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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
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(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934.
For the quarterly period ended March 31, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934.
For the transition period from to
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Commission File Number 333-39373
SOVEREIGN SPECIALTY CHEMICALS, INC.
(Exact Name of Registrant as Specified in Its Charter)
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DELAWARE
36-4176637
(State or Other Jurisdiction of Incorporation or Organization)
(IRS Employer Identification No.)
225 W. Washington St. -- Ste. 1450, Chicago, IL 60606
(Address of Principal Executive Offices)
(Zip Code)
Registrant's Telephone Number, Including Area Code: (312) 223-7167
Registrant's Web Address: sovereignsc.com
INDICATE BY CHECK MARK WHETHER THE REGISTRANT: (1) HAS FILED ALL REPORTS
REQUIRED TO BE FILED BY SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934 DURING THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE
REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH
FILING REQUIREMENTS FOR THE PAST 90 DAYS. YES [X] NO [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [ ] No [X]
On May 5, 2003, the registrant had 1,441,189 shares of voting common stock
outstanding and 730,182 shares of non-voting common stock outstanding.
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SOVEREIGN SPECIALTY CHEMICALS, INC.
FORM 10-Q
TABLE OF CONTENTS
PAGE NUMBER
-----------
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements:
Consolidated Balance Sheets at March 31, 2003 (Unaudited)
and December 31, 2002..................................... 1
Consolidated Statements of Operations for the three months
ended March 31, 2003 and 2002 (Unaudited)................. 2
Consolidated Statements of Cash Flows for the three months
ended March 31, 2003 and 2002 (Unaudited)................. 3
Notes to Consolidated Financial Statements.................. 4
ITEM 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations....................... 11
ITEM 3. Quantitative and Qualitative Disclosures about
Market Risk............................................... 18
ITEM 4. Controls and Procedures............................. 19
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings................................... 20
ITEM 2. Changes in Securities and Use of Proceeds........... 20
ITEM 3. Defaults Upon Senior Securities..................... 20
ITEM 4. Submission of Matters to a Vote of Security
Holders................................................... 20
ITEM 5. Other Information................................... 20
ITEM 6. Exhibits and Reports on Form 8-K.................... 20
Signatures.................................................. 21
Certifications Pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002............................................... 24
SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AMOUNTS)
MARCH 31, DECEMBER 31,
2003 2002
----------- ------------
(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents................................. $ 8,463 $ 14,124
Accounts receivable, net.................................. 54,587 49,554
Inventories............................................... 30,879 28,203
Deferred income taxes..................................... 5,257 5,257
Other current assets...................................... 5,051 3,879
-------- --------
Total current assets........................................ 104,237 101,017
Property, plant, and equipment, net......................... 67,620 67,950
Goodwill, net............................................... 124,388 124,388
Deferred financing costs, net............................... 8,863 9,350
Deferred income taxes....................................... 5,133 5,872
Other assets................................................ 87 91
-------- --------
Total assets................................................ $310,328 $308,668
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................... $ 36,448 $ 31,606
Accrued expenses.......................................... 17,805 23,874
Other current liabilities................................. 144 143
Current portion of long-term debt......................... 2,508 2,041
Current portion of capital lease obligations.............. 402 402
-------- --------
Total current liabilities................................... 57,307 58,066
Long-term debt, less current portion........................ 221,379 218,853
Capital lease obligations, less current portion............. 2,453 2,496
Other long-term liabilities................................. 3,432 3,400
Stockholders' equity:
Common stock, $0.01 par value, 2,700,000 shares authorized,
1,441,189 issued and outstanding.......................... 15 15
Common stock, non-voting, $0.01 par value, 2,100,000 shares
authorized, 730,182 issued and outstanding................ 7 7
Additional paid-in capital.................................. 64,073 64,073
Accumulated deficit......................................... (36,177) (36,272)
Accumulated other comprehensive loss........................ (2,161) (1,970)
-------- --------
Total stockholders' equity.................................. 25,757 25,853
-------- --------
Total liabilities and stockholders' equity.................. $310,328 $308,668
======== ========
See accompanying notes to consolidated financial statements.
1
SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS)
THREE MONTHS ENDED
-------------------------------
MARCH 31, 2003 MARCH 31, 2002
-------------- --------------
(UNAUDITED) (UNAUDITED)
Net sales................................................... $89,821 $ 86,748
Cost of goods sold.......................................... 65,485 63,134
------- --------
Gross profit................................................ 24,336 23,614
Selling, general and administrative expenses................ 17,510 17,677
------- --------
Operating income............................................ 6,826 5,937
Interest expense, net....................................... 6,283 6,420
------- --------
Income (loss) before income taxes and cumulative effect of
change in accounting principle............................ 543 (483)
Income tax expense (benefit)................................ 448 (182)
------- --------
Income (loss) before cumulative effect of change in
accounting principle...................................... 95 (301)
Cumulative effect of change in accounting principle related
to goodwill write-off, net of income tax benefit.......... -- (17,064)
------- --------
Net income (loss)........................................... $ 95 $(17,365)
======= ========
See accompanying notes to consolidated financial statements
2
SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
THREE MONTHS ENDED
--------------------------------
MARCH 31, 2003 MARCH 31, 2002
-------------- --------------
(UNAUDITED) (UNAUDITED)
OPERATING ACTIVITIES
Net income (loss)........................................... $ 95 $(17,365)
Adjustments to reconcile net income (loss) to net cash used
in operating activities:
Depreciation and amortization............................. 2,185 2,462
Amortization of deferred financing costs.................. 521 387
Amortization of debt discounts............................ 141 32
Cumulative effect of change in accounting principle, net
of income tax benefit.................................. -- 17,064
Foreign exchange losses................................... 32 183
Deferred income taxes..................................... 739 --
Changes in operating assets and liabilities:
Accounts receivable.................................... (4,989) (2,584)
Inventories............................................ (2,717) (968)
Prepaid expenses and other assets...................... (1,146) (99)
Accounts payable and other liabilities................. (1,388) (2,752)
-------- --------
Net cash used in operating activities....................... (6,527) (3,640)
INVESTING ACTIVITIES
Purchase of property, plant and equipment................... (1,940) (617)
-------- --------
Net cash used in investing activities....................... (1,940) (617)
FINANCING ACTIVITIES
Payments on long-term debt.................................. (500) (250)
Payments for deferred financing costs....................... (34) (726)
Payments on capital lease obligations....................... (43) (59)
Proceeds from revolving credit facilities................... 11,000 203
Payments on revolving credit facilities..................... (7,633) (6,750)
-------- --------
Net cash provided by (used in) financing activities......... 2,790 (7,582)
Effect of exchange rate changes on cash..................... 16 (93)
-------- --------
Net decrease in cash and cash equivalents................... (5,661) (11,932)
Cash and cash equivalents at beginning of period............ 14,124 15,584
-------- --------
Cash and cash equivalents at end of period.................. $ 8,463 $ 3,652
======== ========
See accompanying notes to consolidated financial statements.
3
SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2003
(Dollars in Thousands)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION AND PRINCIPLES OF CONSOLIDATION
The consolidated financial statements as of and for the periods ended March
31, 2003 and 2002, respectively, include the accounts of Sovereign Specialty
Chemicals, Inc. and its wholly owned subsidiaries (the "Company"). All
significant intercompany balances and transactions have been eliminated.
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Actual results could differ from those
estimates.
INTERIM FINANCIAL INFORMATION
The unaudited interim consolidated financial statements of the Company, in
the opinion of management, reflect all necessary adjustments, consisting only of
normal recurring adjustments, for a fair presentation of results as of the dates
and for the interim periods covered by the financial statements. The results for
the interim periods are not necessarily indicative of the results of operations
to be expected for the entire year or any other interim period
The unaudited interim consolidated financial statements of the Company have
been prepared in conformity with generally accepted accounting principles and
reporting practices. Certain information in footnote disclosures normally
included in financial statements prepared in accordance with generally accepted
accounting principles has been condensed or omitted pursuant to the rules and
regulations of the Securities and Exchange Commission; however, the Company
believes the disclosures are adequate to make the information not misleading.
The unaudited interim consolidated financial statements contained herein should
be read in conjunction with the audited financial statements and notes thereto
included in the Company's Annual Report on Form 10-K for the year ended December
31, 2002.
RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform to current
year presentation.
2. PLANT CLOSURE COSTS
In November 2002, the Company announced the closure of two of its
higher-cost manufacturing plants in 2003. The Cincinnati, Ohio plant employs 118
people, and primarily produces water-borne adhesives sold to the industrial
market. Production from this plant will be transferred to the Company's plants
in Greenville, South Carolina, and Carol Stream and Plainfield, Illinois
progressively over the first nine months of 2003. Some of the technical, sales
support, customer service, and administrative functions will be transitioned to
other Company locations. Approximately 88 employees, in both manufacturing and
support functions will be terminated as part of the closure.
The Kapellen, Belgium plant employs 24 people and produces water-borne and
hot-melt adhesives for the European packaging and converting market. This
production will be shifted to the Newark United Kingdom plant during the first
half of 2003. Approximately 14 employees primarily in manufacturing functions
will be terminated as part of the plant closure. A separate Kapellen office will
continue to provide sales, technical and distribution support to continental
Europe.
These closures will include the termination of certain existing employees,
the abandonment or sale at a loss of certain fixed assets, the disposal of
certain inventory and the sale of certain buildings. The Company
4
SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
MARCH 31, 2003
(Dollars in Thousands)
expects the closure of both plants to be completed by the end of the third
quarter of 2003. The closure of these two plants is expected to produce annual
cost savings of over $3.0 million when the shutdowns are complete. As a result
of the announced closures the Company recorded a charge of approximately $4.1
million in the fourth quarter of 2002 included in selling, general and
administrative expense, relative to the following costs: termination benefits of
$1.6 million, loss on fixed assets of $1.3 million and other exit costs of $1.2
million. These costs will be incurred over the next several quarters and $2.5
million is included in accrued liabilities on the balance sheet.
The following provides a roll forward of the plant closure liability for
the three months ended March 31, 2003:
Liability for plant closures, balance at January 1, 2003.... $4,066
Less: Plant closure costs incurred three months ended March
31, 2003.................................................. (279)
------
Total liability for plant closures, balance at March 31,
2003...................................................... $3,787
======
3. INVENTORIES
Inventories are summarized as follows:
MARCH 31, DECEMBER 31,
2003 2002
--------- ------------
Raw materials......................................... $10,724 $ 8,920
Work in process....................................... 543 440
Finished goods........................................ 19,612 18,843
------- -------
$30,879 $28,203
======= =======
4. COMPREHENSIVE LOSS
For the three months ended March 31, 2003 and 2002, respectively, the
calculation of comprehensive loss is as follows:
2003 2002
----- --------
Net income (loss) as reported............................. $ 95 $(17,365)
Foreign currency translation adjustments................ (191) (40)
----- --------
Comprehensive loss...................................... $ (96) $(17,405)
===== ========
5. SEGMENT REPORTING
The Company has two reportable segments: the Commercial segment and the
Construction segment. Applications sold by the Commercial segment include
flexible packaging adhesives and coatings for a number of applications, high
performance, specialty adhesives and coatings for automotive, aerospace,
manufactured housing and textile applications. Through the Construction segment,
the Company manufactures and sells housing repair, remodeling and construction
sealants and adhesives used in exterior and interior applications.
The Company evaluates performance and defines segment profit based upon
operating income. The reportable segments' accounting policies are the same as
those of the Company as a whole. Segment profit is calculated as a reportable
segment's operating income. Total segment profits exceed consolidated operating
5
SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
MARCH 31, 2003
(Dollars in Thousands)
profits to the extent of unallocated corporate expenses included in selling,
general and administrative expenses. Unallocated corporate expenses were $2.4
million and $2.6 million for the quarters ended March 31, 2003 and 2002,
respectively.
The reportable segments are each managed and measured separately primarily
due to the differing customers, products sold and distribution channels. The
reportable segments are as follows:
COMMERCIAL CONSTRUCTION TOTALS
---------- ------------ -------
For the three months ended March 31, 2003:
Net sales................................................. $58,610 $31,211 $89,821
Segment profit............................................ 5,069 4,154 9,223
For the three months ended March 31, 2002:
Net sales................................................. $59,242 $27,506 $86,748
Segment profit............................................ 5,077 3,508 8,585
A reconciliation of the reportable segments to consolidated operating
income is as follows:
FOR THE
THREE MONTHS ENDED
MARCH 31,
-------------------
2003 2002
-------- --------
Profit:
Total profit for reportable segments........................ $9,223 $8,585
Unallocated corporate expense............................... (2,397) (2,648)
------ ------
Income from operations.................................... $6,826 $5,937
====== ======
6. GOODWILL
On January 1, 2002, the Company adopted SFAS No. 142. The adoption of SFAS
No. 142 eliminated the amortization of goodwill beginning January 1, 2002 and
instead required that goodwill be tested for impairment. In connection with our
adoption of SFAS No. 142, the transitional intangible asset impairment test
required an impairment of goodwill charge of $27.6 million ($17.1 million, net
of income tax benefit). The loss was recorded as a cumulative effect of change
in accounting principle. The impairment loss and write-down of goodwill was
recorded relative to the Company's European reporting unit of its Commercial
Segment. Our assessment of the goodwill impairment charge for this reporting
unit was reflective of both lower operating performance in Europe and the use of
lower market multiples. The carrying value of goodwill associated with our other
reporting units was not impaired.
7. OTHER FINANCIAL INFORMATION
The Company is a holding company with no independent assets or operations.
Certain of the Company's subsidiaries (Guarantor Subsidiaries) have guaranteed
the Company's 11 7/8% Senior Subordinated Notes. Full separate financial
statements of the Guarantor Subsidiaries have not been presented as the
guarantors are wholly owned subsidiaries of the Company and the guarantees are
full, unconditional and joint and several. Management does not believe that
inclusion of such financial statements would be material to investors. The
unaudited financial statement data as of March 31, 2003 and 2002, respectively
of the Guarantor Subsidiaries and the non-guarantor subsidiaries are below.
6
SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
MARCH 31, 2003
(Dollars in Thousands)
THE FOLLOWING SETS FORTH THE UNAUDITED FINANCIAL DATA AT MARCH 31, 2003 AND
FOR THE THREE MONTHS THEN ENDED.
GUARANTOR NON-GUARANTOR
SUBSIDIARIES SUBSIDIARIES THE COMPANY ELIMINATIONS TOTAL
------------ ------------- ----------- ------------ --------
STATEMENT OF OPERATIONS DATA:
Net sales............................... $ 77,605 $12,216 $ -- $ -- $ 89,821
Cost of goods sold...................... 56,444 9,041 -- -- 65,485
-------- ------- -------- --------- --------
Gross profit............................ 21,161 3,175 -- -- 24,336
Selling, general and administrative
expense............................... 12,742 2,788 1,980 -- 17,510
-------- ------- -------- --------- --------
Operating income (loss)................. 8,419 387 (1,980) -- 6,826
Interest expense........................ (5,755) (49) (479) -- (6,283)
-------- ------- -------- --------- --------
Income (loss) before extraordinary items
and Income taxes...................... $ 2,664 $ 338 $ (2,459) $ -- $ 543
======== ======= ======== ========= ========
BALANCE SHEET DATA:
Current assets.......................... $ 82,841 $21,122 $ 15,832 $ (15,558) $104,237
Property plant and equipment, net....... 54,946 11,821 853 -- 67,620
Goodwill, net........................... 121,353 3,035 -- -- 124,388
Deferred financing costs, net........... 6,785 -- 2,078 -- 8,863
Deferred income taxes................... 6,091 863 (1,821) -- 5,133
Other assets............................ 10,888 39 282,631 (293,471) 87
-------- ------- -------- --------- --------
Total assets............................ $282,904 $36,880 $299,573 $(309,029) $310,328
======== ======= ======== ========= ========
Liabilities and Stockholders' Equity:
Current liabilities..................... $ 54,779 $15,058 $ 3,028 $ (15,558) $ 57,307
Long-term liabilities................... 210,738 18,171 221,378 (223,023) 227,264
Total stockholders' equity.............. 17,387 3,651 75,167 (70,448) 25,757
-------- ------- -------- --------- --------
Total liabilities and stockholders'
equity................................ $282,904 $36,880 $299,573 $(309,029) $310,328
======== ======= ======== ========= ========
7
SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
MARCH 31, 2003
(Dollars in Thousands)
GUARANTOR NON-GUARANTOR
SUBSIDIARIES SUBSIDIARIES THE COMPANY ELIMINATIONS TOTAL
------------ ------------- ----------- ------------ --------
STATEMENT OF CASH FLOWS DATA:
Operating activities:
Net income (loss)....................... $ 1,181 $ 156 $ (1,242) $ -- $ 95
Depreciation and amortization........... 1,821 319 45 -- 2,185
Deferred income taxes................... -- -- 739 -- 739
Foreign exchange (gains) losses......... (30) 62 -- -- 32
Amortization of debt discounts.......... -- -- 141 -- 141
Amortization of deferred financing
costs................................. 386 -- 135 -- 521
Changes in operating assets and
liabilities........................... (1,617) (1,884) (6,739) -- (10,240)
-------- ------- -------- --------- --------
Net cash provided by (used in) operating
activities............................ 1,741 (1,347) (6,921) -- (6,527)
Investing activities:
Purchase of property, plant and
equipment............................. (1,774) (45) (121) -- (1,940)
-------- ------- -------- --------- --------
Net cash used in investing activities... (1,774) (45) (121) -- (1,940)
Financing activities:
Intercompany financing.................. (5,068) 849 4,219 -- --
Payments on long term debt.............. -- (500) -- -- (500)
Deferred financing costs................ -- -- (34) -- (34)
Payments on capital lease obligations... (43) -- -- -- (43)
Net proceeds (payments) on revolving
credit facilities..................... -- 510 2,857 -- 3,367
-------- ------- -------- --------- --------
Net cash provided by (used in) financing
activities............................ (5,111) 859 7,042 -- 2,790
Effect of foreign currency changes on
cash.................................. 102 (86) -- -- 16
-------- ------- -------- --------- --------
Net decrease in cash and cash
equivalents........................... (5,042) (619) -- -- (5,661)
Cash and cash equivalents, beginning of
period................................ 11,378 2,746 -- -- 14,124
-------- ------- -------- --------- --------
Cash and cash equivalents, end of
period................................ $ 6,336 $ 2,127 $ -- $ -- $ 8,463
======== ======= ======== ========= ========
8
SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
MARCH 31, 2003
(Dollars in Thousands)
THE FOLLOWING SETS FORTH THE UNAUDITED FINANCIAL DATA AT MARCH 31, 2002 AND
FOR THE THREE MONTHS THEN ENDED.
GUARANTOR NON-GUARANTOR
SUBSIDIARIES SUBSIDIARIES THE COMPANY ELIMINATIONS TOTAL
------------ ------------- ----------- ------------ --------
STATEMENT OF OPERATIONS DATA:
Net sales............................... $ 75,950 $10,798 $ -- $ -- $ 86,748
Cost of goods sold...................... 54,952 8,182 -- -- 63,134
-------- ------- -------- --------- --------
Gross profit............................ 20,998 2,616 -- -- 23,614
Selling, general and administrative
expense............................... 12,502 2,527 2,648 -- 17,677
-------- ------- -------- --------- --------
Operating income (loss)................. 8,496 89 (2,648) -- 5,937
Interest expense........................ (5,856) (216) (348) -- (6,420)
-------- ------- -------- --------- --------
Income (loss) before income taxes and
cumulative effect of change in
accounting principle.................. $ 2,640 $ (127) $ (2,996) $ -- $ (483)
======== ======= ======== ========= ========
BALANCE SHEET DATA:
Current assets.......................... $ 88,239 $20,926 $ 19,413 $ (18,255) $110,323
Property plant and equipment, net....... 56,736 11,212 371 -- 68,319
Goodwill, net........................... 121,353 3,035 -- -- 124,388
Deferred financing costs, net........... 8,122 -- 1,161 -- 9,283
Other assets............................ 10,061 1,047 269,449 (269,449) 11,108
-------- ------- -------- --------- --------
Total assets............................ $284,511 $36,220 $290,394 $(287,704) $323,421
======== ======= ======== ========= ========
Current liabilities..................... $ 53,610 $12,703 $ 17,723 $ (19,334) $ 64,702
Long term liabilities................... 212,740 19,058 211,394 (211,126) 232,066
Total stockholders' equity.............. 18,161 4,459 61,277 (57,244) 26,653
-------- ------- -------- --------- --------
Total liabilities and stockholders'
equity................................ $284,511 $36,220 $290,394 $(287,704) $323,421
======== ======= ======== ========= ========
9
SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
MARCH 31, 2003
(Dollars in Thousands)
GUARANTOR NON-GUARANTOR
SUBSIDIARIES SUBSIDIARIES THE COMPANY ELIMINATIONS TOTAL
------------ ------------- ----------- ------------ --------
STATEMENT OF CASH FLOWS DATA:
Operating activities:
Net income (loss)....................... $(15,376) $(1,599) $ (390) $ -- $(17,365)
Depreciation and amortization........... 2,145 284 33 -- 2,462
Cumulative effect of change in
accounting principle.................. 15,669 1,395 -- -- 17,064
Foreign exchange losses................. -- 183 -- -- 183
Amortization of deferred financing
costs................................. 365 -- 22 -- 387
Amortization of bond discount........... 32 -- -- -- 32
Changes in operating assets and
liabilities........................... (11,516) 789 7,811 (3,487) (6,403)
-------- ------- -------- --------- --------
Net cash provided by (used in) operating
activities............................ (8,682) 1,053 7,476 (3,487) (3,640)
Investing activities:
Sale of property, plant & equipment..... -- 80 -- -- 80
Purchase of property, plant &
equipment............................. (640) (57) -- -- (697)
Net cash provided by (used in) investing
activities............................ (640) 23 -- -- (617)
-------- ------- -------- --------- --------
Financing activities:
Payments on long term debt.............. -- (250) (3,750) -- (4,000)
Payments for deferred financing costs... -- -- (726) -- (726)
Payments on capital leases.............. (59) -- -- -- (59)
Net proceeds (payments) from revolving
credit facilities..................... (1) 204 (3,000) -- (2,797)
-------- ------- -------- --------- --------
Net cash used in financing activities... (60) (46) (7,476) -- (7,582)
Effect of foreign currency changes on
cash.................................. -- (93) -- -- (93)
-------- ------- -------- --------- --------
Net increase (decrease) in cash......... (9,382) 937 -- (3,487) (11,932)
Cash and cash equivalents, beginning of
period................................ 10,955 1,142 -- 3,487 15,584
-------- ------- -------- --------- --------
Cash and cash equivalents, end of
period................................ $ 1,573 $ 2,079 $ -- $ -- $ 3,652
======== ======= ======== ========= ========
10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis is provided to increase the
understanding of, and should be read in conjunction with, the consolidated
financial statements and accompanying notes included herein.
GENERAL
We were formed to acquire and consolidate adhesives, sealants and coatings
businesses in the highly fragmented adhesives, sealants and coatings business
segment of the specialty chemical industry. We have grown through the
acquisition and integration of businesses. From 1996 to 2002, we increased
annual net sales through acquisitions and internal growth from $37.8 million to
$361.1 million. We plan to continue our growth through a combination of new
product development, continued market penetration, international expansion, and
in the longer term, strategic acquisitions.
The operating results of acquired businesses have been included in our
consolidated operating results for all periods after their respective dates of
acquisition.
SUMMARY OF CRITICAL ACCOUNTING POLICIES
The discussion and analysis of our financial condition and results of
operations are based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires us to make
estimates and judgments that affect the reported amounts of assets, liabilities,
revenues and expenses, and related disclosure of contingent assets and
liabilities. On an ongoing basis, we continually evaluate our estimates. We base
our estimates on historical experience and on various other assumptions that are
believed to be reasonable under the circumstances, the results of which form the
basis for making judgments about the carrying values of assets and liabilities
that are not readily apparent from other sources. Actual results may differ from
these estimates.
We believe the following critical accounting policies affect our more
significant judgments and estimates used in the preparation of our consolidated
financial statements.
Revenue Recognition. Revenue is recognized when products are shipped to
the customer and title transfers.
Cost of Goods Sold. Cost of goods sold represents the actual cost of
purchased raw materials, direct and indirect labor, warehousing and
manufacturing overhead costs, including depreciation, utilized directly in the
production of products for which revenue has been recognized.
Selling, General & Administrative Expenses. Selling, general &
administrative expenses generally are those costs not directly related to the
production process and include all selling, marketing, research and development
customer service expenses as well as expenses related to general management,
finance and accounting, information services, human resources, legal and
corporate overhead expense.
Goodwill. Goodwill represents the excess of acquisition cost over the fair
value of net assets acquired and was being amortized using the straight-line
method over periods ranging from 15 to 25 years through December 31, 2001.
Accumulated amortization of goodwill was $30.1 million at December 31, 2001. On
January 1, 2002, the Company adopted SFAS No. 142, Goodwill and Other Intangible
Assets, which eliminated the amortization of goodwill and instead required that
goodwill be tested for impairment at least annually.
Reserve for Inventory Obsolescence. Our estimated reserves for
obsolescence or unmarketable inventory is equal to the difference between the
cost of the inventory and the estimated market value based upon assumptions
about market conditions, future demand and expected usage rates. We periodically
review inventory and if applicable, record additional inventory writedowns. If
actual market conditions are less favorable than those projected by management
and cause usage rates to vary from those estimated, additional inventory
write-downs may be required, however these would not be expected to have a
material adverse impact on our financial statements.
11
Allowance for Doubtful Accounts. We maintain allowances for doubtful
accounts for estimated losses resulting from the failure of our customers to
make required payments. We evaluate the adequacy of our allowance for doubtful
accounts and make judgments and estimates in determining the appropriate
allowance at each reporting period. If a customer's financial condition were to
deteriorate, additional allowances may be required.
SEGMENT REPORTING
We have two reportable segments: the Commercial segment and the
Construction segment. Applications sold by the Commercial segment include
flexible packaging adhesives and coatings for a number of applications, high
performance, specialty adhesives and coatings for automotive, aerospace,
manufactured housing, and textile applications. Through the Construction
segment, we manufacture and sell housing repair, remodeling and construction
sealants and adhesives used in exterior and interior applications.
We evaluate the performance of each segment based on operating income.
Segment profit is calculated as a reportable segment's operating income. Total
segment profits exceed consolidated operating profits to the extent of
unallocated corporate expenses included in selling, general and administrative
expenses. Unallocated corporate expenses were $2.4 million and $2.6 million for
the three months ended March 31, 2003 and 2002, respectively.
RESULTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 2003 COMPARED TO THREE MONTHS ENDED MARCH 31, 2002
Net Sales. Net sales were $89.8 million and $86.7 million for the three
months ended March 31, 2003 and 2002, respectively. The first quarter 2003 net
sales level represents an increase of $3.1 million or 3.4% over the prior year.
The increase resulted from gains in the Construction segment, which were
partially offset by a decrease in net sales in the Commercial segment.
Construction segment sales were $31.2 million in the first three months of 2003,
up $3.7 million, or 13.5% from the prior year reflecting sales increases in
building material applications due to the continued strength in the housing
market and increased sales to the retail do-it-yourself market. Commercial
segment sales were $58.6 million in the first quarter of 2003, down $0.6
million, or 1.1% from the prior year due to declines in a number of end markets
primarily paper converting and graphic arts, particularly high-end printing
applications.
Cost of Goods Sold. Cost of goods sold was $65.5 million for the three
months ended March 31, 2003, an increase of $2.4 million, or 4.0% over first
quarter 2002 cost of sales of $63.1 million. Gross profit as a percentage of net
sales decreased slightly in 2003 to 27.1% from 27.2% in the first three months
of 2002. We were able to keep margins relatively stable despite raw material
cost increases year over year.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses were $17.5 million for the three months ended March 31,
2003, a decrease of $0.2 million, or 1.0% from the first quarter 2002 expenses
of $17.7 million. As a percentage of net sales, selling, general and
administrative expenses decreased to 19.5% for the first quarter of 2003 from
20.4% in the first quarter of 2002. This decrease is reflective of a management
focus on cost containment.
Operating Income. Operating income was $6.8 million and $5.9 million for
the three months ended March 31, 2003 and 2002, respectively. Operating income
as a percentage of net sales was 7.6% and 6.8% for the three months ended March
31, 2003 and 2002, respectively, and is primarily a result of decreasing
selling, general and administrative expenses while increasing net sales.
Interest Expense. Net interest expense was $6.3 million and $6.4 million
for the three months ended March 31, 2003 and 2002, respectively. The 1.5%
decrease in interest expense was due primarily to a decrease in our average
outstanding level of variable rate debt quarter over quarter offset largely by
increased non-cash interest expense due to additional amortization of deferred
financing cost and debt discounts and a slight increase in the weighted average
interest rate on our variable rate debt to 5.9% from 5.8% for the first three
months of last year. In December 2002, we refinanced $45.1 million of borrowings
under our existing term loan under our credit agreement with $47.5 million of
borrowings under a new term loan facility. The
12
applicable margin or "spread" on the new term loan facility is 75 basis points
higher than the applicable margin that was in effect for the existing term loan
during most of 2002. As a result, in the absence of continued decreases in the
interest rates on which our variable rate debt is based, we will expect to have
an increase in the weighted average interest rate of our variable rate debt in
2003.
Income tax expense (benefit). Income tax expense was $0.4 million for the
three months ended March 31, 2003. Income tax expense in the current quarter
reflects the full impact of the reversal of some permanent differences resulting
in an unusual effective tax rate. The effective income tax rate is expected to
be consistent with that of the prior year on an annualized basis. Income tax
benefit was $0.2 million for the same period in 2002.
Net income (loss). Net income was $0.1 million for the three months ended
March 31, 2003. Net loss was $0.3 million for the same period in 2002.
COMMERCIAL SEGMENT
The following table presents net sales and segment profit expressed in
millions of dollars and segment profit margin, which is segment profit expressed
as a percentage of net sales:
FOR THE
THREE MONTHS
ENDED
MARCH 31,
---------------- DOLLAR PERCENTAGE
2003 2002 CHANGE CHANGE
---- ---- ------ ----------
Net sales.................................. $58.6 $59.2 $(0.6) (1.1)%
===== =====
Segment profit............................. $ 5.1 $ 5.1 $ -- --%
===== =====
Segment profit margin...................... 8.6% 8.6% -- --%
===== =====
Net sales were $58.6 million for the three months ended March 31, 2003,
representing a $0.6 million decrease from first quarter 2002. This decrease was
due primarily to declines in a number of end markets primarily paper converting
and graphic arts, particularly high-end printing applications. Declines in these
end markets offset increased sales of product assembly and transportation
applications. Segment profit was $5.1 million for the quarter ended March 31,
2003 and 2002. The decrease in net sales was offset by a decrease in operating
expenses attributable to management's focus on selling, general and
administrative cost containment.
In November 2002, we announced plans for the closure in 2003 of two of our
higher-cost manufacturing plants. The Cincinnati, Ohio plant employs 118 people,
and primarily produces water-borne adhesives sold to the industrial market.
Production from this plant is being transferred to our plants in Greenville,
South Carolina, and Carol Stream, Illinois and Plainfield, Illinois
progressively during the first nine months of 2003. Also housed in Cincinnati
are technical, sales support, customer service, and administrative functions,
some of which will be transitioned to other of our locations. As part of the
closure, approximately 88 employees in both manufacturing and support functions
will be terminated in 2003.
The Kapellen, Belgium plant employs 24 people and produces water-borne and
hot-melt adhesives for the European packaging and converting market. This
production is being shifted to the Newark, United Kingdom plant during the first
half of 2003. A separate Kapellen office will continue to provide sales,
technical and distribution support to continental Europe. Approximately 14
employees, primarily in manufacturing functions, will be terminated as part of
the closure in 2003.
These closures include the termination of certain existing employees, the
abandonment or sale at a loss of certain fixed assets, the disposal of certain
inventory and the sale of certain buildings. We expect the closure of both
plants to be completed by end of the third quarter of 2003. The closure of these
two plants is expected to produce annual cost savings of approximately $3.0
million when the shutdowns are complete. As a result of the announced closures,
we recorded a charge of approximately $4.1 million in the fourth quarter of 2002
relative
13
to the following costs: termination benefits of $1.6 million, loss on fixed
assets of $1.3 million and other exit costs of $1.2 million. These costs will be
incurred over the next several quarters and approximately $2.5 million was
recorded in accrued liabilities. In the three months ended March 31, 2003, we
incurred $0.3 million in termination related payments.
CONSTRUCTION SEGMENT
The following table presents net sales and segment profit expressed in
millions of dollars and segment profit margin, which is segment profit expressed
as a percentage of net sales:
FOR THE
THREE MONTHS
ENDED
MARCH 31,
---------------- DOLLAR PERCENTAGE
2003 2002 CHANGE CHANGE
---- ---- ------ ----------
Net sales.................................. $31.2 $27.5 $3.7 13.5%
===== =====
Segment profit............................. $ 4.2 $ 3.5 $0.7 18.4%
===== =====
Segment profit margin...................... 13.3% 12.8% -- 4.4%
===== =====
Net sales for the Construction segment were $31.2 million for the quarter
ended March 31, 2003 and $27.5 million for the quarter ended March 31, 2002. The
$3.7 million and 13.5% increase in sales in 2003 was primarily due to the
sustained strength of its building materials end markets and strength at major
retail accounts. Segment profit increased by $0.7 million, or 18.4%, primarily
as a result of higher sales volume, management focus on reduction of selling,
general and administrative costs and pricing increases that offset higher year
over year raw material costs.
LIQUIDITY AND CAPITAL RESOURCES
Net cash used in operating activities was $6.5 million and $3.6 million for
the three months ended March 31, 2003 and 2002, respectively. Net income (loss),
adjusted for non-cash charges, such as depreciation and amortization,
amortization of deferred financing costs, deferred income taxes, foreign
currency gains/losses, accounted for approximately $3.7 million and $2.8 million
of cash flow for the three months ended March 31, 2003 and 2002, respectively.
Cash provided from operations decreased as we increased inventory levels by $2.6
million and accounts receivable balances by $5.0 million in the current quarter.
While accounts receivable and inventory balances at March 31, 2003 ($54.6
million and $30.9 million, respectively) are greater than at December 31, 2002,
they are significantly below the levels at March 31, 2002 ($58.4 million and
$38.7 million, respectively) on an increased level of net sales, reflecting
management's focus on controlling working capital. Accounts payable and other
liabilities decreased by $1.4 million for the three months ended March 31, 2003,
primarily as a result of our semi-annual interest payment on our 11 7/8% senior
subordinated notes on March 15, 2003.
Net cash used in investing activities was $1.9 million and $0.6 million in
the three months ended March 31, 2003 and 2002, respectively, and resulted from
additions to property, plant and equipment.
Net cash used in financing activities was $2.8 million for the three months
ended March 31, 2003. We increased our aggregate borrowings under our credit
agreement by approximately $3.0 million in the first quarter of 2003.
Credit Facilities
Our credit agreement, as amended (Credit Agreement), provides for aggregate
borrowings of $108.6 million. The Credit Agreement includes (1) a $50.0 million
revolving credit facility (Credit Facility) (including letters of credit of up
to $20 million), (2) Term Loan A with remaining outstanding balance of $11.1
million at March 31, 2003 and no capacity to borrow additional funds under that
facility and (3) Term Loan B with an aggregate principal balance of $47.5
million at March 31, 2003 and no additional capacity to borrow additional funds
under that facility.
14
The Credit Facility matures December 30, 2005. Commitment fees on the
unused portion of the Credit Facility of 0.375% to 0.050% are payable quarterly
in arrears. At March 31, 2003, we had $16.4 million outstanding and $31.5
million in available borrowings under the Credit Facility (net of approximately
$2.1 million outstanding letters of credit). Our effective interest rate for our
borrowings under the Credit Agreement was 5.9% and 5.8%, for the quarters ended
March 31, 2003 and 2002, respectively.
Borrowings under the Credit Facility are available on a revolving basis and
may be used for general corporate purposes, excluding, however, loans, advances
and investments, including acquisitions, by us other than specified exceptions.
On December 20, 2002 we amended our Credit Agreement and we refinanced
$45.1 million of the $56.3 Term Loan A outstanding balance at that date with a
new six year, $47.5 million Term Loan B facility. The Term Loan B includes a
$2.4 million discount (representing a fee) which is being amortized through
interest expense over the life of the facility. The Term Loan B will mature
December 30, 2007. Scheduled principal repayment under the Term Loan B facility
for the years ending December 31, 2003 through 2006 will be $0.5 million per
year payable quarterly. The remaining balance under Term Loan B, will be repaid
in 2007. We have three scheduled quarterly payments in 2007 at the same rate of
$0.5 million per year and a final payment due for the balance outstanding at
December 30, 2007. There is no scheduled amortization for the $11.1 million
outstanding under the Term Loan A for the years ending December 31, 2003 and
2004. The remaining $11.1 million drawn under Term Loan A will be repaid in
2005.
Borrowings under the Credit Agreement bear interest at our option at a rate
per annum equal to either (1) the higher of (a) the current base rate as offered
by JPMorgan Chase or (b) 1/2 of 1% per annum above the federal funds rate plus,
in either case, an applicable margin or (2) a Eurodollar rate plus an applicable
margin. The applicable margin varies by facility. For amounts drawn under the
Term Loan A and the Credit Facility the Eurodollar margin is 3.75% and the base
rate margin is 2.75%. For amounts drawn under the Term Loan B facility, the
Eurodollar margin is 4.50% and the base rate margin is 3.50%. Amounts
outstanding under the Credit Facility, Term Loan A and Term Loan B bear
interest, payable quarterly in the case of base rate advances and payable at the
end of the relevant interest period of one, two, three or six months (or
quarterly in certain cases) for all Eurodollar advances. Our credit ratings do
not affect the interest rates for our borrowings under our Credit Agreement.
Our Singapore-based sales office has a facility providing for borrowings up
to approximately $1.2 million in U.S. dollars and is secured by a letter of
credit. Interest is payable at United States prime plus 1.0%. At March 31, 2003,
approximately $1.2 million was drawn on the facility.
At March 31, 2003, we had $16.4 million drawn under our Credit Facility,
and approximately $2.1 million of outstanding letters of credit. At March 31,
2003, we had approximately $31.5 million of borrowing availability under the
Credit Facility.
Our Credit Agreement obligates us to make mandatory prepayments in certain
circumstances with the proceeds of asset sales or issuance of capital stocks or
indebtedness and with certain excess cash flow. Our Credit Agreement contains
covenants that restrict our and our subsidiaries' ability to incur additional
indebtedness, incur liens, dispose of assets, prepay or amend other
indebtedness, pay dividends or purchase our stock, and change the business
conducted by us or our subsidiaries. In addition, we must also comply with
specified financial ratios and tests including maintenance of specified total
and senior debt coverage ratios, interest expense coverage ratios and other
covenants at the end of each fiscal quarter. At March 31, 2003, we are in
compliance with all financial and other covenants as prescribed by the Credit
Agreement.
Each of these covenants continues for the term of the Credit Agreement
either at the latest level, or a more restrictive level. A deterioration in our
current operating performance could result in our failure to satisfy our
financial covenants. A failure by us to satisfy the covenants under the Credit
Agreement would trigger the lenders' right to require immediate repayment of all
or part of the indebtedness; such acceleration, in turn, would also give rise to
a right to require immediate repayment by holders of our subordinated notes. The
Credit Facility, Term Loan A and Term Loan B are secured by a security interest
in substantially all of our subsidiaries' assets, including pledges of the
common stock of our subsidiaries. In addition, the Credit Facility,
15
Term Loan A and Term Loan B are guaranteed by our subsidiaries. Some of our
guarantees and pledges are in support of only offshore advances, if any, under
the Credit Facility.
Senior Subordinated Notes
On December 30, 1999, SSCI Investors LLC, an entity owned by an investor
group led by AEA Investors Inc., acquired approximately 75% of our outstanding
capital stock directly from the former majority stockholder with the balance
owned by other investors, including members of our current management team. SSCI
Investors LLC's acquisition of our common stock constituted a change of control
under the terms of the indenture relating to our 9 1/2% Senior Subordinated
Notes due 2007 and, as a result, we were required to make an offer to purchase
for cash any and all of the outstanding $125.0 million principal amount of
9 1/2% Senior Subordinated Notes for 101% of the principal amount thereof plus
accrued and unpaid interest to the date of repurchase. The repurchase was
completed on March 6, 2000 with the repurchase of the entire $125.0 million
principal amount of 9 1/2% Senior Subordinated Notes for an aggregate purchase
price of approximately $127.4 million which was financed with borrowings under
the Credit Agreement. On March 29, 2000 we completed an issuance of $150.0
million in aggregate principal amount of 11 7/8% Senior Subordinated Notes due
2010 in a private placement to qualified institutional investors in accordance
with Securities and Exchange Commission Rule 144A and outside of the United
States in accordance with Regulation S under the Securities Act of 1933. The
privately placed 11 7/8% Senior Subordinated Notes were subsequently exchanged
for notes with substantially identical terms that were registered with the
Securities and Exchange Commission. The cash proceeds from this private
placement of notes of approximately $143.8 million were used to repay amounts
drawn under our Credit Facilities for the repurchase of the 9 1/2% Senior
Subordinated Notes and for general corporate purposes.
At March 31, 2003 the aggregate principal amount of 11 7/8% Senior
Subordinated Notes was $149.3 million. The 11 7/8% Senior Subordinated Notes
mature on March 15, 2010. Interest is payable semi-annually in arrears each
March 15 and September 15. On or after March 15, 2005, we may redeem these
notes, at our option, in whole or in part, at specified redemption prices plus
accrued and unpaid interest. The redemption price is 105.938% in 2005 and
decreases in equal annual increments to 100.000% in 2008 and thereafter. In
addition, at any time on or prior to March 15, 2003, we may redeem, in the
aggregate, up to 35% of the original aggregate principal amount of 11 7/8%
Senior Subordinated Notes (calculated after giving effect to the issuance of
additional notes, if any) with the net cash proceeds of one or more public
equity offerings by us, at a redemption price in cash equal to 111.875% of the
principal amount, plus accrued and unpaid interest. In the event of a change in
control, we would be required to offer to repurchase the notes at a price equal
to 101.0% of the principal amount plus accrued and unpaid interest.
The 11 7/8% Senior Subordinated Notes are our general obligations,
subordinated in right of payment to all existing and future senior debt and are
guaranteed by our subsidiaries. The indenture under which the 11 7/8% Senior
Subordinated Notes were issued contains certain covenants that, among other
things, limit our ability to incur additional indebtedness, incur liens, dispose
of assets, prepay or amend other indebtedness, pay dividends or purchase our
stock, and engage in transactions with affiliates.
Liquidity and Capital Requirements
We have a management agreement with AEA Investors Inc. under which we
receive advisory and consulting services provided by AEA Investors LLC, the
successor company to AEA Investors Inc. and sometimes referred to in this report
collectively with its successor as AEA Investors. The management agreement
provides for an annual aggregate fee of $1.0 million plus reasonable
out-of-pocket costs and expenses.
Interest payments on the amounts drawn under the Credit Agreement, as well
as other indebtedness and obligations, represent significant obligations for us.
Our remaining liquidity demands relate to capital expenditures and working
capital needs. Our capital expenditures were approximately $6.6 million in 2002
and management currently anticipates capital expenditures will be approximately
$8.0 million in 2003 and approximately $8.5 million in 2004. While we engage in
ongoing evaluations of, and discussions with, third
16
parties regarding possible acquisitions, as of the date of this report, we have
no current expectations with respect to any acquisitions. Exclusive of the
impact of any future acquisitions, joint venture arrangements or similar
transactions, our management does not expect capital expenditure requirements to
increase materially in the foreseeable future.
The following summarizes certain of our contractual obligations at December
31, 2002 and the effect of such obligations are expected to have on our
liquidity and cash flow in future periods. During the ordinary course of
business, we enter into contracts to purchase raw materials and components for
manufacture. In general, these commitments do not extend for more than a few
months.
PAYMENTS DUE BY PERIOD
---------------------------------------------------
LESS THAN 1-3 4-5 AFTER
TOTAL 1 YEAR YEARS YEARS 5 YEARS
----- --------- ----- ----- -------
Long-term debt(1)........................ 224,042 2,041 25,926 46,075 150,000
Operating leases......................... 9,525 1,327 1,707 1,442 5,050
Capital leases(2)........................ 4,104 764 1,467 1,474 399
Total obligations........................ 237,666 4,132 29,100 48,991 155,444
- -------------------------
(1) Represent principal amounts, but not interest.
(2) Represents minimum future payments.
Our primary sources of liquidity are cash flows from operations and
borrowings under our Credit Agreement. Based on current and anticipated
financial performance, we expect that cash flow from operations and borrowings
under our Credit Agreement will be adequate to meet anticipated requirements for
capital expenditures, working capital and scheduled interest payments, including
interest payments on the amounts outstanding under the 11 7/8% Senior
Subordinated Notes, the Credit Agreement and other indebtedness through March
31, 2004. Our ability to satisfy capital requirements will be dependent upon our
future financial performance. Additionally our ability to repay or refinance our
debt obligations will also be subject to economic conditions and to financial,
business and other factors, many of which are beyond our control.
INFLATION
After declining through early 2002, the costs of certain of our raw
materials have increased. We expect costs to stabilize by mid 2003. To offset
these increases we raised our selling prices selectively. Historically, in
aggregate, price increases have been sufficient to recover new raw material cost
increases, but not to maintain margins.
FORWARD-LOOKING STATEMENTS
Some of the information presented in, or connection with, this report
include "forward-looking statements" based on our current expectations and
projections about future events and involve potential risks and uncertainties.
Our future results could differ materially from those discussed in this report.
Some of the factors that could cause or contribute to such differences include:
- changes in economic and market conditions that impact the demand for our
products and services;
- risks inherent in international operations, including possible economic,
political or monetary instability;
- uncertainties relating to our ability to consummate our business
strategy, including realizing synergies and cost savings from the
integration of acquired businesses or from plant closures.
- the impact of new technologies and the potential effect of delays in the
development or deployment of such technologies; and,
- changes in raw material costs and our ability to adjust selling prices.
You should not place undue reliance on these forward-looking statements,
which are applicable only as of May 5, 2003. All written and oral
forward-looking statements attributable to us are expressly qualified in their
17
entirety by the foregoing factors and those identified in Exhibit 99.1
incorporated by reference into this report. We undertake no obligation to revise
or update these forward-looking statements to reflect events or circumstances
that arise after May 5, 2003 or to reflect the occurrence of unanticipated
events. New risks emerge from time to time and it is not possible for us to
predict all such risks, nor can we assess the impact of all such risks on our
business or the extent to which any risks, or combination of risks, may cause
actual results to differ materially from those contained in any forward-looking
statement.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The principal market risks, which are potential losses in fair values, cash
flows or earnings due to adverse changes in market rates and prices, to which we
are exposed, as a result of our holdings of financial instrument and commodity
positions, are:
- interest rates on debt;
- foreign exchange rates; and
- commodity prices, which affect the cost of raw materials.
Our financial instruments include short-term debt and long-term debt. Trade
accounts payable and trade accounts receivable are not considered financial
instruments for purposes of this item because their carrying amount approximate
fair value. We do not maintain a trading portfolio and do not utilize derivative
financial instruments to manage our market risks. In the future, we may enter
into foreign exchange currency hedging agreements in connection with our
international operations.
MARKET RISK MANAGEMENT
We have measured our market risk related to our financial instruments based
on changes in interest rates and foreign currency rates utilizing a sensitivity
analysis. The sensitivity analysis measures the potential loss in fair values,
cash flows and earnings based on a hypothetical change (increase and decrease)
in interest rates and a decline in the U.K. pound/dollar exchange rate. We used
market rates as of March 31, 2003 on our financial instruments to perform the
sensitivity analysis. We believe that these potential changes in market rates
are reasonably possible in the near-term (one year or less). We have conducted
an analysis of the impact of a 100 basis point change in interest rates and a
10% decline in the U.K. pound/dollar exchange rate, discussed below.
INTEREST RATE EXPOSURE
Our primary interest rate exposure relates to our variable rate debt. We
utilize a combination of variable rate debt, primarily under our Credit
Agreement, and fixed rate debt, primarily under our 11 7/8% Senior Subordinated
Notes. Our Credit Agreement requires that, at least 45% of our funded
indebtedness be fixed-rate or subject to interest rate hedging agreements to
reduce the risk associated with variable-rate debt. At March 31, 2003
approximately 68% of our funded indebtedness was fixed-rate. The variable rate
debt is primarily exposed to changes in interest expense from changes in the
U.S. prime rate, the federal funds effective rate and the eurodollar borrowing
rate, while the fixed rate debt is primarily exposed to changes in fair value
from changes in medium term interest rates. Based on our indebtedness at March
31, 2003, we estimate that an immediate 100 basis point rise in interest rates
would result in $0.7 million increase in interest expense for the period April
1, 2003 to March 31, 2004. For purposes of this estimate, we have assumed a
constant level of variable rate debt and a constant interest rate over the
period equal to those existing on March 31, 2003.
CURRENCY RATE EXPOSURE
Our primary foreign currency exchange rate exposure relates to the U.K.
pound which results in our exposure to changes in the dollar exchange rate. Our
exposure to changes in U.S. dollar exchange rates with currencies other than the
U.K. pound are not currently material. Changes in translation risk are reported
as adjustments to stockholders' equity. We estimate that the impact of a 10%
decline in the dollar/U.K. pound
18
exchange rate from $1.58/L1.00 to $1.43/L1.00 at March 31, 2003 would result in
a decrease in our earnings before taxes of $0.3 million for the period from
April 1, 2003 to March 31, 2004.
COMMODITIES RISK
We are subject to market risk with respect to commodities because our
ability to recover increased raw materials costs through higher pricing may be
limited by the competitive environment in which we operate.
We use a broad variety of specialty and some commodity raw materials in our
manufacturing processes. In 2002, we purchased about $195 million of raw
materials including acrylic monomers and polymers, resins, natural and synthetic
rubbers, solvents, and urethanes. Although these raw materials are derived from
crude oil or natural gas, the raw materials are several manufacturing steps
removed (downstream) from these basic feedstocks. The price of oil and gas will
affect our costs for these raw materials both upward and downward, but the
magnitude of change is diluted.
We typically purchase strategic raw materials on a contract basis to
moderate price changes during the contract period, however, prices can change
significantly at the end of contract periods if supply shortages, feedstock cost
pressures, or other unforeseen market events occur. Commodity raw materials are
available from numerous independent suppliers, and specialty raw materials are
usually available from several suppliers.
We expect the cost of many raw materials to increase during 2003 and in the
long term. In aggregate, we have been successful historically in passing on raw
material cost increases through price increases to our customers over time under
certain competitive market conditions, but we may not be able to do so in the
future or we may not be able to do so as to maintain margins.
These sensitivity analyses are estimates and are based on certain
simplifying assumptions. These analyses should not be viewed as predictive of
our future financial performance. Additionally, we cannot give any assurance
that the actual impact in any particular year will not materially exceed the
amounts indicated above.
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures
Within 90 days prior to the date of this report, we carried out an
evaluation, under the supervision and with the participation of our management,
including our Chief Executive Officer and Chief Financial Officer, of the
effectiveness of the design and operation of our disclosure controls and
procedures. Based upon that evaluation, our Chief Executive Officer and Chief
Financial Officer concluded that our disclosure controls and procedures are
effective in timely alerting them to material information relating to us
(including our consolidated subsidiaries) required to be included in our
periodic SEC filings.
(b) Changes in Internal Controls
There were no significant changes in our internal controls or in other
factors that could significantly affect these controls subsequent to the date of
our Chief Executive Officer's and Chief Financial Officer's most recent
evaluation. There have been no corrective actions taken with regard to
significant deficiencies and material weaknesses subsequent to the date of our
Chief Executive Officer's and Chief Financial Officer's most recent evaluation.
19
PART II -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
99.1 -- Cautionary Statements for Regarding Forward Looking
Statements incorporated by reference to Exhibit 99.1 to
the Company's Form 10-K dated March 14, 2003.
(b) Reports on Form 8-K
On March 18, 2003, we filed a current report of Form 8-K disclosing that we
had issued a press release on March 14, 2003 to provide an update on our
operating results for the year ended December 31, 2002.
20
SOVEREIGN SPECIALTY CHEMICALS, INC.
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.
SOVEREIGN SPECIALTY CHEMICALS, INC.
/s/ NORMAN E. WELLS JR.
--------------------------------------
Norman E. Wells Jr., Chairman, Chief
Executive Officer
(Principal Executive Officer)
/s/ TERRY D. SMITH
--------------------------------------
Terry D. Smith, Vice President, Chief
Financial Officer
Date: May 5, 2003 (Principal Financial Officer)
21
CERTIFICATIONS AS REQUIRED BY SECTION 302(A)
OF THE SARBANES-OXLEY ACT OF 2002
I, Norman E. Wells Jr., certify that:
1. I have reviewed this quarterly report on Form 10-Q of Sovereign
Specialty Chemicals Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors:
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and
material weaknesses.
Date: May 5, 2003
/s/ NORMAN E. WELLS, JR.
- ---------------------------------------------------------
Norman E. Wells, Jr.
Chairman, Chief Executive Officer
I, Terry D. Smith, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Sovereign
Specialty Chemicals Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors:
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and
material weaknesses.
Date: May 5, 2003
/s/ TERRY D. SMITH
- ---------------------------------------------------------
Terry D. Smith
Vice President, Chief Financial Officer