>
<CAPTION>
INCOME/
(LOSS) SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- ----------
<S> <C> <C> <C>
THREE MONTHS ENDED JANUARY 23, 1999:
Basic loss per share $ (12,463) 36,626 $ (0.34)
-------
-------
Effect of dilutive employee stock options
--------- --------
Diluted loss per share $ (12,463) 36,626 $ (0.34)
--------- -------- -------
--------- -------- -------
</TABLE>
Page 10
<PAGE>
<TABLE>
THREE MONTHS ENDED JANUARY 24, 1998:
<S> <C> <C> <C>
Basic income per share $ 15,431 31,915 $ 0.48
-------
-------
Effect of dilutive employee stock options 628
--------- ---------
Diluted income per share $ 15,431 32,543 $ 0.47
--------- -------- -------
--------- -------- -------
NINE MONTHS ENDED JANUARY 23, 1999:
Basic loss per share $ (99,988) 36,089 $ (2.77)
-------
-------
Effect of dilutive employee stock options
--------- --------
Diluted loss per share $ (99,988) 36,089 $ (2.77)
--------- -------- -------
--------- -------- -------
NINE MONTHS ENDED JANUARY 24, 1998:
Basic income per share $ 37,236 28,698 $ 1.30
-------
-------
Effect of dilutive employee stock options 607
--------- --------
Diluted income per share $ 37,236 29,305 $ 1.27
--------- -------- -------
--------- -------- -------
</TABLE>
The basic and diluted loss per share amounts, for the three and nine month
periods ended January 23, 1999, were calculated using the same number of shares
outstanding since, as a result of the losses from continuing operations for such
periods, all of the Company's employee stock options and the two series of
convertible debt securities outstanding during such periods were anti-dilutive.
The Company had additional employee stock options and two series of convertible
debt securities outstanding during the three and nine month periods ended
January 24, 1998, that were not included in the computation of diluted EPS
because they were anti-dilutive.
NOTE 5 - BUSINESS COMBINATIONS
In fiscal 1998, the Company completed a total of 73 business combinations (51
related to continuing operations and 22 related to discontinued operations), all
of which were accounted for under the purchase method. During the nine months
ended January 23, 1999, the Company completed a total of 22 business
combinations (all related to continuing operations), all of which were accounted
for under the purchase method, for an aggregate cash purchase price of $34,508.
NOTE 6 - PRO FORMA RESULTS OF OPERATIONS
The following presents the unaudited pro forma results of operations of the
Company for the three and nine month periods ended January 23, 1999 and January
24, 1998, as if the Strategic Restructuring Plan, the Financing Transactions and
all of the purchase acquisitions and dispositions related to continuing
operations completed since the beginning of fiscal 1998 had been consummated at
the beginning of fiscal 1998. The pro forma results of operations, compared to
the historical actual results, reflect (i) substantially higher amortization
expenses as compared to prior periods (as a result of reclassifying 12 business
combinations as purchase acquisitions (including the Company's acquisition of
MBE), rather than under the pooling-of-interests method, as the Company had
expected when it completed those acquisitions); and (ii) substantially higher
interest expense, as a result of increased borrowing that the Company incurred
to help finance the cost of the Equity Tender. The pro forma results of
operations reflect certain pro forma adjustments including the amortization of
intangible assets, reductions in executive compensation and the removal of
Strategic Restructuring Plan costs. The pro forma results of operations include
$5,034 and $17,229 in operating restructuring costs during the three and nine
month periods ended January 23, 1999, respectively, $2,778 in impaired asset
write-offs during the three and nine month periods ended January 23, 1999 and
$4,964 and $7,500 in losses on the sale of businesses in New Zealand during the
three and nine month periods ended January 23, 1999, respectively.
Page 11
<PAGE>
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
------------------ -----------------
JANUARY 23, JANUARY 24, JANUARY 23, JANUARY 24,
1999 1998 1999 1998
------------ ----------- ------------ -------------
<S> <C> <C> <C> <C>
Revenues $ 676,122 $ 700,965 $ 2,012,697 $ 2,092,961
Income (loss) from continuing operations
before extraordinary items $ (9,920) $ 4,520 $ (19,478) $ 9,454
Basic income (loss) per share from
continuing operations $ (0.27) $ 0.12 $ (0.53) $ 0.25
Diluted income (loss) per share from
continuing operations $ (0.27) $ 0.12 $ (0.53) $ 0.25
</TABLE>
The pro forma results of operations are prepared for comparative purposes only
and do not necessarily reflect the results that would have occurred had the
Strategic Restructuring Plan, the Financing Transactions and the acquisitions
and dispositions occurred at the beginning of fiscal 1998 or the results that
may occur in the future.
NOTE 7 - CONDENSED CONSOLIDATING FINANCIAL INFORMATION
The following is summarized condensed consolidating financial information for
the Company, showing guarantor subsidiaries and non-guarantor subsidiaries
separately. The financial information shown in the "Guarantor Subsidiaries"
column represents the financial information of the domestic subsidiaries that
are guarantors of the Credit Facility and the 2008 Notes. The guarantor
subsidiaries are wholly-owned subsidiaries of the Company and the guarantees are
full, unconditional and joint and several. Separate financial statements of the
guarantor subsidiaries are not presented because management believes that
separate financial statements would not provide additional meaningful
information to investors.
Page 12
<PAGE>
BALANCE SHEETS
<TABLE>
<CAPTION>
JANUARY 23, 1999
-----------------------------------------------------------------------------------
U.S. OFFICE NON-
PRODUCTS COMPANY GUARANTOR GUARANTOR CONSOLIDATING CONSOLIDATED
(PARENT COMPANY) SUBSIDIARIES SUBSIDIARIES ADJUSTMENTS TOTAL
---------------- ------------ ------------ ------------- -------------
<S> <C> <C> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................... $ 7,727 $ 6,756 $ 1,952 $ $ 16,435
Accounts receivable, less allowance for ....
doubtful accounts......................... (1,950) 243,082 100,313 341,445
Inventory................................... 114,372 117,861 (75) (b) 232,158
Prepaid expenses and other current
assets.................................... 70,890 11,965 51,658 236 (b) 134,749
------------- -------------- ------------- ------------- -------------
Total current assets.................... 76,667 376,175 271,784 161 724,787
Property and equipment, net.................... 9,948 106,860 114,546 (559) (b) 230,795
Intangible assets, net......................... 576,007 343,241 919,248
Investment in subsidiaries..................... 973,792 (973,792) (a)
Other assets................................... 110,252 30,270 68,170 208,692
------------- -------------- ------------- ------------- -------------
Total assets............................ $ 1,170,659 $ 1,089,312 $ 797,741 $ (974,190) $ 2,083,522
------------- -------------- ------------- ------------- -------------
------------- -------------- ------------- ------------- -------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Short-term debt............................. $ 14,000 $ 1,691 $ 9,860 $ $ 25,551
Short-term intercompany balances............ 204,281 (205,944) 1,663
Accounts payable............................ 2,565 104,420 75,011 181,996
Accrued compensation........................ 4,450 24,393 16,807 45,650
Other accrued liabilities................... 15,107 28,958 59,288 103,353
------------- -------------- ------------- ------------- -------------
Total current liabilities............... 240,403 (46,482) 162,629 356,550
Long-term debt................................. 1,186,119 3,887 2,370 1,192,376
Other long-term liabilities and minority
interests.................................... 13,928 3,020 304 17,252
Long-term intercompany balances................ (642,435) 239,192 403,340 (97) (b)
-------------- -------------- ------------- -------------- -------------
Total liabilities....................... 798,015 199,617 568,643 (97) 1,566,178
-------------- -------------- ------------- -------------- -------------
Stockholders' equity:
Common stock................................ 37 37
Additional paid-in capital.................. 650,570 733,398 267,545 (973,792) (a) 677,721
Accumulated other comprehensive loss........ (72,006) (57,754) (129,760)
Retained earnings (accumulated deficit)..... (205,957) 156,297 19,307 (301) (b) (30,654)
------------- -------------- ------------- -------------- --------------
Total stockholders' equity.............. 372,644 889,695 229,098 (974,093) 517,344
------------- -------------- ------------- -------------- -------------
Total liabilities and stockholders'
equity $ 1,170,659 $ 1,089,312 $ 797,741 $ (974,190) $ 2,083,522
-------------- -------------- ------------- -------------- -------------
-------------- -------------- ------------- -------------- -------------
</TABLE>
Page 13
<PAGE>
<TABLE>
<CAPTION>
APRIL 25, 1998
-----------------------------------------------------------------------------------
U.S. OFFICE NON-
PRODUCTS COMPANY GUARANTOR GUARANTOR CONSOLIDATING CONSOLIDATED
(PARENT COMPANY) SUBSIDIARIES SUBSIDIARIES ADJUSTMENTS TOTAL
---------------- ------------ ------------ ------------- -------------
<S> <C> <C> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................... $ 19,684 $ 15,743 $ 16,594 $ $ 52,021
Accounts receivable, less allowance for ....
doubtful accounts......................... 219,046 91,481 310,527
Inventory................................... 118,553 110,248 (130) (b) 228,671
Prepaid expenses and other current
assets.................................... 29,799 34,753 52,598 117,150
------------- -------------- ------------- ------------- -------------
Total current assets.................... 49,483 388,095 270,921 (130) 708,369
Property and equipment, net.................... 11,441 101,671 116,103 (500) (b) 228,715
Intangible assets, net......................... 567,010 356,014 923,024
Investment in subsidiaries..................... 1,140,020 (1,140,020) (a)
Other assets................................... 97,683 30,334 66,684 194,701
Net assets of discontinued operations:
Amounts to become receivable upon the
Distributions............................. 132,145 132,145
All other net assets........................ 354,473 354,473
------------- -------------- ------------- ------------- -------------
Total assets............................ $ 1,430,772 $ 1,087,110 $ 1,164,195 $ (1,140,650) $ 2,541,427
------------- -------------- ------------- ------------- -------------
------------- -------------- ------------- ------------- -------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Short-term debt............................. $ 365,000 $ 1,859 $ 1,368 $ $ 368,227
Short-term intercompany balances............ 66,027 (100,324) 34,297
Accounts payable............................ 2,303 85,712 74,703 162,718
Accrued compensation........................ 4,218 20,918 17,877 43,013
Other accrued liabilities................... (26,456) 60,113 47,988 (234) (b) 81,411
------------- -------------- ------------- ------------- -------------
Total current liabilities............... 411,092 68,278 176,233 (234) 655,369
Long-term debt................................. 373,750 5,083 3,341 382,174
Other long-term liabilities and minority
interests.................................... 13,908 3,510 335 17,753
Long-term intercompany balances................ (651,930) 195,242 456,785 (97) (b)
------------- -------------- ------------- ------------- -------------
Total liabilities....................... 146,820 272,113 636,694 (331) 1,055,296
------------- -------------- ------------- ------------- -------------
Stockholders' equity:
Common stock................................ 33 33
Additional paid-in capital.................. 1,417,917 709,266 484,962 (1,140,020) (a) 1,472,125
Accumulated other comprehensive loss........ (66,472) (46,331) (112,803)
Retained earnings (accumulated deficit)..... (67,526) 105,731 88,870 (299) (b) 126,776
------------- -------------- ------------- ------------- -------------
Total stockholders' equity.............. 1,283,952 814,997 527,501 (1,140,319) 1,486,131
------------- -------------- ------------- ------------- -------------
Total liabilities and stockholders'
equity $ 1,430,772 $ 1,087,110 $ 1,164,195 $ (1,140,650) $ 2,541,427
------------- -------------- ------------- ------------- -------------
------------- -------------- ------------- ------------- -------------
</TABLE>
Page 14
<PAGE>
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
FOR THE THREE MONTHS ENDED JANUARY 23, 1999
-----------------------------------------------------------------------------------
U.S. OFFICE NON-
PRODUCTS COMPANY GUARANTOR GUARANTOR CONSOLIDATING CONSOLIDATED
(PARENT COMPANY) SUBSIDIARIES SUBSIDIARIES ADJUSTMENTS TOTAL
---------------- ------------ ------------ ------------- -------------
<S> <C> <C> <C> <C> <C>
Revenues....................................... $ $ 469,497 $ 215,322 $ (8,197) (c) $ 676,622
Cost of revenues............................... (2,919) 347,239 146,366 (8,137) (c) 482,549
------------- -------------- ------------- ------------- -------------
Gross profit............................ 2,919 122,258 68,956 (60) 194,073
Selling, general and administrative expenses... 9,080 92,562 52,460 (60) (c) 154,042
Amortization expense........................... 103 4,100 2,234 6,437
Strategic Restructuring Plan costs.............
Operating restructuring costs.................. 1,176 2,974 884 5,034
Impaired asset write-offs...................... 2,778 2,778
------------- -------------- ------------- ------------- -------------
Operating income (loss)................. (7,440) 19,844 13,378 25,782
Interest expense............................... 31,376 (14,084) 11,614 28,906
Interest income................................ (8) (200) (91) (299)
Loss on sale of businesses..................... 4,964 4,964
Other expense................................. (12) 448 628 1,064
------------- -------------- ------------- ------------- -------------
Income (loss) from continuing operations before
provision for (benefit from) income taxes ..... (38,796) 33,680 (3,737) (8,853)
Provision for (benefit from) income taxes...... (13,559) 16,377 792 3,610
------------- -------------- ------------- ------------- -------------
Net income (loss).............................. $ (25,237) $ 17,303 $ (4,529) $ $ (12,463)
------------- -------------- ------------- ------------- -------------
------------- -------------- ------------- ------------- -------------
</TABLE>
<TABLE>
<CAPTION>
FOR THE THREE MONTHS ENDED JANUARY 24, 1998
-----------------------------------------------------------------------------------
U.S. OFFICE NON-
PRODUCTS COMPANY GUARANTOR GUARANTOR CONSOLIDATING CONSOLIDATED
(PARENT COMPANY) SUBSIDIARIES SUBSIDIARIES ADJUSTMENTS TOTAL
---------------- ------------ ------------ ------------- -------------
<S> <C> <C> <C> <C> <C>
Revenues....................................... $ $ 446,929 $ 224,785 $ (5,755) (c) $ 665,959
Cost of revenues............................... (2,057) 330,164 154,309 (5,677) (c) 476,739
------------- -------------- ------------- ------------- -------------
Gross profit............................ 2,057 116,765 70,476 (78) 189,220
Selling, general and administrative expenses... 5,327 86,957 54,279 (66) (c) 146,497
Amortization expense........................... 3,200 2,234 5,434
------------- -------------- ------------- ------------- -------------
Operating income (loss)................. (3,270) 26,608 13,963 (12) 37,289
Interest expense............................... 7,548 (1,755) 3,687 9,480
Interest income................................ 2,420 (2,528) (309) (417)
Other expense.................................. 57 92 149
------------- -------------- ------------- ------------- -------------
Income (loss) from continuing operations
before provision for (benefit from) income
taxes........................................ (13,238) 30,834 10,493 (12) 28,077
Provision for (benefit from) income taxes...... (6,102) 14,213 4,540 (5) (c) 12,646
------------- -------------- ------------- ------------- -------------
Income (loss) from continuing operations...... (7,136) 16,621 5,953 (7) 15,431
Income from discontinued operations,
net of income taxes.......................... 3,085 3,085
------------- -------------- ------------- ------------- -------------
Net income (loss).............................. $ (7,136) $ 16,621 $ 9,038 $ (7) $ 18,516
------------- -------------- ------------- ------------- -------------
------------- -------------- ------------- ------------- -------------
</TABLE>
Page 15
<PAGE>
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
FOR THE NINE MONTHS ENDED JANUARY 23, 1999
-----------------------------------------------------------------------------------
U.S. OFFICE NON-
PRODUCTS COMPANY GUARANTOR GUARANTOR CONSOLIDATING CONSOLIDATED
(PARENT COMPANY) SUBSIDIARIES SUBSIDIARIES ADJUSTMENTS TOTAL
---------------- ------------ ------------ ------------- -------------
<S> <C> <C> <C> <C> <C>
Revenues....................................... $ $ 1,420,968 $ 609,880 $ (25,072) (c) $ 2,005,776
Cost of revenues............................... (5,615) 1,058,932 420,655 (24,972) (c) 1,449,000
------------- -------------- ------------- -------------- -------------
Gross profit............................ 5,615 362,036 189,225 (100) 556,776
Selling, general and administrative expenses... 25,063 274,714 153,828 (97) (c) 453,508
Amortization expense........................... 308 11,685 6,566 18,559
Strategic Restructuring Plan costs............. 96,948 555 97,503
Operating restructuring costs.................. 1,176 10,469 5,584 17,229
Impaired asset write-offs...................... 2,778 2,778
------------- -------------- ------------- ------------- -------------
Operating income (loss)................. (117,880) 61,835 23,247 (3) (32,801)
Interest expense............................... 83,240 (35,665) 29,210 76,785
Interest income................................ (101) (726) (298) (1,125)
Loss on sale of businesses..................... 7,500 7,500
Other expense.................................. (7) 756 (704) 45
------------- -------------- -------------- ------------- -------------
Income (loss) from continuing operations
before provision for (benefit from) income
taxes and extraordinary items................ (201,012) 97,470 (12,461) (3) (116,006)
Provision for (benefit from) income taxes...... (62,850) 46,904 (71) (1) (c) (16,018)
------------- -------------- ------------- -------------- -------------
Income (loss) from continuing operations
before extraordinary items ................. (138,162) 50,566 (12,390) (2) (99,988)
Loss from discontinued operations,
net of income taxes.......................... (1,294) (1,294)
------------- -------------- -------------- -------------- -------------
Income (loss) before extraordinary items....... (138,162) 50,566 (13,684) (2) (101,282)
Extraordinary items - loss on early
termination of debt facilities, net of
income taxes................................. 269 269
------------- -------------- ------------- ------------- -------------
Net income (loss).............................. $ (138,431) $ 50,566 $ (13,684) $ (2) $ (101,551)
------------- -------------- ------------- ------------- -------------
------------- -------------- ------------- ------------- -------------
</TABLE>
<TABLE>
<CAPTION>
FOR THE NINE MONTHS ENDED JANUARY 24, 1998
-----------------------------------------------------------------------------------
U.S. OFFICE NON-
PRODUCTS COMPANY GUARANTOR GUARANTOR CONSOLIDATING CONSOLIDATED
(PARENT COMPANY) SUBSIDIARIES SUBSIDIARIES ADJUSTMENTS TOTAL
---------------- ------------ ------------ ------------- -------------
<S> <C> <C> <C> <C> <C>
Revenues....................................... $ $ 1,275,439 $ 669,101 $ (14,427) (c) $ 1,930,113
Cost of revenues............................... (2,604) 949,832 457,790 (14,163) (c) 1,390,855
------------- -------------- ------------- ------------- -------------
Gross profit............................ 2,604 325,607 211,311 (264) 539,258
Selling, general and administrative expenses... 15,153 250,328 170,669 (113) (c) 436,037
Amortization expense........................... 7,022 6,808 13,830
------------- -------------- ------------- ------------- -------------
Operating income (loss)................. (12,549) 68,257 33,834 (151) 89,391
Interest expense............................... 21,877 (4,993) 10,650 27,534
Interest income................................ 4,849 (5,040) (1,354) (1,545)
Other expense.................................. (1,084) (4,878) (407) (6,369)
------------- --------------- ------------- ------------- -------------
Income (loss) from continuing operations
before provision for (benefit from) income
taxes........................................ (38,191) 83,168 24,945 (151) 69,771
Provision for (benefit from) income taxes...... (18,565) 40,429 10,738 (67) (c) 32,535
------------- -------------- ------------- ------------- -------------
Income (loss) from continuing operations...... (19,626) 42,739 14,207 (84) 37,236
Income from discontinued operations,
net of income taxes.......................... 25,464 25,464
------------- -------------- ------------- ------------- -------------
Net income (loss).............................. $ (19,626) $ 42,739 $ 39,671 $ (84) $ 62,700
------------- -------------- ------------- ------------- -------------
------------- -------------- ------------- ------------- -------------
</TABLE>
Page 16
<PAGE>
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
FOR THE NINE MONTHS ENDED JANUARY 23, 1999
-----------------------------------------------------------------------------------
U.S. OFFICE NON-
PRODUCTS COMPANY GUARANTOR GUARANTOR CONSOLIDATING CONSOLIDATED
(PARENT COMPANY) SUBSIDIARIES SUBSIDIARIES ADJUSTMENTS TOTAL
---------------- ------------ ------------ ------------- -------------
<S> <C> <C> <C> <C> <C>
Cash flows from operating activities........... $ (107,246) $ 119,237 $ (463) $ (56) (d) $ 11,472
Cash flows from investing activities........... (26,031) (16,420) (22,271) 56 (d) (64,666)
Cash flows from financing activities........... 121,322 (111,804) 20,287 29,805
Effect of exchange rates on cash and cash
equivalents.................................. 321 321
Cash used in discontinued operations........... (12,518) (12,518)
------------- -------------- ------------- ------------- -------------
Net decrease in cash and cash
equivalents................................... (11,955) (8,987) (14,644) (35,586)
Cash and cash equivalents at beginning
of period.................................... 19,684 15,743 16,594 52,021
------------- -------------- ------------- ------------- -------------
Cash and cash equivalents at end of period..... $ 7,729 $ 6,756 $ 1,950 $ $ 16,435
------------- -------------- ------------- ------------- -------------
------------- -------------- ------------- ------------- -------------
</TABLE>
<TABLE>
<CAPTION>
FOR THE NINE MONTHS ENDED JANUARY 24, 1998
-----------------------------------------------------------------------------------
U.S. OFFICE NON-
PRODUCTS COMPANY GUARANTOR GUARANTOR CONSOLIDATING CONSOLIDATED
(PARENT COMPANY) SUBSIDIARIES SUBSIDIARIES ADJUSTMENTS TOTAL
---------------- ------------ ------------ ------------- -------------
<S> <C> <C> <C> <C> <C>
Cash flows from operating activities........... $ (51,548) $ 56,210 $ 32,258 $ (83) (d) $ 36,837
Cash flows from investing activities........... (29,036) 2,638 (73,249) 180 (d) (99,467)
Cash flows from financing activities........... 87,985 (52,855) 35,803 (97) (d) 70,836
Effect of exchange rates on cash and cash
equivalents.................................. (3,159) (3,159)
Cash used in discontinued operations........... (3,815) (3,815)
------------- -------------- ------------- ------------- -------------
Net increase (decrease) in cash and cash
equivalents................................... 7,401 5,993 (12,162) 1,232
Cash and cash equivalents at beginning
of period.................................... 13,210 7,758 23,058 44,026
------------- -------------- ------------- ------------- -------------
Cash and cash equivalents at end of period..... $ 20,611 $ 13,751 $ 10,896 $ $ 45,258
------------- -------------- ------------- ------------- -------------
------------- -------------- ------------- ------------- -------------
</TABLE>
The "U.S. Office Products Company (Parent Company)" column in the foregoing
condensed consolidating financial information reflects equity method accounting
for the Company's investment in subsidiaries.
Consolidating adjustments to the condensed consolidating balance sheets
include the following:
(a) Elimination of investments in subsidiaries.
(b) Elimination of intercompany profit in inventory and property and
equipment.
Consolidating adjustments to the condensed consolidating statements of
income include the following:
(c) Elimination of intercompany sales.
Consolidating adjustments to the condensed consolidating statements of
cash flows include the following:
(d) Elimination of intercompany profits.
Page 17
<PAGE>
NOTE 8 - NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS No. 133 is effective for all fiscal
quarters of all fiscal years beginning after June 15, 1999 (fiscal 2001 for the
Company). SFAS No. 133 requires that all derivative instruments be recorded on
the balance sheet at their fair value. Changes in the fair value of derivatives
are recorded each period in current earnings or other comprehensive income,
depending on whether a derivative is designated as part of a hedge transaction
and, if it is, the type of hedge transaction. Management of the Company
anticipates that, due to its limited use of derivative instruments, the adoption
of SFAS No. 133 will not have a significant effect on the Company's results of
operations or its financial position.
In March 1998, the Accounting Standards Executive Committee issued SOP 98-1,
"Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use." SOP 98-1 is effective for financial statements for fiscal years
beginning after December 15, 1998 (fiscal 2000 for the Company). SOP 98-1
provides guidance for accounting for the costs of computer software developed or
obtained for internal use. Management of the Company anticipates that the
adoption of SOP 98-1 will not have a significant effect on the Company's results
of operations or its financial position.
NOTE 9 - SUBSEQUENT EVENTS
At the end of February 1999, Thomas Morgan tendered his resignation as President
and Chief Executive Officer and a director of the Company, to assume the
position of Chief Executive Officer of Value America, Inc. Effective February
26, 1999, the Company's Board of Directors accepted Mr. Morgan's resignation and
named Charles P. Pieper, Chairman of the Company's Board of Directors, to the
additional position of Chief Executive Officer of the Company.
Page 18
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS.
THIS QUARTERLY REPORT ON FORM 10-Q CONTAINS FORWARD-LOOKING STATEMENTS THAT
INVOLVE RISKS AND UNCERTAINTIES. WHEN USED IN THIS REPORT, THE WORDS
"ANTICIPATE," "BELIEVE," "ESTIMATE," "INTEND," "MAY," "WILL," "EXPECT" AND
SIMILAR EXPRESSIONS AS THEY RELATE TO THE COMPANY OR ITS MANAGEMENT ARE INTENDED
TO IDENTIFY SUCH FORWARD-LOOKING STATEMENTS. THE COMPANY'S ACTUAL RESULTS,
PERFORMANCE OR ACHIEVEMENTS COULD DIFFER MATERIALLY FROM THE RESULTS EXPRESSED
IN, OR IMPLIED BY, THESE FORWARD-LOOKING STATEMENTS. FACTORS THAT COULD CAUSE OR
CONTRIBUTE TO SUCH DIFFERENCES INCLUDE THOSE DISCUSSED UNDER THE HEADING
"-FACTORS AFFECTING THE COMPANY'S BUSINESS." THE COMPANY DOES NOT UNDERTAKE ANY
OBLIGATION TO REVISE THESE FORWARD-LOOKING STATEMENTS TO REFLECT ANY FUTURE
EVENTS OR CIRCUMSTANCES.
CAPITALIZED TERMS USED IN THE MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS WITHOUT SEPARATE DEFINITIONS HAVE THE
MEANING GIVEN TO THEM IN NOTE 1 TO THE NOTES TO THE COMPANY'S CONSOLIDATED
FINANCIAL STATEMENTS INCLUDED ELSEWHERE IN THE QUARTERLY REPORT ON FORM 10-Q.
INTRODUCTION
The Company consists of three operating divisions: the North American Office
Products Group, which includes office supplies, office furniture, and breakroom
products and services (office coffee, beverage, and vending services) ("NAOPG");
Mail Boxes Etc. ("MBE"), which the Company acquired in November 1997; and the
Company's operations in New Zealand and Australia (owned principally through
Blue Star Group Limited). The Company also holds a 49% equity interest in Dudley
Stationery Limited, a U.K. contract stationer. The NAOPG operates primarily in
the United States; it also includes three coffee and beverage businesses located
in Canada.
The Company derives revenues primarily from the sale of a wide variety of office
supplies, office furniture, and other office products, including office coffee,
beverage, and vending products and services to corporate, commercial and
industrial customers. Cost of revenues represents the purchase price for office
supplies, office furniture, and other office products and includes occupancy and
delivery costs and is reduced by rebates and discounts on inventory when such
inventory is sold. Selling, general and administrative expenses represent
product marketing and selling costs, customer service and product design costs,
warehouse costs, and other administrative expenses.
From its inception in 1994 through the end of the 1997 calendar year, the
Company grew primarily through acquisitions. At the time it adopted the
Strategic Restructuring Plan in January 1998, the Company announced its
intention to change its strategic focus and pursue increased revenues and
profitability primarily through operating strategies intended to improve the
efficiency of its existing businesses. The Company said it expected to reduce
its acquisition volume significantly. The Company has acquired many fewer
businesses since the start of the 1999 fiscal year than it did during comparable
periods of prior years. In addition, consistent with the Company's announced
expectations, acquisitions have involved smaller businesses and have accounted
for a much smaller percentage of the Company's revenue growth than in the past.
In November 1998, the Company indicated that it intended to reduce future
acquisitions even further than originally expected, in order to devote
substantially all of its management attention and capital resources to the
operation of its existing businesses. See "--Factors Affecting the Company's
Business - Change in Strategic Focus and Growth Strategy" and "--Challenges of
Business Integration and Consolidation" for a discussion of risks and
uncertainties associated with these changes.
Page 19
<PAGE>
As a result of the Strategic Restructuring Plan and the Financing Transactions,
the Company's reported results reflect substantially higher interest expense,
and higher effective income tax rates, than in prior periods. Consistent with
the Company's announced expectations at the time it adopted the Strategic
Restructuring Plan, these increased expenses have significantly reduced the
Company's reported net income and net income per share in fiscal 1999, as
compared to prior periods. In the quarter ended January 23, 1999, the Company
reported a net loss. See - "Consolidated Results of Operations." Rather than net
income and net income per share, management believes that a more meaningful
indication of the Company's performance is cash flows from operations and
earnings from continuing operations before interest expense, provision for
income taxes, depreciation expense, amortization expense, loss on sale of
businesses, impaired asset write-offs and restructuring costs ("EBITDA"). In
focusing on improving the operations of its existing businesses, the Company is
seeking to increase EBITDA both in absolute terms and as a percentage of
revenues. For a discussion of EBITDA in the quarter ended January 23, 1999, as
compared with prior periods, as well as a discussion of the Company's plans to
seek increases in EBITDA as a percentage of revenues, see "--Consolidated
Results of Operations."
The Company derives approximately one-third of its revenues from operations in
New Zealand and Australia. Consequently, the Company's results of operations,
cash flows and financial position will continue to be affected by fluctuations
in foreign currency exchange rates. The exchange rates for the New Zealand and
Australian dollars, as compared to the U.S. dollar, have declined significantly
since the beginning of fiscal 1998. See "--Liquidity and Capital Resources" and
"--Factors Affecting the Company's Business -Fluctuations in the Value of the
New Zealand and Australian Dollars."
Consistent with the objectives of the Strategic Restructuring Plan and as part
of the Company's increased focus on operational matters, the Company instituted
cost reduction measures following completion of the Strategic Restructuring
Plan, including reductions in headcount, the elimination of duplicative
facilities, the consolidation of certain operating functions, and the deployment
of common information systems. In implementing these cost reduction measures,
the Company has incurred, and will in the future incur, certain operating
restructuring costs. The Company recorded operating restructuring charges of
approximately $12.2 million in the first six months of fiscal 1999, reflecting
the costs of the plans actually being implemented. Approximately $2.3 million of
this charge reflected non-cash items. In the third fiscal quarter of 1999, the
Company recorded additional operating restructuring charges of approximately
$5.0 million. A majority of the restructuring charge recorded in the third
fiscal quarter reflects severance costs relating to employees who were notified
that their positions were being eliminated. The remainder of the charges reflect
costs associated with facility consolidations. Approximately $0.1 million of the
charge in the third quarter reflects non-cash items.
Management has estimated that the Company will record a total of approximately
$30-35 million of operating restructuring charges (including the $17.2 million
recorded in the first three quarters of the 1999 fiscal year) during the 1999
and 2000 fiscal years for cost reduction measures adopted since the completion
of the Strategic Restructuring Plan. Management expects to record approximately
$4 million of these charges in the fourth quarter of fiscal 1999, and the
remaining amount in fiscal 2000. It is expected that approximately one-quarter
of these charges will reflect non-cash items. These charges will include
employee severance costs resulting from the expense reduction program that the
Company initiated in the second quarter of the current fiscal year, costs
associated with the establishment of District Fulfillment Centers ("DFCs") in
Nashville, New Orleans, Austin, Portland, Los Angeles, and Milwaukee, and other
costs associated with additional facility consolidation. (DFCs are centralized
warehouses conducting operations that service geographic regions previously
serviced by multiple facilities.)
Page 20
<PAGE>
In recent months, the Company has decided to implement additional significant
changes designed to reduce costs and increase profitability more quickly than
had been occurring. The Company has formed a series of "accelerated change
teams" including Company personnel and outside professional consultants. The
initiatives address the following areas:
- - Improvements in a wide variety of operational and functional areas,
including pricing, sourcing, product warehousing and distribution
systems, financial reporting and information systems, and
organizational structure;
- - Identification of under-performing operations, or businesses that are
non-core and that management does not believe can be managed
productively in the near term, within NAOPG and Blue Star, and
development of recommendations for fixing, selling or closing these
units and businesses;
- - Analysis of the organization and management of the NAOPG; and
- - Reduction of working capital needs by improved management of
inventory, receivables and payables.
While these initiatives are aimed at producing cost savings and margin and
productivity improvements, the Company is in the early stages of developing
these initiatives, and there is no assurance that they will be successful. In
addition, over the near term these initiatives will produce an increase in
costs, principally due to the costs of outside professional assistance.
Implementation of the changes may also result in additional charges including
severance costs, facility closure costs, write-downs or write-offs of
goodwill and other assets. Because the Company is seeking to effect change at
an accelerated pace, these charges may be recognized more rapidly than they
otherwise have; in addition, because of the rapid changes the Company is
seeking to effect, it may write-down or write-off assets that it previously
had expected to use in continuing operations. In some cases, charges may
relate to businesses that the Company had expected to continue to operate or
to operate on a temporary basis, pending disposition, but decides instead to
close. See "--Risks Related to Dispositions." These charges will be in
addition to the $30-$35 million related to plans that have already been
approved. Although management cannot yet estimate these costs, they are
likely to have the effect of reducing earnings and EBITDA over the near term.
Except where specifically noted, the discussion of financial condition and
results of operations that appears below covers only the Company's continuing
operations. For additional information about the results of discontinued
operations, see Note 2 to the Notes to the Company's consolidated financial
statements included elsewhere in this Quarterly Report on Form 10-Q.
The Company's financial condition and results of operations have changed
dramatically from the Company's inception in October 1994 to January 23, 1999 as
a result of the Company's aggressive acquisition program and the completion of
the Strategic Restructuring Plan. The Company completed 238 business
combinations (195 related to continuing operations and 43 related to
discontinued operations) from its inception through the end of fiscal 1998, 54
of which were accounted for under the pooling-of-interests method (39 related to
continuing operations and 15 related to discontinued operations). All 73
business combinations completed during fiscal 1998 were accounted for under the
purchase method. Prior to the adoption of the Strategic Restructuring Plan, 22
of the fiscal 1998 business combinations had been accounted for under the
pooling-of-interests method (12 related to continuing operations, including the
acquisition of MBE, and 10 related to discontinued operations). Following
adoption of the Strategic Restructuring Plan, the Company restated its
historical consolidated financial statements to account for these 22 business
combinations under the purchase method. The Company has completed an additional
22 business combinations, all of which were accounted for under the purchase
method, during the nine months ended January 23, 1999. The Company's
consolidated financial statements give retroactive effect to the business
combinations accounted for under the pooling-of-interests method during fiscal
Page 21
<PAGE>
1997 and 1996 and include the results of companies acquired in business
combinations accounted for under the purchase method from their respective
acquisition dates.
Due to the Company's growth through acquisitions, year-to-year comparisons of
the historical results of the Company's operations have been affected primarily
by the addition of acquired companies. In most instances, dollar increases in
the various revenue and expense components of the Company's results are due
primarily to growth from acquisitions. However, the increases in interest
expense are directly related to the increase in debt, and the interest rates
associated with such debt, resulting from the completion of certain elements of
the Strategic Restructuring Plan. Neither the magnitude nor the source of such
year-to-year changes is necessarily indicative of changes that will occur in the
future. As noted above, the Company's strategy is to continue to focus on
operational improvements and to significantly reduce its acquisition activity.
The Company expects that the impact of acquisitions on the future results of the
Company's continuing operations will decrease because the number and size of
companies that it acquires are likely to be much smaller, and the Company's
existing operations are much larger, than in prior years.
CONSOLIDATED RESULTS OF OPERATIONS
THREE MONTHS ENDED JANUARY 23, 1999 COMPARED TO THREE MONTHS ENDED
JANUARY 24, 1998
Consolidated revenues increased 1.6%, from $666.0 million for the three months
ended January 24, 1998, to $676.6 million for the three months ended January 23,
1999. This increase was primarily due to acquisitions. Revenues for the three
months ended January 23, 1999 include revenues from 49 companies acquired in
business combinations accounted for under the purchase method after the
beginning of the third quarter of fiscal 1998 (the "3Q Purchased Companies").
Revenues for the three months ended January 24, 1998 include revenues from 16 of
such 3Q Purchased Companies for a portion of such period. This increase was
partially offset by a decline in international revenues as a result of the
devaluation of the New Zealand and Australian dollars against the U.S. dollar
(the "USD"). Because revenues generated in New Zealand and Australia contributed
approximately one-third of the Company's consolidated revenues during this
period, management estimates that currency devaluation had the effect of
reducing the Company's increase in reported consolidated revenues (in U.S.
dollar terms) by approximately 4.1%. On a pro forma basis, to give effect to the
Strategic Restructuring Plan and the purchase acquisitions completed after the
beginning of the third fiscal quarter of 1998, and assuming that the average
exchange rates for the New Zealand and Australian dollars in the third fiscal
quarter of 1998 were equal to the average exchange rates in the third quarter of
fiscal 1999, revenues increased 0.2%. See "--Pro Forma Results of Operations."
NAOPG revenues increased 2.9% from $431.0 million or 64.7% of consolidated
revenues for the three months ended January 24, 1998, to $443.4 million or
65.5% of consolidated revenues for the three months ended January 23, 1999.
This increase was primarily due to acquisitions. On a pro forma basis NAOPG
revenues in the third quarter decreased 1.5%, primarily due to the impact of
losing a number of larger local and regional accounts to competitors, often
when the headquarters office of a customer's business consolidates its office
supply purchasing activities and awards a contract to a single supplier other
than the Company. See "-Pro Forma Results of Operations." Although the
Company has been successful in adding a substantial number of mid-sized and
smaller accounts (including more than 5,000 new accounts during a six-week
sales program in the third quarter of fiscal 1999), the loss of larger
customer business more than offset the increase in business from such
mid-sized and smaller accounts. To address the loss of larger customers the
Company has instituted a national accounts system that allows it to handle
such customers' order, pricing, billing and delivery requirements.
International revenues decreased 4.2%, from $224.8 million, or 33.8% of
consolidated revenues, for the three months ended January 24, 1998, to $215.3
million, or 31.8% of consolidated revenues, for the three months ended January
23, 1999. International revenues consist primarily of revenues from New Zealand
and Australia, with the balance from Canada. This decrease is due primarily to
the devaluation of the New Zealand and Australian dollars against the USD. The
following table details the declines in the average exchanges rates of
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<PAGE>
the New Zealand and Australian dollars versus the USD for the three months ended
January 23, 1999 and January 24, 1998:
<TABLE>
<CAPTION>
AVERAGE EXCHANGE RATES
FOR THE THREE MONTHS ENDED
-----------------------------
JANUARY 23, JANUARY 24,
1999 1998 DECLINE
-------------- ------------- -----------
<S> <C> <C> <C>
New Zealand dollar $.53 $.60 $(.07)
Australian dollar $.63 $.68 $(.05)
</TABLE>
International revenues in New Zealand and Australia, calculated in their local
currencies, increased 8.1% for the three months ended January 23, 1999, as
compared to the three months ended January 24, 1998. This increase was due
primarily to the inclusion, in the revenues for the three months ended January
23, 1999, of revenues from 24 companies that were acquired in business
combinations accounted for under the purchase method after the beginning of the
third quarter of fiscal 1998. Revenues from nine such companies were included in
revenues for a portion of the three months ended January 24, 1998. See "-Pro
Forma Results of Operations."
MBE revenues increased 58.4%, from $13.4 million, or 2.0% of consolidated
revenues, for the three months ended January 24, 1998, to $21.2 million, or 3.1%
of consolidated revenues, for the three months ended January 23, 1999. This
increase was primarily the result of MBE only being consolidated for two months
in the earlier period. On a pro forma basis MBE revenues decreased 4%, however,
same store sales increased 9% over the last year. The primary reason for the
overall decline in pro forma revenues is due to the fact that in the third
quarter of fiscal 1998, MBE recorded revenues related to the sale of several
area franchises and there were no area franchises sold in the third quarter of
fiscal 1999. See "-Pro Forma Results of Operations."
Gross profit increased 2.6%, from $189.2 million for the three months ended
January 24, 1998, to $194.1 million for the three months ended January 23,
1999. The increase in gross profit is directly related to the increase in
revenues. As a percentage of revenues, gross profit increased from 28.4% for
the three months ended January 24, 1998, to 28.7% for the three months ended
January 23, 1999. The Company believes that the increase in gross profit as a
percentage of revenues reflects a number of positive factors including the
disposal in the third quarter of a low margin under-performing technology
business in New Zealand and a strong New Zealand retail performance over the
holiday season. Such positive factors were offset in part by disappointing
margins at certain under-performing units at NAOPG and Blue Star. The
initiatives discussed above in "-Introduction" are designed to address the
factors that management believes are adversely affecting gross margins, but
gross margins are affected in part by circumstances beyond management's
control (including the factors described under "--Factors Affecting the
Company's Business" below) and there can be no assurances of the timing or
magnitude of such improvements, or whether they will be realized at all.
Gross margin improvement efforts could be offset in whole or in part by
further declines in the value of the New Zealand dollar, increasing price
competition in the United States, and other factors discussed above in
"-Introduction" and below under "--Factors Affecting the Company's Business."
Selling, general and administrative expenses increased 5.2%, from $146.5 million
for the three months ended January 24, 1998, to $154.0 million for the three
months ended January 23, 1999, primarily due to the increase in revenues and
corporate costs. Selling, general and administrative expenses as a percentage of
revenues increased from 22.0% for the three months ended January 24, 1998, to
22.8% for the three months ended January 23, 1999. The increase in selling,
general and administrative expenses as a percentage of revenues was the net
result of a number of factors, including: (i) the disposal of a low overhead
under-performing technology business in New Zealand; (ii) increased corporate
expenses; and (iii) slower than expected reduction of expenses through the
continued consolidation of certain redundant facilities and job functions.
Amortization expense increased 18.5%, from $5.4 million for the three months
ended January 24, 1998, to $6.4 million for the three months ended January 23,
1999. This increase is due exclusively to the amortization of
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<PAGE>
intangible assets recorded in conjunction with the significant number of
business combinations, accounted for under the purchase method, completed since
the beginning of the fiscal 1998.
EBITDA decreased from $51.9 million, for the three months ended January 24,
1998, to $49.7 million, for the three months ended January 23, 1999. EBITDA as a
percentage of revenues decreased from 7.8% for the three months ended January
24, 1998, to 7.3% for the three months ended January 23, 1999. EBITDA is
provided because it is a measure commonly used by analysts and investors to
determine a company's ability to incur and service debt. EBITDA is not a
measurement of performance under generally accepted accounting principles and
should not be considered an alternative to net income as a measure of
performance or to cash flow as a measure of liquidity. EBITDA is not necessarily
comparable with similarly titled measures for other companies.
The Company recorded operating restructuring costs of approximately $5.0 million
during the three months ended January 23, 1999. See "--Introduction" for a
complete discussion of operating restructuring charges.
The Company wrote off $2.8 million of impaired assets during the three months
ended January 23, 1999. The write-off consisted entirely of goodwill related to
an under-performing technology business in the United States that was closed in
December 1998.
Interest expense, net of interest income, increased 215.6%, from $9.1 million
for the three months ended January 24, 1998, to $28.6 million for the three
months ended January 23, 1999. This increase is due primarily to the completion
of the Strategic Restructuring Plan and the Financing Transactions in June 1998.
This resulted from a significant increase in both the amount of debt outstanding
and the average interest rate related to such debt. At January 23, 1999, the
Company had total debt outstanding of approximately $1,217.9 million at an
average interest rate of approximately 9.2%.
The Company recorded a $5.0 million pre-tax loss on the sale of businesses
during the three months ended January 23, 1999. The loss was the result of the
sale of an under-performing technology business in New Zealand during the three
months ended January 23, 1999.
Other expenses increased from $0.1 million for the three months ended January
24, 1998, to $1.1 million for the three months ended January 23, 1999. Other
expenses include the Company's share of the net income or loss of Dudley, in
which the Company has a 49% equity investment, and miscellaneous other income
and expense items. The increase is due primarily to Dudley reporting a net loss
for the three months ended January 23, 1999, of which the Company's share
amounted to approximately $0.6 million and net income for the three months ended
January 24, 1998, of which the Company's share amounted to approximately $0.1
million. The loss reported by Dudley in the current quarter is primarily due to
the impact of a new national distribution facility which has increased operating
costs.
Provision for income taxes decreased from $12.6 million for the three months
ended January 24, 1998 to $3.6 million for the three months ended January 23,
1999, reflecting effective income tax rates of 45.0% and -40.8%, respectively.
The provision for income taxes for the three month period ended January 24, 1998
reflects the recording of an income tax provision at the federal statutory rate
of 35.0%, plus appropriate state, local and foreign taxes. In addition, the
effective tax rate was increased to reflect non-deductible goodwill amortization
expense. The provision for income taxes for the three months ended January 23,
1999 reflects the net impact of (i) an income tax provision of 180.0% on the
results from continuing operations, excluding the operating restructuring costs
and loss on the sale of the business in New Zealand; and (ii) an income tax
benefit on the operating restructuring costs ($5.0 million) and the loss on the
sale of businesses in New Zealand ($5.0 million), as the Company believes that
such costs will be deductible for income tax purposes. The 180.0% effective tax
rate discussed above reflects the recording of an income tax provision at the
federal statutory rate of 35.0%, plus appropriate state, local and foreign
taxes. The effective tax rate in the current quarter is not comparable to the
effective tax rate in the third quarter last year due to the combined effect of
(i) the low level of pre-tax earnings in the current quarter, (ii) the
incurrence of significant non-deductible goodwill and (iii) the impact of
reducing
Page 24
<PAGE>
the earnings estimate for the full year. As a result, the Company has recorded a
tax provision in the current quarter despite reporting a pre-tax loss in the
financial statements.
Although Note 6 of the Notes to the Company's consolidated financial statements
indicates that, on a pro forma basis, the Company would have had a net loss of
$9.9 million from continuing operations before extraordinary items for the three
months ended January 23, 1999, the Company had pro forma EBITDA for such period
of $50.4 million, which was significantly greater than the pro forma interest
expense of $26.5 million. See "--Liquidity and Capital Resources" and "--Factors
Affecting the Company's Business" for a discussion of the Company's ability to
meet its debt service obligations.
Income from discontinued operations was $3.1 million for the three months ended
January 24, 1998. There was no income from discontinued operations included in
the Company's consolidated financial statements for the three months ended
January 23, 1999, as the Distributions were completed on June 9, 1998.
Therefore, the results of the Spin-Off Companies were not included in the
Company's consolidated statement of operations during the three months ended
January 23, 1999. See Note 2 of the notes to the Company's consolidated
financial statements included elsewhere in the Quarterly Report on Form 10-Q.
NINE MONTHS ENDED JANUARY 23, 1999 COMPARED TO NINE MONTHS ENDED
JANUARY 24, 1998
Consolidated revenues increased 3.9%, from $1,930.1 million for the nine months
ended January 24, 1998, to $2,005.8 million for the nine months ended January
23, 1999. This increase was primarily due to acquisitions. Revenues for the nine
months ended January 23, 1999 include revenues from 73 companies acquired in
business combinations accounted for under the purchase method after the
beginning of the first quarter of fiscal 1998 (the "Purchased Companies").
Revenues for the nine months ended January 24, 1998 include revenues from 40 of
such Purchased Companies for a portion of such period. This increase was
partially offset by a decline in international revenues as a result of the
devaluation of the New Zealand and Australian dollars against the USD. Because
revenues generated in New Zealand and Australia contributed approximately
one-third of the Company's consolidated revenues during this period, management
estimates that currency devaluation had the effect of reducing the Company's
increase in reported consolidated revenues (in U.S. dollar terms) by
approximately 6.9%. On a pro forma basis, and assuming that the average exchange
rates for the New Zealand and Australian dollars in the first three quarters of
fiscal 1998 were equal to the average exchange rates in the first three quarters
of fiscal 1999, revenues increased 2.3%. See "--Pro Forma Results of
Operations."
NAOPG revenues increased 7.4% from $1,256.7 million or 65.1% of consolidated
revenues for the nine months ended January 24, 1998 to $1,350.1 million or
67.3% of consolidated revenues for the nine months ended January 23, 1999.
This increase was primarily due to acquisitions. On a pro-forma basis NAOPG
revenues in the current nine month period increased 2.2% over the same nine
month period last year.
International revenues decreased 8.8%, from $669.1 million, or 34.7% of
consolidated revenues, for the nine months ended January 24, 1998, to $609.9
million, or 30.4% of consolidated revenues, for the nine months ended January
23, 1999. This decrease is due exclusively to the devaluation of the New Zealand
and Australian dollars against the USD. The following table details the declines
in the average exchange rates of the New Zealand and Australian dollars versus
the USD for the nine months ended January 23, 1999 and January 24, 1998:
<TABLE>
<CAPTION>
AVERAGE EXCHANGE RATES
FOR THE NINE MONTHS ENDED
------------------------------
JANUARY 23, JANUARY 24,
1999 1998 DECLINE
-------------- ------------- -----------
<S> <C> <C> <C>
New Zealand dollar $.52 $.64 $(.12)
Australian dollar $.62 $.72 $(.10)
</TABLE>
International revenues in New Zealand and Australia, calculated in their local
currencies, increased 11.7% for the nine months ended January 23, 1999, as
compared to the nine months ended January 24, 1998. This increase was due
primarily to the inclusion, in the revenues for the nine months ended January
23, 1999, of revenues from 31 companies that were acquired in business
combinations accounted for under the purchase
Page 25
<PAGE>
method after the beginning of the first quarter of fiscal 1998. Revenues from 16
such companies were included in revenues for a portion of the nine months ended
January 24, 1998.
MBE revenues have increased from $13.4 million or 0.7% of consolidated revenues
for the nine months ended January 24, 1998, to $55.0 million or 2.7% of
consolidated revenues for the nine months ended January 23, 1999. This increase
was primarily the result of MBE only being consolidated for two months in the
earlier period. On a pro forma basis MBE revenues in the current nine month
period have decreased 2.3% over the same nine month period last year. For a
discussion of this pro forma trend, see - "Consolidated Results of Operations -
Three Months Ended January 23, 1999 Compared to Three Months Ended January 24,
1998".
Gross profit increased 3.2%, from $539.3 million for the nine months ended
January 24, 1998, to $556.8 million for the nine months ended January 23, 1999.
The increase in gross profit is directly related to the increase in revenues. As
a percentage of revenues, gross profit decreased from 27.9% for the nine months
ended January 24, 1998, to 27.8% for the nine months ended January 23, 1999. The
Company believes that the decrease in gross profit as a percentage of revenues
is primarily a result of: (i) softness in the contract furniture market; (ii)
significant competitive pressures on the Company's retail business in the United
States; (iii) the increased cost of importing certain inventory into New
Zealand; and (iv) a slight change in account mix at some of the Company's NAOPG
operating units, with some lower margin accounts replacing higher margin
business; offset in part by the inclusion of the high margin MBE business for
the full nine month period in the current year. For a discussion of the
Company's expectations regarding future gross margin trends, see "--Consolidated
Results of Operations Three Months Ended January 23, 1999 Compared to Three
Months Ended January 24, 1998."
Selling, general and administrative expenses increased 4.0%, from $436.0 million
for the nine months ended January 24, 1998, to $453.5 million for the nine
months ended January 23, 1999, primarily due to the increase in revenues and
corporate costs. Selling, general and administrative expenses as a percentage of
revenues was 22.6% for the nine months ended January 24, 1998 and the nine
months ended January 23, 1999. The Company believes that selling, general and
administrative expenses have remained flat as a percentage of revenues due
primarily to the net impact of: (i) increased corporate expenses; and (ii) the
disposal of a low-overhead under-performing technology business in New Zealand;
offset by the elimination of some expenses through the consolidation of certain
redundant facilities and job functions.
Amortization expense increased 34.2%, from $13.8 million for the nine months
ended January 24, 1998, to $18.6 million for the nine months ended January 23,
1999. This increase is due exclusively to the amortization of intangible assets
recorded in conjunction with the significant number of business combinations,
accounted for under the purchase method, completed since the beginning of the
fiscal 1998.
EBITDA decreased from $131.2 million, for the nine months ended January 24,
1998, to $130.5 million, for the nine months ended January 23, 1999. EBITDA as a
percentage of revenues decreased from 6.8% for the nine months ended January 24,
1998, to 6.5% for the nine months ended January 23, 1999.
In conjunction with the completion of the Strategic Restructuring Plan, the
Company incurred non-recurring costs from continuing operations of approximately
$97.5 million, $70.4 million of which were non-cash. In addition, approximately
$11.7 million of such costs were incurred by the Spin-Off Companies and were
included in results of discontinued operations. The Strategic Restructuring Plan
costs related to continuing operations consisted of: (i) compensation expense of
approximately $50.8 million ($49.9 million of which was non-cash) related to the
difference between the exercise prices of employee stock options underlying
shares that were accepted in the Equity Tender and the $108.00 per share ($27.00
per share prior to the Reverse Stock Split) purchase price in the Equity Tender;
(ii) professional fees (including accounting, legal, investment banking and
printing fees) of approximately $26.2 million; and (iii) a non-cash expense of
approximately $20.5 million resulting from the issuance of 301,646 incremental
shares of common stock (with a market value of $67.75 per share on the date of
issuance) related to the temporary, effective reduction in the conversion price
of the 2001 Notes from $76.00 to $64.68 per share ($19.00 and $16.17 per share
prior to the Reverse Stock Split) on approximately $131.0 million, principal
amount, of the 2001 Notes, which the Company made as part of the exchange offer
for the 2001 Notes. For a description of the Strategic Restructuring Plan and
the Financing
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<PAGE>
Transactions, see Note 1 of the Notes to the Company's consolidated financial
statements included elsewhere in this Quarterly Report on Form 10-Q.
The Company recorded operating restructuring costs of $17.2 million during the
nine months ended January 23, 1999, related to the approval and commencement of
restructuring plans at a limited number of operating locations. See
"--Introduction" for a complete discussion of operating restructuring charges.
Interest expense, net of interest income, increased 191.1%, from $26.0 million
for the nine months ended January 24, 1998, to $75.7 million for the nine months
ended January 23, 1999. This increase is due primarily to the completion of the
Strategic Restructuring Plan and the Financing Transactions in June 1998. This
resulted in a significant increase in both the amount of debt outstanding and
the average interest rate related to such debt.
Although Note 6 of the Notes to the Company's consolidated financial statements
indicates that, on a pro forma basis, the Company would have had a net loss of
$19.5 million from continuing operations before extraordinary items for the nine
months ended January 23, 1999, the Company had pro forma EBITDA for such period
of $134.2 million, which was significantly greater than the pro forma interest
expense of $79.5 million. See "--Liquidity and Capital Resources" and "--Factors
Affecting the Company's Business" for a discussion of the Company's ability to
meet its debt service obligations.
Other income decreased from income of $6.4 million for the nine months ended
January 24, 1998, to an expense of $45,000 for the nine months ended January
23, 1999. The decrease is due primarily to the recording of a gain on the
sale of an investment and a marketing fee earned in conjunction with
providing a license to use a list of the Company's customers during the nine
months ended January 24, 1998, and the loss reported by Dudley in the third
quarter of fiscal year 1999, due to the impact of a new national distribution
facility.
Provision for income taxes changed from an income tax provision of $32.5 million
for the nine months ended January 24, 1998 to an income tax benefit of $16.0
million for the nine months ended January 23, 1999, reflecting an effective
income tax rate of 46.6% and an effective income tax benefit rate of 13.8%,
respectively. The provision for income taxes for the nine month period ended
January 24, 1998 reflects the recording of an income tax provision at the
federal statutory rate of 35.0%, plus appropriate state, local and foreign
taxes. In addition, the effective tax rate was increased to reflect
non-deductible goodwill amortization expense. The benefit from income taxes for
the nine months ended January 23, 1999 reflects the net impact of: (i) an income
tax provision of 116.0% on the results from continuing operations, excluding the
aggregate $125.0 million of Strategic Restructuring Plan costs, operating
restructuring costs, impaired asset write-offs and the loss on sale of
businesses in New Zealand; and (ii) an income tax benefit on approximately half
of the aggregate $122.2 million of Strategic Restructuring Plan costs ($97.5
million), operating restructuring costs ($17.2 million) and the loss on the sale
of businesses in New Zealand ($7.5 million), as the Company believes that
approximately half of such costs will be deductible for income tax purposes. The
116.0% effective tax rate discussed above reflects the recording of an income
tax provision at the federal statutory rate of 35.0%, plus appropriate state,
local and foreign taxes. The effective tax rate was also increased to reflect
the incurrence of non-deductible goodwill amortization expense. The effective
income tax benefit rate for the current nine month period is substantially lower
than the effective income tax provision rate for the nine months ended January
24, 1998 primarily due to the combined effect of: (i) the pre-tax loss reported
in the current period, (ii) the non-deductible nature of a significant
proportion of the Strategic Restructuring Plan costs and (iii) the increased
level of non-deductible goodwill in the current period.
Income from discontinued operations changed from income of $25.5 million for the
nine months ended January 24, 1998, to a loss of $1.3 million for the nine
months ended January 23, 1999. See Note 2 of the Notes to Company's consolidated
financial statements included elsewhere in the Quarterly Report on Form 10-Q.
The extraordinary loss, net of income taxes, of $269,000 represents the
aggregate of several extraordinary items, all of which involve indebtedness that
the Company either repaid or converted into equity in connection with the
Strategic Restructuring Plan and the Financing Transactions. The primary
components of this
Page 27
<PAGE>
extraordinary loss are: (i) the pre-tax non-cash write-offs of $5.2 million,
$4.7 million and $2.9 million of debt issue costs incurred in conjunction with
the issuance of the 2003 Notes, the former credit facility and the issuance of
the 2001 Notes, respectively; and (ii) a pre-tax gain of $12.2 million related
to the early extinguishment of $222.2 million of 2003 Notes at a purchase price
of 94.5% of the principal amount. See "--Introduction."
PRO FORMA RESULTS OF OPERATIONS AND EXCHANGE RATE ADJUSTED PRO FORMA RESULTS OF
OPERATIONS
The following presents the unaudited quarterly pro forma results of
operations of the Company by operating division for the first nine months of
fiscal 1999 and 1998 and the unaudited quarterly exchange rate adjusted pro
forma results of operations of the Company by operating division for the
first nine months of fiscal 1998. The pro forma financial information
represents the results of the Company as if the Strategic Restructuring Plan,
the Financing Transactions, dispositions and all of the purchase acquisitions
related to continuing operations completed after the beginning of fiscal 1998
had been completed on the first day of fiscal 1998. The exchange rate
adjusted pro forma results of operations for fiscal 1998 reflect the
financial results for the Blue Star Group during the first, second and third
quarters of fiscal 1998 converted to USD using the average currency exchange
rates from the first, second and third quarters of fiscal 1999, respectively,
rather than the average currency exchange rates for the first, second and
third quarters of fiscal 1998. The inclusion of exchange rate adjusted data
has been made to permit a comparison of the performance of the Company's
business, excluding the impact of currency fluctuation, which is beyond the
Company's control. This adjustment is not intended to suggest that currency
fluctuation does not have a real cost to, or impact on, the Company. However,
the impact of currency fluctuation can distort or obscure the Company's true
operating performance.
Page 28
<PAGE>
<TABLE>
<CAPTION>
FISCAL 1999 PRO FORMA RESULTS
------------------------------------------------------------
FIRST SECOND THIRD NINE MONTH
QUARTER QUARTER QUARTER TOTAL
------- ------- ------- -----------
<S> <C> <C> <C> <C>
Consolidated:
Revenues $659,777 $676,798 $676,122 $2,012,697
Operating income before
restructuring costs and asset write-downs 24,679 29,209 34,292 88,180
EBITDA before
restructuring costs and asset write-downs 39,568 44,327 50,352 134,247
NAOPG:
Revenues 453,085 472,139 442,867 1,368,091
Operating income before
restructuring costs and asset write-downs 18,801 21,836 22,648 63,285
EBITDA before
restructuring costs and asset write-downs 25,703 29,203 30,241 85,147
Blue Star Group:
Revenues 191,246 186,315 212,093 589,654
Operating income before
restructuring costs 7,126 8,181 13,906 29,213
EBITDA before
restructuring costs 13,144 13,870 20,316 47,330
Average exchange rates .53 .51 .53 .52
Mail Boxes Etc.:
Revenues 15,446 18,344 21,162 54,952
Operating income before
restructuring costs 3,415 3,579 4,441 11,435
EBITDA before
restructuring costs 5,288 5,507 6,381 17,176
Parent Company:
Revenues
Operating loss before
restructuring costs (4,663) (4,387) (6,703) (15,753)
EBITDA before
restructuring costs (4,567) (4,253) (6,586) (15,406)
</TABLE>
Page 29
<PAGE>
<TABLE>
<CAPTION>
FISCAL 1998 PRO FORMA RESULTS
----------------------------------------------------------
FIRST SECOND THIRD NINE MONTH
QUARTER QUARTER QUARTER TOTAL
------- ------- ------- ----------
<S> <C> <C> <C> <C>
Consolidated:
Pro forma:
Revenues $684,804 $707,192 $700,965 $2,092,961
Operating income 31,343 32,826 42,961 107,130
EBITDA 48,598 49,876 59,363 157,837
Pro forma - Exchange rate adjusted:
Revenues 631,927 661,167 674,685 1,967,779
Operating income 28,981 30,468 41,198 100,647
EBITDA 44,499 45,986 56,786 147,271
NAOPG:
Pro forma:
Revenues 427,301 461,467 449,678 1,338,446
Operating income 21,078 22,343 23,760 67,181
EBITDA 27,622 30,873 31,051 89,546
Blue Star Group:
Pro forma:
Revenues 241,824 227,179 229,249 698,252
Operating income 10,804 11,641 15,381 37,826
EBITDA 18,745 19,201 22,481 60,427
Average exchange rates .68 .64 .60 .64
Pro forma - Exchange rate adjusted:
Revenues 188,947 181,154 202,969 573,070
Operating income 8,442 9,283 13,618 31,343
EBITDA 14,646 15,311 19,904 49,861
Average exchange rates .53 .51 .53 .52
Mail Boxes Etc.:
Pro forma:
Revenues 15,679 18,546 22,038 56,263
Operating income 2,805 1,865 6,658 11,328
EBITDA 4,595 3,605 8,550 16,750
Parent Company:
Pro forma:
Revenues
Operating loss (3,344) (3,023) (2,838) (9,205)
EBITDA (2,364) (3,803) (2,719) (8,886)
</TABLE>
For the three months ended January 23, 1999, pro forma consolidated revenues of
$676.1 million increased $1.4 million, or 0.2%, over the exchange rate adjusted
pro forma consolidated revenues of $674.7 million, for the three months ended
January 24, 1998. Pro forma revenues for the three months ended January 23, 1999
decreased 1.5% and 4.0% at NAOPG and MBE, respectively, and increased 4.5% at
Blue Star Group, over pro forma revenues (exchange rate adjusted in the case of
Blue Star Group) for the three months ended January 24, 1998.
For the nine months ended January 23, 1999, pro forma consolidated revenues of
$2,012.7 million increased $44.9 million, or 2.3%, over the exchange rate
adjusted pro forma consolidated revenues of $1,967.8 million, for the nine
months ended January 24, 1998. Pro forma revenues for the nine months ended
January 23, 1999 increased 2.2% and 2.9% at NAOPG and Blue Star Group,
respectively, and decreased 2.3% at MBE,
Page 30
<PAGE>
respectively, over pro forma revenues (exchange rate adjusted in the case of
Blue Star Group) for the nine months ended January 24, 1998.
The decline in revenues at MBE is due primarily to a decline in franchisee fee
revenue due to a fewer number of domestic franchises sold in the third quarter
and first nine months of fiscal 1999 versus the third quarter and first nine
months of fiscal 1998. See "--Consolidated Results of Operations" for an
explanation of the changes in revenues at NAOPG and Blue Star Group.
For the three months ended January 23, 1999, pro forma consolidated EBITDA of
$50.4 million declined $6.4 million, or 11.3%, over the exchange rate adjusted
pro forma consolidated EBITDA of $56.8 million, for the three months ended
January 24, 1998. Pro forma EBITDA for the three months ended January 23, 1999
decreased 2.6% and 25.3% at NAOPG and MBE, respectively, and increased 2.1% at
Blue Star Group, over pro forma EBITDA (exchange rate adjusted in the case of
Blue Star Group) for the three months ended January 24, 1998.
The decrease in EBITDA at MBE for the current quarter was primarily due to the
fact that certain annually recurring expenses incurred in the third quarter of
fiscal 1999 were incurred in a different quarter in fiscal 1998. In addition,
there was an increase in franchisee support activities and a reduction in vendor
support for advertising programs.
For the nine months ended January 23, 1999, pro forma consolidated EBITDA of
$134.2 million declined $13.1 million, or 8.9%, over the exchange rate adjusted
pro forma consolidated EBITDA of $147.3 million, for the nine months ended
January 24, 1998. Pro forma EBITDA for the nine months ended January 23, 1999
increased 2.5% at MBE and declined 4.9% and 5.1% at NAOPG and Blue Star Group,
respectively, over pro forma EBITDA (exchange rate adjusted in the case of Blue
Star Group) for the nine months ended January 24, 1998.
HISTORICAL DIVISIONAL RESULTS OF OPERATIONS
The following presents the unaudited quarterly results of operations of the
Company by operating division for the first nine months of fiscal 1999 and 1998.
<TABLE>
<CAPTION>
FISCAL 1999 HISTORICAL RESULTS
---------------------------------------------------------
FIRST SECOND THIRD NINE MONTH
QUARTER QUARTER QUARTER TOTAL
------- ------- ------- ----------
<S> <C> <C> <C> <C>
Consolidated:
Revenues $ 651,949 $ 677,205 $ 676,622 $ 2,005,776
Operating income before
restructuring costs and asset write-downs 22,882 28,233 33,594 84,709
EBITDA before
restructuring costs and asset write-downs 37,500 43,384 49,662 130,546
NAOPG:
Revenues 440,212 466,481 443,367 1,350,060
Operating income before
restructuring costs and asset write-downs 17,702 21,299 21,950 60,951
EBITDA before
restructuring costs and asset write-downs 24,268 28,615 29,551 82,434
Blue Star Group:
Revenues 196,291 192,380 212,093 600,764
Operating income before
restructuring costs 6,428 7,742 13,906 28,076
EBITDA before
restructuring costs 12,511 13,514 20,316 46,341
</TABLE>
Page 31
<PAGE>
<TABLE>
<CAPTION>
FISCAL 1999 HISTORICAL RESULTS
-------------------------------------------------------
FIRST SECOND THIRD NINE MONTH
QUARTER QUARTER QUARTER TOTAL
------- ------- ------- ----------
<S> <C> <C> <C> <C>
Mail Boxes Etc.:
Revenues $ 15,446 $ 18,344 $ 21,162 $ 54,952
Operating income before
restructuring costs 3,415 3,579 4,441 11,435
EBITDA before
restructuring costs 5,288 5,507 6,381 17,176
Parent Company:
Revenues
Operating loss before
restructuring costs (4,663) (4,387) (6,703) (15,753)
EBITDA before
restructuring costs (4,567) (4,252) (6,586) (15,405)
</TABLE>
<TABLE>
<CAPTION>
FISCAL 1998 HISTORICAL RESULTS
--------------------------------------------------------
FIRST SECOND THIRD NINE MONTH
QUARTER QUARTER QUARTER TOTAL
------- ------- ------- ----------
<S> <C> <C> <C> <C>
Consolidated:
Revenues $ 614,814 $ 649,340 $ 665,959 $ 1,930,113
Operating income 23,802 28,300 37,289 89,391
EBITDA 37,296 42,013 51,869 131,178
NAOPG:
Revenues 390,655 435,057 431,023 1,256,735
Operating income 18,309 20,860 22,569 61,738
EBITDA 23,786 28,546 29,421 81,753
Blue Star Group:
Revenues 224,159 214,283 221,576 660,018
Operating income 8,837 10,463 13,619 32,919
EBITDA 15,874 17,270 19,942 53,086
Mail Boxes Etc.:
Revenues 13,360 13,360
Operating income 3,939 3,939
EBITDA 5,225 5,225
Parent Company:
Revenues
Operating loss (3,344) (3,023) (2,838) (9,205)
EBITDA (2,364) (3,803) (2,719) (8,886)
</TABLE>
Historical results for the first and second quarters of fiscal 1998 were not
included for MBE since MBE was not acquired by the Company until the third
quarter of fiscal 1998. The MBE results for the third quarter of fiscal 1999
were significantly greater than the third quarter of fiscal 1998 because MBE was
only consolidated for two months in the earlier period.
Page 32
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
At January 23, 1999, the Company had cash of $16.4 million and working capital
of $368.2 million. The Company's capitalization, defined as the sum of long-term
debt and stockholders' equity, at January 23, 1999, was approximately $1.7
billion.
In June 1998, the Company completed the Strategic Restructuring Plan. See Note 1
of the Notes to the Company's consolidated financial statements included
elsewhere in this Quarterly Report on Form 10-Q. The Company financed the
aggregate cost of purchasing shares in the Equity Tender, repurchasing $222.2
million of the 2003 Notes, and repaying its former credit facility with the
proceeds of the Equity Investment, the net proceeds from the sale and issuance
of the 2008 Notes and borrowings under the Credit Facility. The Company also
incurred significant transaction (including financing) costs and expenses. See
"--Consolidated Results of Operations." In connection with the completion of the
Strategic Restructuring Plan, the Company incurred approximately $400.0 million
of additional indebtedness, and the weighted average annual interest rate on all
outstanding indebtedness increased from approximately 6.8% prior to completion
of the Strategic Restructuring Plan to approximately 9.2% after completion of
the Strategic Restructuring Plan.
At January 23, 1999, the Company had $784.5 million outstanding under the Credit
Facility. The Credit Facility's financial covenants include restrictions based
on the Company's pro forma EBITDA. For the third quarter of fiscal 1999, these
financial covenants were (i) a debt-to-EBITDA ratio ("Leverage Ratio") of 6.85
to 1.0 and (ii) an EBITDA-to-interest expense ratio ("Interest Coverage Ratio")
of 1.5 to 1.0. For the third quarter, the Company remained in compliance with
these financial covenants. The actual Leverage Ratio was 6.67 to 1.0 and the
actual Interest Coverage Ratio was 1.78 to 1.0. As of January 23, 1999, the
Company had additional borrowing availability of approximately $30 million under
the terms of these financial ratios. For the fourth quarter of fiscal 1999
(ending April 24, 1999), the financial covenants will become more restrictive;
the required Leverage Ratio will be 6.65 to 1.0, and the required Interest
Coverage Ratio will be 1.75 to 1.0. The financial covenants will continue to
become more restrictive during fiscal 2000.
The Company expects that performance at the low end of the EBITDA range of
$175-$185 million for fiscal 1999 should keep it in compliance with the
financial covenants at the end of the fourth quarter. However, the Company's
ability to perform within this EBITDA range is under increasing pressure. See
"-Factors Affecting the Company's Business" for a discussion of factors that
could affect the Company's performance. If the Company does not perform within
this EBITDA range, it would need to reduce its total indebtedness significantly
or negotiate changes to, or relief from, the current financial covenants in the
Credit Facility. The Company meets regularly with its banks and keeps them
advised of the Company's ongoing performance.
Upon completion of the Strategic Restructuring Plan, the Company terminated and
repaid the balance outstanding under its former $500.0 million credit facility
and entered into the Credit Facility. The Credit Facility provides for an
aggregate principal amount of $1,225.0 million, consisting of (i) a seven-year
multi-draw term loan facility totaling $200.0 million, (ii) a seven-year
revolving credit facility totaling $250.0 million, (iii) a seven-year term loan
facility totaling $100.0 million, and (iv) an eight-year term loan facility
totaling $675.0 million. In connection with the completion of the Strategic
Restructuring Plan and the Financing Transactions, the Company borrowed the full
amount of the two single-draw term loan facilities. The multi-draw facility and
the revolving facility remain available for future borrowings. Interest rates on
such borrowings bear interest, at the Company's option, at the lending bank's
base rate plus an applicable margin of up to 1.50%, or a eurodollar rate plus an
applicable margin of up to 2.50%. The Company's obligations under the Credit
Facility are guaranteed by its present domestic subsidiaries; future material
domestic subsidiaries will also be required to guarantee these obligations. The
Credit Facility is secured by substantially all of the assets of the Company and
its domestic subsidiaries; future material domestic subsidiaries also will be
required to pledge their assets as security. The Company was required to enter
into arrangements to ensure that the effective interest rate paid by the Company
on at least 50% of the aggregate amount outstanding under the Credit Facility
Page 33
<PAGE>
and the 2008 Notes was at a fixed rate of interest. As a result, the Company has
entered into interest rate swap arrangements to limit the LIBOR-based interest
rate exposure on $500.0 million of the outstanding balance under the Credit
Facility to rates ranging from 5.7% to 6.0%. The interest rate swap agreements
expire over a period ranging from 2001 to 2003. As a result of these swap
agreements (and including the fixed-rate 2008 Notes), the Company has fixed the
interest rates on $900 million (75.5%) of the long-term debt outstanding at
January 23, 1999.
The Credit Facility includes, among others, restrictions on the Company's
ability to incur additional indebtedness, sell assets, pay dividends, or engage
in certain other transactions, and requirements that the Company maintain
certain financial ratios, and other provisions customary for loans to highly
leveraged companies, including representations by the Company, conditions to
funding, cost and yield protections, restricted payment provisions, amendment
provisions and indemnification provisions. The Credit Facility is subject to
mandatory prepayment in a variety of circumstances, including upon certain asset
sales and financing transactions, and also from excess cash flow (as defined in
the Credit Facility).
The 2008 Notes are unsecured but are guaranteed by the Company's present
domestic subsidiaries; future material domestic subsidiaries will be required to
guarantee the 2008 Notes. The indenture governing the 2008 Notes places
restrictions on the Company's ability to incur indebtedness, to make certain
payments, investments, loans and guarantees and to sell or otherwise dispose of
a substantial portion of its assets to, or merge or consolidate with, another
entity. The eight-year term loan facility contains negative covenants and
default provisions substantially similar to those contained in the indenture
governing the 2008 Notes.
During the nine months ended January 23, 1999, the New Zealand and Australian
dollars weakened against the USD. The New Zealand exchange rate decreased from
U.S. $.56 at April 25, 1998 to U.S. $54 at January 23, 1999. The Australian
exchange rate decreased from U.S. $.65 at April 25, 1998 to U.S. $.64 at January
23, 1999. This resulted in a reduction in stockholders' equity, through a
cumulative translation adjustment of approximately $18.1 million, reflecting
primarily the impact of the declining exchange rate on the Company's investments
in its New Zealand and Australian subsidiaries. In addition, the devaluation has
adversely affected the return on the Company's investment in its New Zealand and
Australian operations. The Company cannot predict whether exchange rates will
increase or decline in the future. If the exchange rates were to decline
further, the Company's return on assets and equity from its New Zealand and
Australian operations would be further depressed. See "--Factors Affecting the
Company's Business - Fluctuations in the Value of the New Zealand and Australian
Dollars."
As a result of the Company's increased indebtedness, a portion of the cash flows
from the Company's international operations will be required to service debt and
interest payments. The Company expects that it will incur additional costs with
respect to accessing cash flows from international operations including such
items as New Zealand and Australian withholding and other taxes and foreign
currency hedging costs. During the nine months ended January 23, 1999, the
Company entered into foreign currency forward contracts against (i) the New
Zealand dollar with an aggregate notional amount of approximately $30.0 million
expiring in January through April 1999; and (ii) the Australian dollar with an
aggregate notional amount of approximately $3.5 million expiring in January
through April 1999. The effect of these foreign currency forward contracts is to
limit the foreign currency exposure on (i) approximately $30.0 million of the
Company's net investment in its New Zealand subsidiary at rates of U.S. $.48 to
U.S. $.51; and (ii) approximately $3.5 million of the Company's net investment
in its Australian subsidiary at a rate of U.S. $.60. As at January 23, 1999, the
Company had remaining outstanding forward exchange contracts with an aggregate
notional amount of approximately $10.0 million against the New Zealand dollar
and $1.0 million against the Australian dollar. See "--Factors Affecting the
Company's Business - Fluctuations in the Value of the New Zealand and Australian
Dollars."
Page 34
<PAGE>
The Company anticipates its cash on hand, cash flows from operations and
borrowings available from the Credit Facility will be sufficient to meet its
liquidity requirements for its operations, capital expenditures and additional
debt service obligations for the remainder of the fiscal year. See
"--Introduction," "--Factors Affecting the Company's Business - Changes in
Strategic Focus and Business and Growth Strategies" and "-- Challenges of
Business Integration and Consolidation." The Company anticipates capital
expenditures of approximately $40.0 million in both fiscal 1999 and fiscal 2000.
It is expected that capital expenditures will support the Company's program of
operational improvement including consolidation of existing facilities and
information system upgrades.
During the nine months ended January 23, 1999, net cash provided by operating
activities was $11.5 million. This included the payment of approximately $21.7
million of costs related to the Strategic Restructuring Plan, the payment of
approximately $10.4 million of operating restructuring costs and increases in
accounts receivable and inventory. However, working capital decreased from
$381.1 million as of October 24, 1998 to $368.2 million as of January 23, 1999.
The decrease is primarily the result of the Company utilizing working capital,
including a reduction in retail inventories in New Zealand, to reduce short-term
debt and compensate for the increase in accounts receivable since October 24,
1998. Net cash used in investing activities for the nine months ended January
23, 1999, was $64.7 million, including $34.5 million used for acquisitions and
$31.2 million used for additions to property and equipment. Net borrowings
increased approximately $467.5 million during the nine months ended January 23,
1999, primarily to fund the Strategic Restructuring Plan and Financing
Transactions, and also to fund the purchase prices of acquisitions and additions
to property and equipment during the period. In addition, the Company received
approximately $254.2 million from Investor related to the Equity Investment, net
of expenses, and $123.6 million from discontinued operations in repayment of
intercompany loan balances outstanding at the date of the Distributions.
Discontinued operations used $12.5 million of cash during the nine months ended
January 23, 1999.
During the nine months ended January 24, 1998, net cash provided by operating
activities was $36.8 million. Net cash used in investing activities was $99.5
million, including $40.8 million paid to Dudley to satisfy the remaining
commitment related to the Company's 49% equity investment in Dudley, $33.6
million used for acquisitions and $28.2 million used for additions to property
and equipment, partially offset by $5.7 million received on the sale of an
investment. Net borrowings increased $161.8 million during the nine months ended
January 24, 1998, primarily to fund the purchase prices of acquisitions and to
repay higher-cost debt assumed in acquisitions. The Company advanced $99.2
million to the discontinued operations during the nine months ended January 24,
1998 and the discontinued operations used $3.8 million of cash during such
period.
YEAR 2000 COMPLIANCE
The Company has commenced a process to assess Year 2000 compliance of its
systems and the systems of major vendors and third party service providers, and
to remediate any non-compliance of its systems.
The Company has not performed any material acceleration of hardware or software
systems write-down as a result of Year 2000 performance and/or compliance
issues.
As described below, each NAOPG, MBE, Blue Star Group and Dudley is performing
its own Year 2000 readiness review.
NAOPG
NAOPG's Year 2000 compliance process involves three phases, as described below.
Page 35
<PAGE>
PHASE ONE- INVENTORY AND PLANNING
The Company completed this phase in May 1998. In this phase, the Company
inventoried all hardware and software that potentially is susceptible to Year
2000 problems, prepared plans for assessing compliance and for completing
remediation, and prepared vendor and supplier compliance surveys.
PHASE TWO- ASSESSMENT
The Company completed this phase in December 1998. The Company assessed which of
its systems are Year 2000 compliant, obtained compliance statements from
hardware and software vendors, supply manufacturers and service trading
partners, and planned for remediation of non-compliant systems.
PHASE THREE- REMEDIATION AND TESTING
In this phase, the Company will deploy plans for elimination, upgrade,
replacement or modification of non-compliant systems, and test compliance. The
Company has scheduled completion of this phase for the summer of 1999.
Verification and testing will continue through December 1999.
The Company's Trinity system, which is the core information management and
processing system for its NAOPG operations, is Year 2000 compliant. The Company
is installing this system throughout its NAOPG operations, but currently does
not expect to complete installation at all locations before the end of 1999.
Therefore, the Company is assessing the compliance of other systems used by its
NAOPG operating subsidiaries. The Company has determined that some of the
systems used by its NAOPG subsidiaries are not currently Year 2000 compliant,
but the Company believes that it is highly likely that these systems will be
made compliant without material expense by the middle of 1999.
The Company's assessment plan includes assessment of Year 2000 compliance of
non-information technology (non-IT) components, including the Company's bindery
machinery, coffee roasting facilities, office furniture manufacturing
facilities, security systems, credit card processing devices and freight
elevators. The Company believes there are no significant uses of
micro-processing oriented equipment within its manufacturing systems and will
complete verification of other non-IT components by June 1999.
The Company has received compliance statements from approximately 86% of its
primary supply vendors. Based on these statements, the Company believes that 95%
of supply vendors who have responded will be Year 2000 compliant by the end of
June 1999. The Company believes that the non-responding or non-compliant systems
are not critical to its operations and that non-compliance of these systems
would not have a material effect on the Company's performance.
If the Company fails to achieve Year 2000 compliance in all its systems, the
Company could lose the ability to process certain of its customer's orders until
compliance is achieved or a means to work around the failure is implemented. The
Company's systems are not now uniform across all operations and the Company does
not expect uniformity by the end of 1999. Therefore, any failure would not be
system wide. The Company believes that in a worst case scenario, at most 20% of
its orders would be affected. A failure to fill orders would not however,
necessarily result in a complete loss of the order. An order could be filled
through alternative methods within a relatively short period. Nevertheless, any
disruption in order fulfillment could result in some loss of revenue. If this
disruption is the result of noncompliance that is greater than anticipated, the
loss of revenue could be material. The Company intends to establish by the
middle of 1999 contingency plans to deal with possible failures in order
fulfillment systems or other systems.
Page 36
<PAGE>
With respect to NAOPG, the Company's assessment and remediation of Year 2000
compliance issues has a budget of less than $1.0 million, and expenses have been
less than expected. The Company does not currently expect that future expenses
for assessment or remediation will be material.
MBE, BLUE STAR GROUP AND DUDLEY
The Company has received reports from MBE that address the Year 2000 readiness
of software and hardware provided by MBE and used by MBE franchisees, as well as
that used by MBE's corporate operations. MBE is in the process of assessing and
testing mission critical systems, and performing additional activities, as
summarized below. These efforts fall within three categories. First, MBE has
reviewed Year 2000 compliance as it relates to the software that MBE writes and
provides to its franchisees. Second, MBE has reviewed Year 2000 compliance as it
relates to its internal hardware and software that it uses for the daily
operations of its corporate business. Third, MBE is currently reviewing Year
2000 compliance statements of major vendors of MBE and its franchisees,
including statements of vendors that supply hardware to MBE that MBE re-sells to
its franchisees.
MBE creates proprietary software ("MBE Software") for its franchisees that is
used for a variety of functions to operate an MBE center. Based on MBE's
testing, the majority of this software is currently Year 2000 compliant. For the
remaining MBE Software, MBE plans either (i) to reprogram or otherwise upgrade
such software, or (ii) to no longer support, and no longer require franchisees
to purchase and use such software. MBE's franchisees may also use other
software, not provided or recommended by MBE, and this software and/or its
combinations with MBE Software may not be Year 2000 compliant. The franchisees
are responsible for ensuring that software not provided by MBE is Year 2000
compliant both standing alone and in combination with MBE Software. MBE's
franchisee's purchase or lease some hardware from MBE, which is provided to MBE
by various manufacturers. MBE has reviewed statements from the vendors of
hardware currently being sold or leased to franchisees by MBE, and such
statements indicate that such hardware is Year 2000 compliant.
With respect to software and hardware used by MBE's corporate operations, MBE
has reported to the Company that some software products used by MBE for certain
accounting and database functions, as well as some desktop computers, are not
currently Year 2000 compliant. MBE and the providers of this software and
hardware are in the process of reprogramming such software and upgrading such
hardware, and expect to complete this process by June 1999. MBE expects to be
able to bring its software and hardware that are not currently Year 2000
compliant into compliance within budgeted limits and without material expense.
MBE has not determined the effect on its operations of any failure to reprogram
or upgrade the non-compliant software supplied to its franchisees or the
software and hardware used by MBE in its corporate operations, but such failure
could have a material adverse effect on MBE.
Much of MBE's hardware and software depends upon the proper interaction of
various hardware, software and services furnished by third parties. While MBE is
performing Year 2000 readiness tests on its systems and attempting to obtain
statements from its primary vendors, the vast array of combinations of MBE and
third party components (including those provided by franchisees), functions and
entry and exit points make it impractical to test every aspect of the systems.
MBE is currently evaluating statements from its mission critical vendors to
develop contingency plans in the event one or more of such vendors experiences a
failure due to Year 2000 non-readiness. MBE currently expects to complete such
contingency plans by mid-1999. However, any such contingency plans to be
developed by MBE will be limited by the fact that there are only a small number
of vendors providing shipping and delivery services on a national and worldwide
scale; accordingly, alternative means of delivery will be limited in the event
one or more of MBE's major vendors experiences a failure due to Year 2000
non-compliance.
Page 37
<PAGE>
The Blue Star Group's review of compliance is ongoing. Based on reports received
to date by the Company from Blue Star Group, the majority of systems used in New
Zealand and Australia are currently Year 2000 compliant, and the Company expects
that the majority of non-compliant systems will be Year 2000 compliant by June
30, 1999, with the balance scheduled for completion by September 30, 1999. Blue
Star Group is continuing to survey its major vendors to determine such vendors'
Year 2000 readiness. Some vendors have failed to reply, but key vendors have
been identified and Blue Star Group has obtained assurances, which it believes
are reliable, from these vendors where potential exposure was deemed critical.
Based on reports received to date by the Company from Dudley, an initial
assessment of the systems indicates that there are no significant Year 2000
issues.
The Company's review of Year 2000 compliance issues at MBE, Blue Star Group and
Dudley to date has been based on reports received from those operations, and no
on-site review or testing has been conducted to date by Company personnel. These
operations also have not segregated their expenses for Year 2000 compliance from
other information technology costs, but the Company does not expect these
expenses to exceed $4.0 million. The Company's level of assurance regarding the
compliance of systems of MBE, Blue Star Group and Dudley is lower than if it had
conducted on-site testing. The Company does intend to schedule on-site testing
at MBE, and, if necessary, Blue Star Group and Dudley, by Company personnel, by
mid-1999, to improve its level of assurance regarding these systems. MBE, Blue
Star Group and the Company's interest in Dudley represent approximately
one-third of the Company's consolidated revenues. If the operations of any of
these groups is not materially compliant within a safe timeframe, the Company's
results of operations could be materially adversely affected.
FLUCTUATIONS IN QUARTERLY RESULTS OF OPERATIONS
The Company's business is subject to seasonal influences. The Company's
historical revenues and profitability in its core office products business have
been lower in the first two quarters of its fiscal year, primarily due to the
lower level of business activity in North America during the summer months. The
revenues and profitability of the Company's operations in New Zealand and
Australia and at MBE have generally been higher in the Company's third quarter.
Results for any quarter are not necessarily indicative of the results that the
Company may achieve for any subsequent fiscal quarter or for a full fiscal year.
Quarterly results also may be affected by the timing and magnitude of
dispositions, the timing and magnitude of costs related to such dispositions,
variations in the prices paid by the Company for the products it sells, the mix
of products sold, and general economic conditions. Results for any quarter are
not necessarily indicative of the results that the Company may achieve for any
subsequent fiscal quarter or for a full fiscal year.
INFLATION
The Company does not believe that inflation has had a material impact on its
results of operations during fiscal 1998 or the first three quarters of fiscal
1999.
FACTORS AFFECTING THE COMPANY'S BUSINESS
A number of factors, including those discussed below, may affect the Company's
future operating results.
CHANGE IN STRATEGIC FOCUS AND BUSINESS AND GROWTH STRATEGIES. From its inception
in 1994 through the end of the 1997 calendar year, the Company grew primarily
through acquisitions. At the time it adopted the Strategic Restructuring Plan,
the Company announced its intention to change its strategic focus and pursue
increased revenues and profitability primarily through operating strategies
intended to improve the efficiency of its existing businesses. The Company has
made this strategic transition and currently intends to focus management
Page 38
<PAGE>
and capital resources almost entirely on operating activities and does not
expect to pursue acquisitions in the near term. The Company may consider
targeted, strategic acquisition opportunities from time to time, as and if they
arise. See "-Introduction." The Company's ability to achieve its operating
objectives will depend upon a number of factors, including its generation of
increased revenues and margins in existing businesses through, among other
things, (i) improved sales and marketing programs, and (ii) the achievement of
operating improvements and cost reductions, through, among other things,
expanding and improving consolidated purchasing and procurement arrangements,
further consolidating general corporate and administrative functions,
eliminating redundant facilities (and establishing new DFCs and reconfiguring
existing facilities), reducing headcount, and improving technology and operating
and distribution systems. There can be no assurance that these efforts to
achieve operating improvements will be successful or will result in anticipated
levels of cost savings and efficiencies or growth in revenues and margins.
In March 1999, the Company announced that it intends to accelerate its efforts
to achieve improvements in the profitability of its existing operations, by
commencing an aggressive program to improve the performance of certain of its
under performing locations within the NAOPG. These efforts may involve making
certain changes to the operations of such locations, including, for example,
consolidation of duplicative facilities and functions, reductions in staff, and
other operating changes. In addition, the Company may pursue the sale or closure
of such under performing locations. There can be no assurances that the
Company's efforts to achieve the desired improvements in such under performing
locations will be successful, or that the Company will be successful in
accelerating the pace of such improvements as quickly as it wishes.
See "-Introduction".
CHALLENGES OF BUSINESS INTEGRATION AND CONSOLIDATION. The Company's
acquisition program produced a significant increase in revenues, employees,
facilities and distribution systems. One of the Company's primary strategies
is to take advantage of substantial opportunities to reduce costs by
rationalizing and consolidating the businesses it has acquired. Such efforts
initially will require additional costs and expenditures to expand
operational and financial systems, construct DFCs and reconfigure existing
facilities, and augment management and administrative functions. Because
cost-savings strategies will involve some initial increases in expenses and
are likely to impact overall spending over a period of time, operating
results may fluctuate in the near future and historical operating results may
not be indicative of future performance. For example, the Company has
retained certain outside consultants to assist it in the accelerated change
process. See "-Introduction". In addition, attempts to achieve economies of
scale through cost cutting and lay-offs of existing personnel may, at least
in the short term, have an adverse impact upon the Company. Delays in
implementing planned integration and consolidation strategies, or the failure
of such strategies to achieve anticipated cost savings, also could materially
and adversely affect the Company's results of operations and financial
condition. Finally, there can be no assurance that the Company's management
and financial controls, personnel, computer systems and other corporate
support systems will be adequate to manage the size and scope of its
operations and the complexity of its integration and consolidation efforts.
OPERATIONS OUTSIDE OF THE UNITED STATES. Management expects foreign revenues to
continue to represent a significant portion of the Company's total revenues. In
general, the discussion included in this "Factors Affecting the Company's
Business" section that apply to the Company's domestic operations may also
affect the Company's foreign operations. In addition, the Company's foreign
operations are subject to a number of other risks, including fluctuations in
currency exchange rates; new and different legal and regulatory requirements in
local jurisdictions; tariffs and trade barriers; potential difficulties in
staffing and managing local operations; credit risk of local customers and
distributors; potential difficulties in protecting intellectual property;
potential imposition of restrictions on investments; potentially adverse tax
consequences, including imposition or increase of withholding and other taxes on
remittances and other payments by subsidiaries; and local economic, political
and social conditions, including the possibility of hyper-inflationary
conditions, in certain countries. There can be no assurance that one or a
combination of these factors will not have a material adverse impact on the
Company's ability to maintain or increase its foreign revenues or on its
business, financial condition or results of operations.
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<PAGE>
IMPACT OF FLUCTUATIONS IN THE VALUE OF THE NEW ZEALAND AND AUSTRALIAN DOLLARS.
Approximately 30.0% of the Company's revenues and 35.5% of its EBITDA for the
nine months ended January 23, 1999 were generated by operations in New Zealand
and Australia. Declines in the value of the currencies in those countries,
relative to the value of the USD, may materially adversely affect the Company's
business, financial condition and results of operations. In addition, because
substantially all of the Company's indebtedness is denominated in USD, declines
in currency exchange rates may also materially adversely affect the Company's
ability to meet its obligations under agreements relating to indebtedness.
Declines in the value of the New Zealand and Australian dollars relative to the
USD have adversely affected the Company's reported results. The Company cannot
predict whether these currencies will, in the future, continue to decline or
will increase in value relative to the USD. For a discussion of the impact of
recent declines in the value of these currencies on the Company's financial
condition and results of operations, see "--Consolidated Results of Operations"
and "--Liquidity and Capital Resources."
SUBSTANTIAL LEVERAGE; ABILITY TO SERVICE DEBT. The Company incurred substantial
indebtedness in connection with the Strategic Restructuring Plan and the
Financing Transactions. See "--Introduction." As a result, total indebtedness at
March 5, 1999 was approximately $1,232.0 million. See "--Liquidity and Capital
Resources." Subject to limitations in its existing debt agreements, the Company
may incur additional indebtedness in the future. The Company's high leverage
could have material consequences to the Company, including, but not limited to,
the following: (i) the Company's ability to obtain additional financing in the
future for working capital, capital expenditures, acquisitions, general
corporate or other purposes may be impaired or any such financing may not be
available on terms favorable to the Company; (ii) a substantial portion of the
Company's cash flow will be required for debt service and, as a result, will not
be available for its operations and other purposes; (iii) a substantial decrease
in net operating cash flows or an increase in expenses could make it difficult
for the Company to meet its debt service requirements or force it to modify its
operations or sell assets; (iv) the Company's ability to withstand competitive
pressures may be limited; and (v) the Company's level of indebtedness could make
it more vulnerable to economic downturns, and reduce its flexibility in
responding to changing business and economic conditions. In addition, a portion
of the Company's borrowings under the Credit Facility are and will continue to
be at variable rates of interest, which exposes the Company to the risk of
increased interest rates. The ability of the Company to meet its debt service
and other obligations (including compliance with financial covenants) will be
dependent upon the future performance of the Company and its cash flows from
operations, which will be subject to prevailing economic conditions and
financial, business and other factors, certain of which are beyond the Company's
control. As a result of the Company's substantial leverage, its financial
capacity to respond to changing market conditions, extraordinary capital needs,
and other developments may be limited. In addition, management's discretion in
responding to certain business matters may be limited by covenants contained in
the Credit Facility and the 2008 Notes. Among other things, these covenants
limit the Company's ability to incur additional indebtedness, create liens on
assets or make loans, investments or guarantees. These limitations may
materially and adversely affect the Company's ability to pursue operating
strategies or capital expenditure plans, or to engage in other business
activities, that the Company may otherwise consider to be in its best interests.
See "--Liquidity and Capital Resources" for a discussion of current limitations
on the Company's borrowing capacity and its ability to comply with financial
covenants.
RISKS RELATED TO DISPOSITIONS. As discussed in "-Introduction," the Company has
determined to address under performing or non-core business by fixing, selling
or closing such units. The decision to pursue the sale of a business unit
involves certain risks. There can be no assurance that the Company will be able
to identify suitable, qualified purchasers of such assets in a timely fashion,
or that the sale of such assets can be completed on terms that are favorable to
the Company. Also, there can be no assurances that the Company will be able to
complete such dispositions as quickly as it wishes. In addition, it is possible
that businesses that the Company identifies for sale may experience near-term
difficulties associated with the disruption in their business during this
disposition process. Such difficulties may include a deterioration of sales,
loss of customers or loss of
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<PAGE>
employees. Finally, the sale of a business may give rise to charges that reduce
the Company's reported results, including write-down of impaired assets or loss
on sale of a business.
HIGHLY COMPETITIVE MARKETS. The Company operates in a highly competitive
environment. It generally competes with a large number of smaller,
independent companies, many of which are well-established in their markets.
In addition, in the United States, the NAOPG competes with five large office
products companies, each of which may have greater financial resources than
the Company. Several of the Company's large competitors operate in many of
its geographic and product markets, and other competitors may choose to enter
its geographic and product markets in the future. In addition, as a result of
this competition, the Company may lose customers or have difficulty acquiring
new customers. Certain of the Company's large, national competitors have
indicated that they are pursuing new and alternative sales channels, such as
direct mail and e-commerce, to target the "middle market", which is the
Company's primary target market. The Company expects that its competitors
will continue to actively pursue new methods of reaching the "middle market"
customer, and there can be no assurances that the Company will be able to
respond to such initiatives. The Company also faces increasing competitive
pressures with respect to its ability to attract and keep certain larger
accounts. In addition, wholesalers and manufacturers that provide products to
the Company are developing initiatives to sell directly to end-users, rather
than exclusively through distributors like the Company. See "-Introduction."
As a result of competitive pressures in the pricing of products, the
Company's revenues or margins may decline. The highly leveraged nature of the
Company after the transactions related to the Strategic Restructuring Plan
and the Financing Transactions could limit the Company's ability to continue
to make necessary or desirable investments or capital expenditures to compete
effectively and to respond to market conditions.
FRANCHISE OPERATIONS OF MAIL BOXES ETC. MBE conducts its business principally
through franchisees or licensees, with the result that MBE has limited control
over franchisee operations and is subject to significant government regulation
of its legal relationships with franchisees that limits the control that MBE has
over its franchisees.
ABILITY OF INVESTOR TO INFLUENCE MANAGEMENT. As part of the Strategic
Restructuring Plan, Investor acquired shares, amounting to 24.9% of the
outstanding shares of the common stock after giving effect to the issuance of
such shares. Investor also acquired various warrants that give it the right to
acquire additional shares of common stock in the future that in certain
circumstances could increase its ownership to as much as 39.9% of the common
stock (if no currently outstanding stock options are exercised). Investor has,
among other things, the right (subject to certain conditions) to nominate three
of the nine members of the Company's Board of Directors (the "Board"), including
the Chairman of the Board. Also, on February 26, 1999, Charles P. Pieper, a
principal of Investor's affiliate, Clayton, Dubilier & Rice, Inc., assumed the
position of Chief Executive Officer of the Company. Investor will retain its
right to nominate three of the Company's nine Directors until Investor's level
of ownership of common stock declines by more than one-third. In addition,
certain Board decisions will be subject to super-majority voting provisions
that, in certain circumstances, may require the concurrence of at least one
director nominated by Investor. The super-majority voting provisions require the
affirmative vote of three-fourths of the Board for certain decisions such as the
sale of certain equity securities; any merger, tender offer involving the
Company's equity securities or sale, lease or disposition of all or
substantially all of the Company's assets or other business combination
involving the Company; any dissolution or partial liquidation of the Company;
and certain changes to the Company's charter and by-laws. These super-majority
Board voting requirements may give Investor the ability to block the approval of
certain actions requiring the super-majority vote of the Board. In addition,
Investor's significant ownership of the common stock may permit Investor to
influence significant matters requiring the approval of the Company's
stockholders.
INTANGIBLE ASSETS. As of January 23, 1999, approximately $919.2 million, or
44.1% of the Company's total assets, represented intangible assets, the
substantial majority of which was goodwill. As a result, a substantial portion
of the value of the Company's assets may not be available to repay creditors in
the event of a bankruptcy or dissolution of the Company.
Page 41
<PAGE>
EFFECT OF SHARES ELIGIBLE FOR FUTURE SALE. Sales of a substantial number of
shares of common stock, or the perception that such sales could occur, could
adversely affect prevailing market prices for shares of common stock. Investor
holds shares of common stock representing 24.9% of shares outstanding and
warrants to purchase an equal number of shares (plus additional shares in
certain circumstances). An investment agreement with Investor restricts
Investor's ability to sell these shares or warrants, but when these restrictions
expire (or if they are waived) Investor may sell these shares or warrants.
Additional shares may be issued either in connection with acquisitions by the
Company, upon exercise of outstanding options, options that may be issued in the
future, and warrants, and upon maturity or exercise of other rights to acquire
stock. The sale of shares upon exercise of options or by Investor, or the
perception that such sales could occur, may have an adverse effect on the
trading price of the common stock if a significant number of shares become
available over a limited period of time.
POTENTIAL LIABILITY FOR CERTAIN LIABILITIES OF THE SPIN-OFF COMPANIES. As part
of the Strategic Restructuring Plan, the Spin-Off Companies are required to
indemnify the Company for certain liabilities that the Company could incur
relating to the Distributions, the operations of the Spin-Off Companies and
other matters. There can be no assurance that the Spin-Off Companies will be
able to satisfy any such indemnities, and the Company may therefore incur such
liabilities even if they arose out of the activities of the Spin-Off Companies.
The Company could be adversely affected if in the future the Spin-Off Companies
are unable to satisfy these obligations. In addition, the Company had agreed to
indemnify Investor and its affiliates against losses resulting from any of the
Spin-Off Companies failing to satisfy their indemnity obligations to the
Company.
POTENTIAL LIABILITY FOR TAXES RELATED TO THE DISTRIBUTIONS. In connection with
the Strategic Restructuring Plan, the Company received an opinion of counsel
that the Distributions qualify as tax-free spin-offs under Section 355 of the
Code, and that the Distributions are not taxable under Section 355(e) of the
Code. That opinion was subject to certain assumptions and limitations and is
not, in any event, binding upon either the Internal Revenue Service or any
court.
If a Distribution fails to qualify as a tax-free spin-off under Section 355 of
the Code, the Company will recognize a gain equal to the difference between the
fair market value of the Spin-Off Company's common stock on the date of the
Distribution and the Company's adjusted tax basis in the Spin-Off Company's
common stock on the date of the Distribution. In addition, each stockholder of
the Company will be treated as having received a taxable corporate distribution
in an amount equal to the fair market value (on the date of the Distribution) of
the Spin-Off Company's common stock distributed to such stockholder. If the
Company were to recognize gain on one or more Distributions, such gain would
likely be substantial. If the Distribution is taxable under Section 355(e), but
otherwise satisfies the requirements of a tax-free spin-off, the Company will
recognize gain equal to the difference between the fair market value of the
Spin-Off Company's common stock on the date of the Distribution and the
Company's adjusted tax basis in the Spin-Off Company's common stock on the date
of the Distribution. However, no gain or loss will be recognized by holders of
common stock (except with respect to cash received in lieu of fractional
shares). If the Company were to recognize gain on one or more Distributions,
such gain would likely be substantial.
POTENTIAL LIMITATIONS ON STOCK ISSUANCES. Certain limitations under Section 355
of the Code may restrict the Company's ability to issue capital stock after the
Distributions. These limitations will generally prevent the Company from issuing
capital stock to the extent the issuance is part of a plan or series of related
transactions that includes one or more of the Distributions and pursuant to
which one or more persons acquire capital stock of the Company that represents
50% or more of the voting power or 50% or more of the value of the Company's
capital stock. These limitations may restrict the Company's ability to undertake
transactions involving issuances of capital stock of the Company that management
otherwise believes would be beneficial.
Page 42
<PAGE>
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Individuals purporting to represent various classes composed of stockholders who
purchased shares of U.S. Office Products common stock between June 5, 1997 and
November 2, 1998 have filed six actions in the United States District Court for
the Southern District of New York and four actions in the United States District
Court of the District of Columbia. The actions in the Southern District of New
York were filed on October 27, 1998, November 3, 1998, November 10, 1998,
November 17, 1998 and November 30, 1998. The actions in the District of Columbia
were filed on November 6, 1998, November 25, 1998, December 15, 1998 and
February 8, 1999. As of the date of this report, the Company has been served
with eight of these actions. Each of the actions name the Company and Jonathan
J. Ledecky and, in some cases Sands Brothers & Co. Ltd. as defendants. The
actions claim that the defendants made misstatements, failed to disclose
material information and otherwise violated Sections 10(b) and/or 14 of the
Securities Exchange Act of 1934 and Rules 10b-5 and 14a-9 promulgated thereunder
in connection with the Company's Strategic Restructuring Plan. Two of the
actions allege a violation of Sections 11, 12 and/or 15 of the Securities Act
of 1933 and/or breach of contract under California law relating to the Company's
acquisition of MBE. The actions seek declaratory relief, unspecified money
damages and attorney's fees. The Company intends to vigorously contest these
actions.
Sellers of businesses USOP acquired in the Fall of 1997 and that were spun
off in connection with the Company's Strategic Restructuring Plan also have
filed complaints in state court in Michigan, the United States District Court
for the District of Delaware, and the United States District Court for the
District of Connecticut. These lawsuits were filed on January 19, 1999,
February 10, 1999 and March 3, 1999, respectively, and name, among others,
the Company as a defendant. As of the date of this report, the Company has
been served in two of these actions. In addition, the Company has been
advised that a complaint was filed on October 23, 1998 in the United States
District Court for the Central District of California by the sellers of
another business naming, among others, the Company as a defendant. As of the
date of this report, this complaint has not been served on the Company. The
Company also has entered into a tolling agreement with the seller of another
business acquired in December 1997. Each of these disputes generally relates
to events surrounding the Strategic Restructuring Plan, and the complaints
that have been filed assert claims of violation of federal and/or state
securities and other laws, fraud, misrepresentation, conspiracy, breach of
contact, negligence, and/or breach of fiduciary duty. The Company believes
that these claims may be subject to indemnification, at least in part under
the terms of the distribution agreement between the Company and the Spin-Off
Companies that was executed in connection with the Strategic Restructuring
Plan. The Company intends to vigorously contest these actions.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) EXHIBITS
27 Financial Data Schedule.
(b) REPORTS ON FORM 8-K
During the period covered by this report, the Company filed the following
Current Reports on Form 8-K:
i. Form 8-K dated December 11, 1998 and filed with the Commission
on December 24, 1998 reporting information under Item 5.
Page 43
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
U.S. OFFICE PRODUCTS COMPANY
MARCH 9, 1999 By: /S/ CHARLES P. PIEPER
- ----------------------------- ------------------------
Date Charles P. Pieper
Chief Executive Officer
MARCH 9, 1999 By: /S/ JOSEPH T. DOYLE
- ----------------------------- ------------------------
Date Joseph T. Doyle
Chief Financial Officer
Page 44
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
NO. EXHIBIT
- --- -------
<S> <C>
27 Financial Data Schedule
</TABLE>
Page 45
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEET AND STATEMENT OF OPERATIONS INCLUDED IN THE COMPANY'S
QUARTERLY REPORT ON FORM 10-Q AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO
SUCH FINANCIAL STATEMENTS.
</LEGEND>
<CIK> 0000934852
<NAME> USOP
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> APR-24-1999
<PERIOD-START> APR-25-1998
<PERIOD-END> JAN-23-1999
<CASH> 16,435
<SECURITIES> 0
<RECEIVABLES> 352,551
<ALLOWANCES> (11,106)
<INVENTORY> 232,158
<CURRENT-ASSETS> 724,787
<PP&E> 381,555
<DEPRECIATION> (150,760)
<TOTAL-ASSETS> 2,083,522
<CURRENT-LIABILITIES> 356,550
<BONDS> 1,192,376
0
0
<COMMON> 37
<OTHER-SE> 517,307
<TOTAL-LIABILITY-AND-EQUITY> 2,083,522
<SALES> 2,005,776
<TOTAL-REVENUES> 2,005,776
<CGS> 1,449,000
<TOTAL-COSTS> 1,449,000
<OTHER-EXPENSES> 595,997<F1>
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 76,785
<INCOME-PRETAX> (116,006)
<INCOME-TAX> (16,018)
<INCOME-CONTINUING> (99,988)
<DISCONTINUED> (1,294)
<EXTRAORDINARY> 269
<CHANGES> 0
<NET-INCOME> (101,551)
<EPS-PRIMARY> (2.81)
<EPS-DILUTED> (2.81)
<FN>
<F1>OTHER EXPENSES INCLUDE STRATEGIC RESTRUCTURING PLAN COSTS ($97,503), OPERATING
RESTRUCTURING COSTS ($17,229), IMPAIRED ASSET WRITE-OFFS ($2,778) AND LOSS ON
SALE OF BUSINESSES (7,500).
</FN>
</TABLE>
