================================================================================
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 September 30, 2003
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 333-39373
SOVEREIGN SPECIALTY CHEMICALS, INC.
(Exact Name of Registrant as Specified in Its Charter)
_______________
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) 223-7970
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 October 30, 2003, the registrant had 1,441,189 shares of voting common
stock outstanding and 730,182 shares of non-voting common stock outstanding.
================================================================================
1
SOVEREIGN SPECIALTY CHEMICALS, INC.
FORM 10-Q
TABLE OF CONTENTS
Page Number
-----------
PART I. Financial Information
Item 1. Financial Statements:
Consolidated Balance Sheets at September 30, 2003 (Unaudited)
and December 31, 2002............................................. 3
Consolidated Statements of Operations for the three and nine
months ended September 30, 2003 and 2002 (Unaudited).............. 4
Consolidated Statements of Cash Flows for the three and nine
months ended September 30, 2003 and 2002 (Unaudited).............. 5
Notes to Consolidated Financial Statements......................... 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations..................... 11
Item 3. Quantitative and Qualitative Disclosures about
Market Risk........................................................ 20
Item 4. Controls and Procedures.................................... 21
PART II. Other Information 22
Item 1. Legal Proceedings.......................................... 22
Item 2. Changes in Securities and Use of Proceeds.................. 22
Item 3. Defaults Upon Senior Securities............................ 22
Item 4. Submission of Matters to a Vote of Security
Holders............................................................ 22
Item 5. Other Information.......................................... 22
Item 6. Exhibits and Reports on Form 8-K........................... 22
Signatures......................................................... 23
2
SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in Thousands, Except Share Amounts)
September 30, December 31,
2003 2002
------------- ------------
(Unaudited)
Assets
Current assets:
Cash and cash equivalents....................................... $ 6,697 $ 14,124
Accounts receivable, net........................................ 60,928 49,554
Inventories..................................................... 31,179 28,203
Deferred income taxes........................................... 5,257 5,257
Other current assets............................................ 4,920 3,879
--------- ---------
Total current assets.............................................. 108,981 101,017
Property, plant, and equipment, net............................... 68,777 67,950
Goodwill, net..................................................... 124,388 124,388
Deferred financing costs, net..................................... 7,866 9,350
Deferred income taxes............................................. 3,699 5,872
Other assets...................................................... 193 91
--------- ---------
Total assets...................................................... $ 313,904 $ 308,668
========= =========
Liabilities and stockholders' equity
Current liabilities:
Accounts payable................................................ $ 37,869 $ 31,606
Accrued expenses................................................ 18,433 23,874
Other current liabilities....................................... 143 143
Current portion of long-term debt............................... 2,465 2,041
Current portion of capital lease obligations.................... 402 402
--------- ---------
Total current liabilities......................................... 59,312 58,066
Long-term debt, less current portion.............................. 219,401 218,853
Capital lease obligations, less current portion................... 2,338 2,496
Other long-term liabilities....................................... 3,314 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............................................... (32,539) (36,272)
Accumulated other comprehensive loss.............................. (2,017) (1,970)
--------- ---------
Total stockholders' equity........................................ 29,539 25,853
--------- ---------
Total liabilities and stockholders' equity........................ $ 313,904 $ 308,668
========= =========
See accompanying notes to consolidated financial statements.
3
SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in Thousands)
Three months ended Nine months ended
September 30, September 30,
2003 2002 2003 2002
------ ------ ------ ------
(Unaudited) (Unaudited)
Net sales............................................. $ 98,747 $ 95,023 $ 281,128 $ 276,717
Cost of goods sold.................................... 70,446 66,083 202,657 196,844
--------- --------- --------- ---------
Gross profit.......................................... 28,301 28,940 78,471 79,873
Selling, general and administrative expenses.......... 18,235 18,343 52,515 53,690
--------- --------- --------- ---------
Operating income...................................... 10,066 10,597 25,956 26,183
Interest expense, net................................. 6,306 6,296 19,111 19,308
--------- --------- --------- ---------
Income before income taxes and cumulative
effect of change in accounting principle............ 3,760 4,301 6,845 6,875
Income tax expense.................................... 1,494 1,742 3,112 2,926
--------- --------- --------- ---------
Income before cumulative effect of change
in accounting principle............................. 2,266 2,559 3,733 3,949
Cumulative effect of change in accounting
principle related to goodwill write-off, net
of income tax benefit............................... -- -- -- (17,063)
--------- --------- --------- ---------
Net income (loss)..................................... $ 2,266 $ 2,559 $ 3,733 $ (13,114)
See accompanying notes to consolidated financial statements
4
SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in Thousands)
Nine months ended
-----------------------------
September 30, September 30,
2003 2002
------ ------
(Unaudited) (Unaudited)
Operating Activities
Net income (loss).............................................. $ 3,733 $ (13,114)
Adjustments to reconcile net income (loss) to net cash provided
by (used in) operating activities:
Depreciation and amortization................................ 6,642 7,096
Amortization of deferred financing costs..................... 1,518 1,364
Amortization of debt discounts............................... 442 42
Cumulative effect of change in accounting principle, net
of income tax benefit..................................... --- 17,063
Foreign exchange losses...................................... (1,036) (798)
Deferred income taxes........................................ 2,214 2,211
Changes in operating assets and liabilities:
Accounts receivable....................................... (10,878) (1,632)
Inventories............................................... (2,692) 3,244
Prepaid expenses and other assets......................... (1,149) 651
Accounts payable and other liabilities.................... 116 1,024
-------- --------
Net cash provided by (used in) operating activities............ (1,090) 17,152
Investing Activities
Purchase of property, plant and equipment...................... (6,789) (4,388)
-------- --------
Net cash used in investing activities.......................... (6,789) (4,388)
Financing Activities
Payments on long-term debt..................................... (1,158) (450)
Payments for deferred financing costs.......................... (34) (726)
Payments on capital lease obligations.......................... (160) (199)
Payments for stock repurchase.................................. --- (5)
Proceeds from revolving credit facilities...................... 25,000 7,141
Payments on revolving credit facilities........................ (23,307) (25,950)
-------- --------
Net cash provided by (used in) financing activities............ 341 (20,189)
Effect of exchange rate changes on cash........................ 111 (249)
-------- --------
Net decrease in cash and cash equivalents...................... (7,427) (7,674)
Cash and cash equivalents at beginning of period............... 14,124 15,584
-------- --------
Cash and cash equivalents at end of period..................... $ 6,697 $ 7,910
======== ========
See accompanying notes to consolidated financial statements.
5
SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 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
September 30, 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. At the time of the announcement, the
Cincinnati, Ohio plant employed 118 people, and primarily produced water-borne
adhesives sold to the industrial market. Substantially all production from this
plant has been 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 have been transitioned to other Company locations.
Approximately 88 employees, in both manufacturing and support functions will be
terminated as part of the closure. At September 30, 2003, 70 employees have been
terminated under the announced plan.
At the time of the November 2002 announcement, the Kapellen, Belgium plant
employed 24 people and produced water-borne and hot-melt adhesives for the
European packaging and converting market. This production has been shifted to
the Newark, United Kingdom plant during the first nine months of 2003.
Approximately 14 employees primarily in manufacturing functions have been
terminated as part of the plant closure. A separate Kapellen office will
continue to provide sales, technical and distribution support to continental
Europe.
6
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. As a result of the announced
closures the Company recorded a charge of approximately $4.1 million in the
fourth quarter of 2002 and an additional charge of $0.4 million in the first
half of 2003, included in selling, general and administrative expense, relative
to the following costs: termination benefits of $2.0 million, loss on fixed
assets of $1.3 million and other exit costs of $1.2 million. Approximately $1.2
million of the termination benefits and $0.9 million of the other exit costs
will be incurred over the next several quarters and are recorded in accrued and
other long term liabilities on the balance sheet. The loss on fixed assets of
$1.3 million is recorded in other long term liabilities.
The following provides an analysis of the changes in the plant closure
liability for the nine months ended September 30, 2003:
Liability for plant closures, balance at January 1, 2003..................... $ 4,066
Add: Adjustment to severance liability for Kapellan 393
Less: Plant closure costs incurred nine months ended September 30, 2003...... (1,008)
---------
Total liability for plant closures, balance at September 30, 2003........... $ 3,451
=========
3. Inventories
Inventories are summarized as follows:
September 30, December 31,
2003 2002
------------- ------------
Raw materials..... $ 11,913 $ 8,920
Work in process... 601 440
Finished goods.... 18,665 18,843
$ 31,179 $ 28,203
4. Comprehensive Loss
For the three and nine months ended September 30, 2003 and 2002,
respectively, the calculation of comprehensive loss is as follows:
September 30, 2003 September 30, 2002
--------------------------- ------------ ------------
Three Months Nine Months Three Months Nine Months
Ended Ended Ended Ended
------------ ----------- ------------ ------------
Net income (loss) as reported................... $ 2,266 $ 3,733 $ 2,559 $ (13,114)
Foreign currency translation adjustments........ (17) (47) (590) (867)
Comprehensive income (loss)..................... $ 2,249 $ 3,686 $ 1,969 $ (13,981)
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
profits to the extent of unallocated corporate expenses included in selling,
general and administrative expenses. Unallocated corporate expenses were $2.2
million and $6.8 million for the three and nine months ended September 30, 2003,
respectively; and $2.8 million and $8.3 million for the three and nine months
ended September 30, 2002.
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:
7
Commercial Construction Totals
---------- ------------ -----------
For the three months ended September 30, 2003:
Revenues from external customers............. $ 60,009 $ 38,738 $ 98,747
Segment profit............................... 6,132 6,111 12,243
For the three months ended September 30, 2002:
Revenues from external customers............. $ 61,909 $ 33,114 $ 95,023
Segment profit............................... 7,965 5,465 13,430
For the nine months ended September 30, 2003:
Revenues from external customers............. $ 177,062 $ 104,066 $ 281,128
Segment profit............................... 17,508 15,209 32,717
For the nine months ended September 30, 2002:
Revenues from external customers............. $ 184,952 $ 91,765 $ 276,717
Segment profit............................... 20,273 14,226 34,499
A reconciliation of the reportable segments to consolidated operating
income is as follows:
For the For the
three months ended nine months ended
September 30, September 30,
----------------- -------------------
2003 2002 2003 2002
------ ------ ------ ------
Profit:
Total profit for reportable segments... $ 12,243 $ 13,430 $ 32,717 $ 34,499
Unallocated corporate expense.......... (2,177) (2,833) (6,761) (8,316)
-------- -------- -------- --------
Income from operations............ $ 10,066 $ 10,597 $ 25,956 $ 26,183
======== ======== ======== ========
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 annually 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 September 30, 2003 and 2002,
respectively of the Guarantor Subsidiaries and the non-guarantor subsidiaries
are below.
8
The following sets forth the unaudited financial data at September 30, 2003 and
for the three and nine months then ended.
Guarantor Non-Guarantor
Subsidiaries Subsidiaries Parent Eliminations Total
(Unaudited) (Unaudited) (Unaudited) (Unaudited) (Unaudited)
------------ ------------- ----------- ------------ ------------
Statement of operations data for
the nine months ended September 30, 2003:
Net sales....................... $ 246,266 $34,862 $ -- $ -- $ 281,128
Cost of goods sold.............. 176,601 26,056 -- -- 202,657
--------- --------- --------- --------- ---------
Gross profit.................... 69,665 8,806 -- -- 78,471
Selling, general and administrative
expense....................... 38,494 7,260 6,761 -- 52,515
--------- --------- --------- --------- ---------
Operating income (loss)......... 31,171 1,546 (6,761) -- 25,956
Interest expense................ 15,967 591 2,553 -- 19,111
--------- --------- --------- --------- ---------
Income (loss) before income taxes $ 15,204 $ 955 $ (9,314) $ -- $ 6,845
========= ========= ========= ========= =========
Statement of operations data for
the three months ended September 30, 2003:
Net sales....................... $ 87,354 $11,393 $ -- $ -- $ 98,747
Cost of goods sold.............. 61,873 8,573 -- -- 70,446
--------- --------- --------- --------- ---------
Gross profit.................... 25,481 2,820 -- -- 28,301
Selling, general and administrative
expense....................... 13,598 2,460 2,177 -- 18,235
--------- --------- --------- --------- ---------
Operating income (loss)......... 11,883 360 (2,177) -- 10,066
Interest expense................ 4,938 487 881 -- 6,306
--------- --------- --------- --------- ---------
Income (loss) before income taxes $ 6,945 $ (127) $ (3,058) $ -- $ 3,760
========= ========= ========= ========= =========
Balance sheet data:
Current assets.................. $ 86,975 $22,037 $ 20,633 $ (20,664) $ 108,981
Property plant and equipment, net 55,334 12,393 1,050 -- 68,777
Goodwill, net................... 121,353 3,035 -- -- 124,388
Deferred financing costs, net... 6,059 -- 1,807 -- 7,866
Deferred tax assets ............ 5,307 863 (2,471) -- 3,699
Other assets.................... 10,853 28 282,633 (293,321) 193
--------- --------- --------- --------- ---------
Total assets.................... $ 285,881 $38,356 $ 303,652 $(313,985) $ 313,904
========= ========= ========= ========= =========
Liabilities and stockholders' equity:
Current liabilities............. $ 60,690 $16,605 $ 2,681 $ (20,664) $ 59,312
Long-term liabilities........... 210,370 18,124 219,432 (222,873) 225,053
Total stockholders' equity...... 14,821 3,627 81,539 (70,448) 29,539
--------- --------- --------- --------- ---------
Total liabilities and stockholders'
equity........................ $ 285,881 $38,356 $ 303,652 $(313,985) $ 313,904
========= ========= ========= ========= =========
Guarantor Non-Guarantor
Subsidiaries Subsidiaries Parent Eliminations Total
(Unaudited) (Unaudited) (Unaudited) (Unaudited) (Unaudited)
------------ ------------- ------------ ------------ -----------
Statement of cash flows data for
the nine months ended September 30, 2003:
Operating activities:
Net income (loss)................ $ 9,505 $ (132) $ (5,640) $ -- $ 3,733
Depreciation and amortization.... 5,456 986 200 -- 6,642
Foreign exchange (gains) losses.. (62) (974) -- -- (1,036)
Deferred income taxes............ -- -- 2,214 2,214
Amortization of deferred financing
costs.......................... 1,112 -- 406 -- 1,518
Amortization of bond discount.... -- -- 442 -- 442
Changes in operating assets and
liabilities.................... (4,302) (2,169) (8,132) -- (14,603)
--------- --------- --------- --------- ---------
Net cash provided by (used in)
operating activities........... 11,709 (2,289) (10,510) -- (1,090)
Investing activities:
Sale of property, plant and
equipment....................... -- -- -- --
Purchase of property, plant and
equipment, net ................ (5,782) (513) (494) -- (6,789)
--------- --------- --------- --------- ---------
Net cash used in investing
activities..................... (5,782) (513) (494) -- (6,789)
Financing activities:
Intercompany financing .......... (12,681) 2,289 10,392 -- --
Payments on long-term debt....... (300) (503) (355) -- (1,158)
Payments for deferred financing
costs.......................... -- -- (34) -- (34)
Payments on capital lease
obligations.................... (203) 43 -- -- (160)
Net proceeds on revolving credit
facilities..................... -- 692 1,001 -- 1,693
--------- --------- --------- --------- ---------
Net cash provided by (used in) financing
activities..................... (13,184) 2,521 11,004 -- 341
Effect of foreign currency changes on
cash........................... (15) 126 -- -- 111
--------- --------- --------- --------- ---------
Net increase (decrease)
in cash ....................... (7,272) (155) -- -- (7,427)
Cash and cash equivalents, beginning
of period...................... 11,378 2,746 -- -- 14,124
--------- --------- --------- --------- ---------
Cash and cash equivalents, end of period $ 4,106 $ 2,591 $ -- $ -- $ 6,697
========= ========= ========= ========= =========
9
The following sets forth the unaudited financial data at September 30, 2002
and for the three and nine months then ended.
Guarantor Non-Guarantor
Subsidiaries Subsidiaries Parent Eliminations Total
(Unaudited) (Unaudited) (Unaudited) (Unaudited) (Unaudited)
------------ ------------- ----------- ------------- ----------
Statement of operations data for
the nine months ended September 30, 2002:
Net sales....................... $ 242,437 $34,280 $ -- $ -- $ 276,717
Cost of goods sold.............. 172,270 24,574 -- -- 196,844
--------- --------- --------- --------- ---------
Gross profit.................... 70,167 9,706 -- -- 79,873
Selling, general and administrative
Expense....................... 37,806 7,627 8,257 -- 53,690
--------- --------- --------- --------- ---------
Operating income (loss)......... 32,361 2,079 (8,257) -- 26,183
Interest expense................ 17,426 810 1,272 -- 19,308
--------- --------- --------- --------- ---------
Income (loss) before income taxes $ 14,935 $ 1,469 $ (9,529) $ -- $ 6,875
========= ========= ========= ========== =========
Statement of operations data for
the three months ended September 30, 2002:
Net sales....................... $ 83,395 $11,628 $ -- $ -- $ 95,023
Cost of goods sold.............. 57,627 8,256 -- -- 66,083
--------- --------- --------- --------- ---------
Gross profit.................... 25,568 3,372 -- -- 28,940
Selling, general and administrative
Expense....................... 12,788 2,753 2,802 -- 18,343
--------- --------- --------- --------- ---------
Operating income (loss)......... 12,780 619 (2,802) -- 10,597
Interest expense................ 5,854 192 450 -- 6,296
--------- --------- --------- --------- ---------
Income (loss) before income taxes $ 7,126 $ 427 $ (3,252) $ -- $ 4,301
========= ========= ========= ========== =========
Balance sheet data:
Current assets.................. $ 81,287 $20,369 $ 8,684 $ (965) $ 109,375
Property plant and equipment, net 65,617 11,434 631 -- 67,682
Goodwill, net................... 121,354 3,035 -- -- 124,389
Deferred financing costs, net... 7,470 -- 836 -- 8,306
Other assets.................... 4,875 904 268,692 (266,692) 5,779
--------- --------- --------- --------- ---------
Total assets.................... $ 270,603 $35,742 $ 278,843 $ (269,657) $ 315,531
========= ========= ========= ========== =========
Liabilities and stockholders' equity:
Current liabilities............. $ 56,875 $12,034 $ 17,520 $ (17,988) $ 68,441
Long-term liabilities........... 198,301 18,719 200,674 (200,674) 217,020
Total stockholders' equity...... 15,427 4,989 60,649 (50,995) 30,070
--------- --------- --------- --------- ---------
Total liabilities and stockholders'
Equity........................ $ 270,603 $35,742 $ 278,843 $(269,657) $ 315,531
========= ========= ========= ========== =========
Guarantor Non-Guarantor
Subsidiaries Subsidiaries Parent Eliminations Total
(Unaudited) (Unaudited) (Unaudited) (Unaudited) (Unaudited)
------------ ------------- ----------- ------------- ----------
Statement of cash flows data for
the nine months ended September 30, 2002:
Operating activities:
Net loss......................... $ (7,144) $ (256) $ (5,713) $ -- $(13,113)
Depreciation and amortization.... 5,976 892 228 -- 7,096
Foreign exchange (gains) losses.. -- (798) -- -- (798)
Deferred income taxes............ 2,211 2,211
Cumulative effect of change in
accounting principle........... 15,668 1,395 17,063
Amortization of deferred financing
Costs.......................... 965 -- 399 -- 1,364
Amortization of bond discount.... 42 -- -- -- 42
Changes in operating assets and
liabilities.................... (19,152) 1,368 24,558 (3,487) 3,287
--------- --------- --------- --------- ---------
Net cash provided by (used in)
operating activities........... (1,434) 2,601 19,472 (3,487) 17,152
Investing activities:
Purchase of property, plant and
equipment...................... (3,626) (762) -- -- (4,388)
--------- --------- --------- --------- ---------
Net cash used in investing
activities..................... (3,626) (762) 4,388)
Financing activities:
Payments on long-term debt....... (200) (250) -- -- (450)
Payments for deferred financing
Costs.......................... -- -- (726) -- (726)
Payments on capital lease
obligations.................... (199) -- -- -- (199)
Net payments on revolving credit -- (68) (18,746) -- (18,814)
facilities.....................
--------- --------- --------- --------- ---------
Net cash provided by (used in) financing (399) (318) (19,472) -- (20,189)
activities.....................
Effect of foreign currency changes on
Cash........................... -- (249) -- -- (249)
--------- --------- --------- --------- ---------
Net increase (decrease) in cash and cash
equivalents.................... (5,459) 1,272 -- (3,487) (7,674)
Cash and cash equivalents, beginning
of period...................... 10,955 1,142 -- 3,487 15,584
--------- --------- --------- --------- ---------
Cash and cash equivalents, end of
period......................... $ 5,496 $ 2,414 $ -- $ -- $ 7,910
========= ========= ========= ========= =========
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, consolidate and operate 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.
11
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, we 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 write downs. 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.
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 $2.2 million and $6.8 million for
the three and nine months ended September 30, 2003, respectively; and $2.8
million and $8.3 million for the three and nine months ended September 30, 2002.
Results of Operations
Three months ended September 30, 2003 compared to three months ended
September 30, 2002
Net Sales. Net sales were $98.7 million and $95.0 million for the three
months ended September 30, 2003 and 2002, respectively. The third quarter 2003
net sales level represents an increase of $3.7 million or 3.8% from the prior
year. This increase resulted from gains in the Construction segment that were
partially offset by a decrease in net sales in the Commercial segment.
Construction segment sales were $38.7 million in the third quarter of 2003, up
$5.6 million, or 17% 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 $60.0 million in the third quarter of 2003, down $1.9 million, or 3.1% from
the prior year due to declines in a number of end markets including
transportation, industrial specialties, and flexible packaging.
12
Cost of Goods Sold. Cost of goods sold was $70.4 million for the three
months ended September 30, 2003, an increase of $4.4 million, or 6.2% over third
quarter 2002 cost of sales of $66.1 million. Gross profit for the three months
ended September 30, 2003 was $28.3 million, a decrease of $0.6 million from the
third quarter of 2002 gross profit of $28.9 million. Gross profit as a
percentage of net sales decreased in the third quarter of 2003 to 28.7% from
30.5% in the third quarter of 2002. This reduction in gross profit percentage is
related to increases in many raw material costs year over year. We continue to
try to keep margins relatively stable despite raw material cost increases,
through raw material substitutions where possible and through selling price
increases where necessary. We also have partially offset the negative impact of
raw material cost increases through reductions in manufacturing costs year over
year. The manufacturing cost reductions have been attained through the
implementation of lean manufacturing initiatives at many of our facilities.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses were $18.2 million for the three months ended September
30, 2003, a decrease of $0.1 million, or 0.6% from the third quarter 2002
expenses of $18.3 million. As a percentage of net sales, selling, general and
administrative expenses decreased to 18.5% for the third quarter of 2003 from
19.3% in the third quarter of 2002. This decrease is reflective of a management
focus on internal cost containment as well as an effort to reduce professional
fees and corporate overhead costs.
Operating Income. Operating income was $10.1 million and $10.6 million for
the three months ended September 30, 2003 and 2002, respectively. Operating
income as a percentage of net sales was 10.2% and 11.2% for the three months
ended September 30, 2003 and 2002, respectively. The decline in operating income
is due primarily to increased raw material costs partially offset by reductions
in manufacturing and selling, general and administrative costs as described
above.
Interest Expense. Net interest expense was $6.3 million for the three
months ended September 30, 2003 and 2002, respectively. The impact of a decrease
in our average outstanding level of variable rate debt quarter over quarter was
offset 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. 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
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.
Income tax expense (benefit). Income tax expense was $1.5 million for the
three months ended September 30, 2003. Income tax expense was $1.7 million for
the same period in 2002.
Net income (loss). Net income for the quarters ended September 30, 2003 and
2002 was $2.3 million and $2.6 million, respectively. The decrease in net income
from the prior year is due to items discussed above.
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
Quarter Ended
September 30
----------------------
Dollar Percentage
2003 2002 Change Change
-------- -------- --------- ----------
Net sales..................................... $ 60.0 $ 61.9 $ (1.9) (3.1)%
======= =======
Segment profit................................ $ 6.1 $ 8.0 $ (1.9) (23.0)%
======= =======
Segment profit margin......................... 10.2% 12.9% (20.6)%
======= =======
13
Net sales were $60.0 million for the three months ended September 30, 2003,
representing a $1.9 million decrease from third quarter 2002. This decrease was
due primarily to declines in a number of end markets primarily transportation,
industrial specialties, graphic arts, particularly high-end printing
applications. Domestic net sales were $48.6 million and $50.3 million for the
three months ended September 30, 2003 and 2002, respectively. The decrease in
domestic net sales for the segment was $1.7 million with international sales
declining by $0.2 million. Segment profit was $6.1 million for the third
quarter, 2003 representing a $1.8 million and 23.0% decrease from the third
quarter 2002. This was reflective of decreased net sales and raw material cost
increases, partially offset through selling price increases and raw material
substitution. Manufacturing costs have decreased year over year and as a
percentage of net sales. This is due to cost inefficiencies in the quarter
related to the transfer of production from two facilities described below and
the implementation of lean manufacturing initiatives. We expect that
manufacturing costs will significantly decrease year over year as a result of
the transfer of production from these facilities.
In November 2002, we announced the closure of two of our higher-cost
manufacturing plants in 2003. At the time of the announcement, the Cincinnati,
Ohio plant employed 118 people, and primarily produced water-borne adhesives
sold to the industrial market. Substantially all production from this plant has
been transferred to the our 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 have been transitioned to other of our locations. Approximately 88
employees, in both manufacturing and support functions will be terminated as
part of the closure. At September 30, 2003, 70 employees have been terminated
under the announced plan.
At the time of the November 2002 announcement, the Kapellen, Belgium plant
employed 24 people and produced water-borne and hot-melt adhesives for the
European packaging and converting market. This production has been shifted to
the Newark, United Kingdom plant during the first nine months of 2003.
Approximately 14 employees primarily in manufacturing functions have been
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 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. As a result of the announced
closures, we recorded a charge of approximately $4.1 million in the fourth
quarter of 2002 and an additional charge of $0.4 million in the first half of
2003, included in selling, general and administrative expense, relative to the
following costs: termination benefits of $2.0 million, loss on fixed assets of
$1.3 million and other exit costs of $1.2 million. Approximately $1.2 million of
the termination benefits and $0.9 million of the other exit costs will be
incurred over the next several quarters and are recorded in accrued and other
long term liabilities on the balance sheet. The loss on fixed assets of $1.3
million is recorded in other long term liabilities.
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
Quarter Ended
September 30,
----------------------
Dollar Percentage
2003 2002 Change Change
-------- -------- --------- ----------
Net sales..................................... $ 38.7 $ 33.1 $ 5.6 17.0%
======= ======
Segment profit................................ $ 6.1 $ 5.4 $ 0.7 11.8%
======= ======
Segment profit margin......................... 15.8% 16.3% (4.4)%
======= ======
Net sales for the Construction segment were $38.7 million for the quarter
ended September 30, 2003, representing a $5.6 million or 17% increase as
compared to the third quarter 2002. This 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 was $6.1 million and $5.4 million for
the three months ended September 30, 2003 and 2002, respectively. The increase
in segment profit was primarily due to increased sales for the segment.
Manufacturing costs decreased in the current quarter, but this was more than
offset by increased raw material costs. Selling, general and administrative
expenses increased primarily as a result of increased marketing and selling
expenses.
14
Nine months ended September 30, 2003 compared to nine months ended
September 30, 2002
Net Sales. Net sales were $281.1 million and $276.7 million for the nine
months ended September 30, 2003 and 2002, respectively. The net sales level
represents an increase of $4.4 million or 1.6% over the prior year's comparable
period. The increase resulted from gains in the Construction segment, largely
offset by decreases in net sales in the Commercial segment. Construction segment
sales were $104.1 million in the first nine months of 2003, up $12.3 million, or
13.4% from the prior year reflecting sales increases in building material
applications as a result of continued strength in the housing market and
increased sales to the retail do-it-yourself market. Commercial segment sales
were $177.1 million in the first nine months of 2003, down $7.9 million, or 4.3%
from the prior year as a result of declines in a number of end markets primarily
industrial specialties, paper converting and graphic arts, particularly high-end
printing applications.
Cost of Goods Sold. Cost of goods sold was $202.7 million and $196.8 for
the nine months ended September 30, 2003 and 2002, respectively. This represents
an increase of $5.8 million, or 2.9% over the comparable period. Gross profit as
a percentage of net sales decreased to 27.9% from 28.9% for the nine months
ended September 30, 2003 and 2002, respectively. This reduction in gross profit
percentage is related to increased raw material costs year over year. We
continue to try to keep margins relatively stable despite raw material cost
increases through raw material substitutions and selling price increases where
possible. We have partially offset the negative impact of raw material cost
increases through reductions in manufacturing costs as a percent of net sales
year over year. This is as a result of the implementation of lean manufacturing
initiatives at many of our facilities.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses were $52.5 million and $53.7 million for the nine months
ended September 30, 2003 and 2002, respectively. This represents a decrease of
$1.2 million, or 2.2% from the comparable period. As a percentage of net sales,
selling, general and administrative expenses decreased to 18.7% for the third
quarter of 2003 from 19.4% in the third quarter of 2002. This decrease is
reflective of a management focus on internal cost containment as well as an
effort to reduce professional fees and corporate overhead costs. Included in the
selling, general and administrative costs for the nine months ended September
30, 2003 are $0.4 million of additional severance related costs related to the
Kapellan plant closure. Included in the selling, general and administrative
costs for the nine months ended September 30, 2002 are $0.5 million of
professional fees incurred related to financing alternatives and $0.4 million of
costs associated with the hiring of a senior executive.
Operating Income. Operating income was $26.0 million and $26.2 million for
the nine months ended September 30, 2003 and 2002, respectively. This represents
an increase of $0.2 million or 0.9% over the comparable period. Operating income
as a percentage of net sales was 9.2% and 9.5% for the nine months ended
September 30, 2003 and 2002, respectively.
Interest Expense. Net interest expense was $19.1 million and $19.3 million
for the nine months ended September 30, 2003 and 2002, respectively. The 1.0%
decrease in interest expense was due primarily to a decrease in our average
outstanding level of variable rate debt year over year offset largely by
increased non-cash interest expense due to additional amortization of deferred
financing cost and debt discounts and an increase in the weighted average
interest rate on our variable rate debt to 6.0% from 5.8% in the first nine
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 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 $3.1 million and $2.9
million for the nine months ended September 30, 2003 and 2002, respectively.
Net income before cumulative effect of change in accounting principle. Net
income before the cumulative effect of change in accounting principle for the
nine months ended September 30, 2003 and 2002 was $3.7 million and $3.9 million,
respectively.
Cumulative effect of change in accounting principle. In connection with
Company's completion of the transitional goodwill impairment test required by
SFAS No. 142 at January 1, 2002, we recorded a $27.6 million ($17.1 million, net
of income tax benefit) goodwill impairment loss and write-down of goodwill
associated with our European reporting unit. Our assessment of our goodwill
impairment 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.
15
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
Nine Months Ended
September 30,
-------------------
Dollar Percentage
2003 2002 Change Change
------- -------- ------- ----------
Net sales............................. $ 177.1 $ 184.9 $(7.8) (4.3)%
======= =======
Segment profit........................ $ 17.5 $ 20.3 $(2.8) (13.6)%
======= =======
Segment profit margin................. 9.9% 11.0% (9.8)%
======= =======
Net sales were $177.1 million and $184.9 million for the nine months ended
September 30, 2003 and 2002, respectively. This represents a $7.8 million
decrease from the comparable period. This decrease was primarily a result of
declines in a number of end markets primarily paper converting and graphic arts,
particularly high-end printing applications. Domestic net sales were $142.2
million and $150.7 million for the nine months ended September 30, 2003 and
2002, respectively. The decrease in domestic net sales for the segment of $8.5
million was offset somewhat by international sales increases of $0.6 million
year over year. Segment profit was $17.5 million and $20.3 million for the nine
months ended September 30, 2003 and 2002, respectively. This was reflective of
decreased net sales, raw material cost increases, partially offset through
selling price increases and raw material substitution. Manufacturing costs have
decreased year over year and as a percentage of net sales. We expect that
manufacturing costs will significantly decrease as a percentage of net sales
going forward based on the transfer of production from the closed facilities and
implementation of lean manufacturing initiatives. Declines in gross profit were
partially offset by decreases in selling, general and administrative expenses.
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
Nine Months Ended
September 30,
-------------------
Dollar Percentage
2003 2002 Change Change
------ ------- ------- ----------
Net sales..................................... $ 104.1 $ 91.8 $ 12.3 13.4%
======= ======
Segment profit................................ $ 15.2 $ 14.2 $ 1.0 6.9 %
======= ======
Segment profit margin......................... 14.6% 15.5% (5.7)%
======= ======
Net sales for the Construction segment were $104.1 million and $91.8 million for
the nine months ended September 30, 2003 and 2002, respectively. The $12.3
million and 13.4% increase in sales in 2003 was primarily a result of the
sustained strength of its building materials end markets and strength at major
retail accounts. Segment profit increased by $1.0 million or 6.9% as a result of
higher sales volume offset largely by decreased gross profit margin due to raw
material costs increases for which we have not been able to recover through
increased selling prices. Manufacturing costs decreased as a percentage of net
sales for the nine months ended September 30, 2003, but this was more than
offset by the raw material margin compression. Selling, general and
administrative expenses remained constant year over year as a percent of sales
but increased in dollars primarily as a result of increased marketing and
selling expenses.
16
Liquidity and Capital Resources
Net cash used in operating activities for the nine months ended September
30, 2003 was $1.1 million. Net income, adjusted for non-cash charges, such as
depreciation and amortization, amortization of deferred financing costs,
deferred income taxes, and foreign currency gains/losses, accounted for
approximately $13.5 million and $13.9 million of positive cash flow for the nine
months ended September 30, 2003 and 2002, respectively. Cash flow provided from
operations decreased as we increased inventory levels by $2.7 million and
accounts receivable balances by $10.9 from December 31, 2002 levels. While
accounts receivable and inventory balances at September 30, 2003 ($60.9 million
and $31.2 million, respectively) are greater than at December 31, 2002, they
compare more favorably to the levels at September 30, 2002 ($57.5 million and
$34.6 million, respectively). We have maintained consistent days receivables and
have been able to reduce inventory levels from the same period in the prior
year.
Net cash used in investing activities was $6.7 million and $4.4 million in
the nine months ended September 30, 2003 and 2002, respectively, and resulted
from additions to property, plant and equipment.
Net cash provided by financing activities was $0.3 million for the nine
months ended September 30, 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 September 30, 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 September 30, 2003 and no additional capacity to borrow additional
funds under that facility.
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 September 30, 2003, we had $14.4 million outstanding and $33.6
million in available borrowings under the Credit Facility (net of approximately
$2.0 million outstanding letters of credit). Our effective interest rate for our
borrowings under the Credit Agreement was 5.9% and 5.8%, for the nine months
ended September 30, 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 the Company 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 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.
17
Our Singapore-based sales office has a facility providing for borrowings up
to approximately $1.4 million in U.S. dollars and is secured by a letter of
credit. Interest is payable at United States prime plus 1.0%. At September 30,
2003, approximately $1.4 million was drawn on the facility.
At September 30, 2003, we had $14.4 million drawn under our Credit
Facility, and approximately $2.0 million of outstanding letters of credit. At
September 30, 2003, we had approximately $33.6 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 maximum total debt
to EBITDA, maximum senior debt to EBITDA, minimum EBITDA to interest expense,
and minimum asset coverage ratios (in each case, as defined in our credit
agreement) and other covenants at the end of each fiscal quarter. The covenant
ratio calculations in our credit agreement utilize non GAAP financial measures
that are specifically defined in the Credit Agreement. At September 30, 2003, we
were 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. 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, 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 September 30, 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 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 certain of 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.
18
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 $8.0 million in 2004. While we engage in
ongoing evaluations of, and discussions with, third 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, expressed in thousands of dollars, 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
September 30, 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 that raw material costs have largely
stabilized in the short term by mid 2003. In an attempt to offset these
increases we raised selling prices selectively and executed raw material
substitutions where possible. Historically, in aggregate, price increases have
been sufficient to recover new raw material cost increases, but not to maintain
margins. There can be no assurance as to our ability to recover additional cost
increases through price increases in the future.
19
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:
o changes in economic and market conditions that impact the demand for our
products and services;
o risks inherent in international operations, including possible economic,
political or monetary instability;
o 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.
o the impact of new technologies and the potential effect of delays in the
development or deployment of such technologies; and,
o 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 October 30, 2003. All written and oral
forward-looking statements attributable to us are expressly qualified in their
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 October 30, 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:
o interest rates on debt;
o foreign exchange rates; and
o 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 September 30, 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 September 30, 2003
approximately 69% 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
September 30, 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 October 1, 2003 to September 30, 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 levels existing on September 30, 2003.
20
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 exchange rate from $1.65/(pound)1.00 to
$1.48/(pound)1.00 at September 30, 2003 would result in a decrease in our
earnings before taxes of $0.8 million for the period from October 1, 2003 to
September 30, 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. As a result, 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 conditions arise. 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 over the long term. In
aggregate, we have had some success historically in passing on raw material cost
increases through price increases to our customers over time under certain
competitive market conditions, although not always in levels adequate to
maintain margins.; we may not have success in the future.
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 provide any assurance
that the actual impact in any particular year will not materially exceed the
amounts indicated above.
Item 4. Controls and Procedures
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 as of the end of the period covered by this
report. 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.
There were no changes in our internal controls over financial reporting
that occurred during the most recent fiscal quarter that have materially
affected, or are reasonably likely to materially affect our internal control
over financial reporting.
21
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
31.1 -- Certifications as required by Section 302(a) of the
Sarbanes-Oxley Act of 2002
31.2 -- Certifications as required by Section 302(a) of the
Sarbanes-Oxley Act of 2002
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 July 31, 2003, we filed a current report of Form 8-K, Item 12.
Disclosure of Results of Operations and Financial Condition, disclosing that we
had issued a press release on July 31, 2003 to provide an update on our
operating results for the quarter ended June 30, 2003.
22
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
(Principal Financial Officer)
Date: October 30, 2003
23