<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE QUARTERLY PERIOD ENDING JUNE 28, 1998.
or
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE TRANSITION PERIOD FROM ________ TO________
Commission File Number: 000-22237
PALEX, INC.
(Exact name of Registrant as specified in its charter)
DELAWARE 76-0520673
(State of other jurisdiction of (I.R.S. Employer Identification No.)
incorporation) or organization)
1360 POST OAK BLVD., SUITE 800
HOUSTON, TEXAS 77056
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: 713-350-6030
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 filed such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [_]
The number of shares of Common Stock of the Registrant, par value $.01 per
share, outstanding at August 10, 1998 was 18,943,306.
<PAGE>
PALEX, INC.
FORM 10-Q FOR THE QUARTERLY PERIOD ENDED JUNE 28, 1998
INDEX
<TABLE>
<S> <C>
Part I - Financial Information
Item 1 - Financial Statements
General Information................................................................................................ 3
Consolidated Balance Sheets - PalEx, Inc. and Subsidiaries as of December 28, 1997 and June 28, 1998............... 4
Consolidated Statements of Income - PalEx, Inc. and Subsidiaries
for the Three and Six Month Periods Ended June 29, 1997 and June 28, 1998.......................................... 5
Consolidated Statement of Changes in Stockholders' Equity- PalEx, Inc. and Subsidiaries for the
Six Month Period Ended June 28, 1998............................................................................... 6
Consolidated Statements of Cash Flows - PalEx, Inc. and Subsidiaries for the Six Month Periods
Ended June 29, 1997 and June 28, 1998.............................................................................. 7
Notes to the Consolidated Financial Statements..................................................................... 8
Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations..................... 17
Part II - Other Information........................................................................................
Item 1 - Legal Proceedings......................................................................................... 22
Item 2 - Recent Sales of Unregistered Securities................................................................... 22
Item 6 - Exhibits and Reports on Form 8-K.......................................................................... 23
Signature.......................................................................................................... 24
</TABLE>
2
<PAGE>
PALEX, INC.
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
GENERAL INFORMATION
PalEx, Inc. ("PalEx" or the "Company") was founded in January 1996 to create a
national provider of pallet products and related services. On March 25, 1997,
concurrently with the closing of the initial public offering (the "Offering") of
its Common Stock, par value $.01 per share (the "Common Stock"), PalEx acquired
the following three businesses in separate transactions (the "Acquisitions"):
Fraser Industries, Inc. ("Fraser"), Ridge Pallets, Inc. ("Ridge") and Interstate
Pallet Co., Inc. ("Interstate" and, together with Fraser and Ridge, collectively
referred to as the "Founding Companies"). The consideration for the Acquisitions
of the Founding Companies consisted of a combination of cash and Common Stock.
Fraser has been identified as the accounting acquiror for financial statement
presentation purposes. The acquisitions of Ridge and Interstate were accounted
for using the purchase method of accounting.
Subsequent to the acquisition of the Founding Companies and the Offering and
during fiscal 1997, PalEx acquired five additional companies. Sheffield Lumber &
Pallet Company, Inc. ("Sheffield"), Sonoma Pacific Company ("Sonoma"), Bay Area
Pallet ("Bay Area") and New London Pallet ("New London") were accounted for as
poolings-of-interests (the "Pooled Companies"). The fifth acquisition, Summers
Pallet Manufacturing, Inc. ("Summers"), was accounted for as a purchase.
After fiscal 1997, and through June 28, 1998, the Company acquired twelve
additional companies, four of which, Acme Barrel Company, Inc. ("Acme"), Drum
Service Co. of Florida ("DSF"), Consolidated Container Corporation ("CCC") and
Western Container, LLC ("Western") were accounted for as poolings-of-interests
(the "1998 Pooled Companies"). The other eight companies, Consolidated Drum
Reconditioning, Inc. ("CDR"), American Pallet Recyclers ("APR"), Capital Pallet
Company ("Capital"), Pallet Outlet Company, Inc. ("POC"), Southern Pallet
Company ("Southern"), Shipshewana Pallet Co., Inc. ("Shipshewana"), Gilbert
Lumber, Inc. ("Gilbert"), and Valley Pallets, Inc. ("Valley") were accounted for
as purchases (the "1998 Purchased Companies" and, together with Summers, the
"Purchased Companies"). Five of the twelve companies acquired after fiscal 1997
and through June 28, 1998 are engaged in the reconditioning and rebuilding of
industrial steel containers.
Unless the context otherwise requires, all references herein to the Company
include PalEx, the Founding Companies, the Pooled Companies, the 1998 Pooled
Companies and the Purchased Companies.
Operating results for interim periods are not necessarily indicative of the
results for full years. The financial statements included herein should be read
in conjunction with the related notes thereto and management's discussion and
analysis and the Supplemental Consolidated Financial Statements of PalEx, Inc.
and Subsidiaries as of December 28, 1997 and related notes thereto as filed on
the Company's Form 8-K, as amended on April 28, 1998.
3
<PAGE>
PALEX, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
December 28, 1997 June 28, 1998
----------------- --------------
(Unaudited)
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents............................................................... $ 7,448 $ 13,728
Accounts receivable, net of allowance of $617 and $1,287................................ 21,592 34,431
Inventories............................................................................. 20,383 25,901
Deferred income taxes................................................................... 945 671
Other current assets.................................................................... 3,387 5,794
-------- --------
Total current assets............................................................... 53,755 80,525
PROPERTY, PLANT AND EQUIPMENT, net...................................................... 37,850 52,959
GOODWILL, net of accumulated amortization of $593 and $1,626............................ 26,262 94,893
OTHER ASSETS............................................................................ 2,138 1,528
-------- --------
Total assets....................................................................... $120,005 $229,905
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Line of credit.......................................................................... $ 1,150 $ --
Current maturities of long-term debt.................................................... 1,057 355
Accounts payable........................................................................ 9,342 13,170
Accrued restructuring charge............................................................ -- 2,502
Accrued expenses........................................................................ 5,094 9,849
Income taxes payable.................................................................... 1,407 724
-------- --------
Total current liabilities.......................................................... 18,050 26,600
LONG-TERM DEBT, net of current maturities............................................... 30,673 109,202
CONVERTIBLE NOTES PAYABLE -- 8,424
DEFERRED REVENUE........................................................................ 568 363
DEFERRED INCOME TAXES................................................................... 3,167 2,876
OTHER LONG-TERM LIABILITIES............................................................. 110 --
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred stock $.01 par value, 5,000,000 shares authorized, no shares issued........... -- --
Common stock, $.01 par value, 30,000,000 shares authorized,
17,644,520 and 18,937,620 outstanding................................................... 176 189
Additional paid-in capital.............................................................. 54,107 68,238
Unearned compensation................................................................... (1,770) (1,770)
Retained earnings....................................................................... 14,924 15,783
-------- --------
67,437 82,440
-------- --------
Total liabilities and stockholders' equity......................................... $120,005 $229,905
======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
4
<PAGE>
PALEX, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTH PERIOD SIX MONTH PERIOD
------------------ -----------------
ENDED ENDED
----- -----
JUNE 29, 1997 JUNE 28, 1998 JUNE 29, 1997 JUNE 28, 1998
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
REVENUES..................................................... $ 63,866 $ 83,362 $ 103,663 $ 152,332
COST OF GOODS SOLD........................................... 52,947 67,093 86,784 123,463
INVENTORY VALUATION ADJUSTMENT............................... -- 2,183 -- 2,183
----------- ----------- ----------- -----------
Gross profit.............................................. 10,919 14,086 16,879 26,686
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES................. 5,554 8,463 8,720 15,043
POOLING EXPENSES............................................. -- 190 -- 1,841
COMPENSATION DIFFERENTIAL.................................... 337 -- 635 1,062
GOODWILL AMORTIZATION........................................ 145 691 145 1,033
RESTRUCTURING CHARGE......................................... -- 2,834 -- 2,834
----------- ----------- ----------- -----------
Income from operations.................................... 4,883 1,908 7,379 4,873
INTEREST EXPENSE............................................. (553) (1,960) (771) (2,897)
OTHER INCOME (EXPENSE), NET.................................. 40 346 (25) 353
----------- ----------- ----------- -----------
INCOME BEFORE INCOME TAXES................................... 4,370 294 6,583 2,329
PROVISION FOR INCOME TAXES................................... 1,752 125 2,623 1,000
----------- ----------- ----------- -----------
NET INCOME................................................... $ 2,618 $ 169 $ 3,960 $ 1,329
=========== =========== =========== ===========
NET INCOME PER SHARE......................................... $ .15 $ .01 $ .28 $ .07
NET INCOME PER SHARE-DILUTED................................. $ .15 $ .01 $ .27 $ .07
NET INCOME PER SHARE-DILUTED, ADJUSTED FOR
POOLING EXPENSES AND OWNER'S COMPENSATION
DIFFERENTIAL.............................................. $ .17 $ .02 $ .32 $ .23
Shares used in computing net income per share................ 17,250,054 18,463,796 14,236,928 18,192,330
Shares used in computing net income per share-diluted........ 17,455,408 18,813,758 14,433,633 18,603,916
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
5
<PAGE>
PALEX, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
Common Stock Capital in Total
------------ Excess of Unearned Retained Stockholders'
Shares Amount Par Value Compensation Earnings Equity
------ ------ --------- ------------ -------- ------
<S> <C> <C> <C> <C> <C> <C>
BALANCE, December 28, 1997 17,644 $176 $54,107 $(1,770) $14,924 $67,437
Acquisition of purchased companies 1,291 13 14,737 -- -- 14,750
Purchase of minority interest in
pooled company -- -- (751) -- -- (751)
Exercise of stock options 3 -- 22 -- -- 22
Capital contribution -- -- 123 -- -- 123
Adjustment to conform year-end of
pooled companies -- -- -- -- (470) (470)
Net income -- -- -- -- 1,329 1,329
------ ---- ------- ------------ ------- -------
BALANCE, June 28, 1998 18,938 $189 $68,238 $(1,770) $15,783 $82,440
====== ==== ======= ============ ======= =======
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
6
<PAGE>
PALEX, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
SIX MONTH PERIOD ENDED
----------------------
JUNE 29, 1997 JUNE 28, 1998
------------- -------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income................................................................................... $ 3,960 $ 1,329
Net loss for Fraser for one-month transition period......................................... (66) --
Adjustment to conform fiscal year-end of Pooled Companies................................... 467 (470)
Unearned compensation........................................................................ (52) --
Cash acquired from pooled company at inception............................................... 51 --
Adjustments to reconcile net income to net cash provided by operating activities -
Depreciation and amortization............................................................. 2,998 4,290
Deferred income taxes..................................................................... 387 (17)
Loss (gain) on sale of assets.................................................................... 82 (25)
Changes in operating assets and liabilities -
Accounts receivable...................................................................... (4,949) (2,164)
Inventories.............................................................................. (1,241) 1,396
Other current assets..................................................................... (650) (2,112)
Accounts payable and accrued expenses.................................................... 245 2,983
Other assets and liabilities............................................................. 392 302
Deferred income.......................................................................... (229) (205)
-------- --------
Net cash provided by operating activities................................................... 1,395 5,307
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property, plant and equipment................................................... (3,871) (5,680)
Proceeds from sale of equipment.............................................................. 263 563
Cash paid for business acquisitions, net of cash acquired.................................... (1,098) (49,752)
-------- --------
Net cash used in investing activities....................................................... (4,706) (54,869)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net borrowings (repayments) on line of credit................................................ 1,144 (1,150)
Proceeds from long-term debt................................................................. 22,092 117,275
Payments on long-term debt................................................................... (34,868) (59,554)
Net proceeds from issuance of common stock................................................... 21,868 --
Net proceeds from exercise of stock options.................................................. -- 22
Distributions and dividends.................................................................. (7,866) ---
Purchase of minority interest in pooled company.............................................. -- (751)
-------- --------
Net cash provided by financing activities................................................... 2,370 55,842
-------- --------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS........................................... (941) 6,280
CASH AND CASH EQUIVALENTS -beginning of period.................................................. 2,865 7,448
-------- --------
CASH AND CASH EQUIVALENTS -end of period........................................................ $ 1,924 $ 13,728
======== ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for -
Interest.................................................................................... $ 457 $ 2,497
Income taxes................................................................................ $ 615 $ 1,683
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
7
<PAGE>
PALEX, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 28, 1998
(UNAUDITED)
1. BASIS OF PRESENTATION
PalEx, Inc. ("PalEx" or the "Company") was founded in January 1996 to create a
nationwide provider of pallet products and related services. On March 25, 1997,
concurrently with the closing of PalEx's initial public offering (the
"Offering") of its common stock, par value $.01 per share (the "Common Stock"),
PalEx and separate wholly owned subsidiaries of PalEx acquired, in separate
transactions (the "Acquisitions"), the following three businesses: Fraser
Industries, Inc. ("Fraser"), Ridge Pallets, Inc. ("Ridge"), and Interstate
Pallet Co., Inc. ("Interstate"), collectively referred to as the "Founding
Companies." The consideration for the acquisitions of the Founding Companies
consisted of a combination of cash and Common Stock.
Subsequent to the acquisition of the Founding Companies and the Offering and
during fiscal 1997, PalEx acquired five additional companies, four of which were
accounted for as poolings-of-interests (the "Pooled Companies"). The fifth
acquisition, Summers Pallet Manufacturing, Inc. ("Summers"), was accounted for
as a purchase.
After fiscal 1997, and through June 28, 1998, the Company acquired twelve
additional companies, four of which, Acme Barrel Company, Inc. ("Acme"), Drum
Service Co. of Florida ("DSF"), Consolidated Container Corporation ("CCC") and
Western Container, LLC ("Western") were accounted for as poolings-of-interests
(the "1998 Pooled Companies"). The remainder were accounted for as purchase
accounting transactions (the "1998 Purchased Companies"). Five of the twelve
companies are engaged in the reconditioning and rebuilding of industrial steel
containers.
The Company's headquarters are in Houston, Texas, with significant manufacturing
operations located in Texas, Georgia, Ohio, Arkansas, California, Florida,
Illinois and North Carolina. Sales are made throughout the United States with
significant concentrations in the southeastern, midwestern and western regions
of the United States serving primarily agricultural and industrial customers.
Revenues related to the agricultural customers are highly seasonal, occurring
primarily during the harvesting season.
Fraser has been identified as the accounting acquiror for financial statement
presentation purposes. The acquisitions of Ridge, Interstate and Summers, and
the 1998 Purchased Companies were accounted for using the purchase method of
accounting. The allocations of the purchase price to the assets acquired and
liabilities assumed has been assigned and recorded based on estimates of fair
value and may be revised for the 1998 Purchased Companies as additional
information concerning the valuation of such assets and liabilities becomes
available. The accompanying consolidated financial statements present Fraser
combined with the Pooled Companies and the 1998 Pooled Companies for the periods
presented, and include the Purchased Companies and the 1998 Purchased Companies
from their respective dates of acquisition. All significant intercompany
transactions and balances have been eliminated in consolidation.
The accompanying unaudited consolidated financial statements are prepared
pursuant to the rules and regulations for reporting on Form 10-Q. Accordingly,
certain information and footnotes required by generally accepted accounting
principles for complete financial statements are not included herein. The
Company believes all adjustments necessary for a fair presentation of these
interim statements have been included and are of a normal and recurring nature.
The interim statements should be read in conjunction with the Company's
supplemental consolidated financial statements and notes thereto included in
Form 8-K, as amended on April 28, 1998.
8
<PAGE>
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
During 1997, PalEx changed its year-end to the last Sunday in the calendar year
from November 30. Accordingly, it maintains its accounting records using a
52/53-week year ending on the last Sunday in December. Each quarter contains 13
weeks, unless otherwise noted.
Acme, DSF and CCC previously reported on year-ends of April 30, October 31 and
November 30, respectively. The results of operations for Acme have been
conformed to the fiscal-year end of PalEx. The results of operations included
herein for the three and six month periods ended June 29, 1997 include DSF and
CCC for their respective three month periods ended April 30 and May 31, 1997. An
adjustment has been made to the accompanying consolidated statements of
stockholders' equity and cash flows for the six month period ended June 28, 1998
to reflect the transition periods of DSF and CCC.
There has been no significant change in the accounting policies of the Company
during the periods presented. For a description of these policies, refer to Note
2 of Notes to Supplemental Consolidated Financial Statements of PalEx as filed
in Company's Form 8-K, as amended on April 28, 1998.
3. LONG TERM DEBT
On March 25, 1997, the Company entered into a credit agreement with Bank One,
Texas, N.A., which was amended on January 29, 1998 (the "Credit Facility"). The
Credit Facility provides the Company with a revolving line of credit of up to
$125.0 million which may be used for general corporate purposes, including the
repayment or refinancing of indebtedness of all acquisitions including future
acquisitions, capital expenditures, letters of credit and working capital.
Advances under the Credit Facility bear interest at designated variable rates
plus margins ranging from 0 to 25 basis points, depending on the ratio of the
Company's interest bearing debt to its pro forma trailing earnings before
interest, taxes, depreciation and amortization for the previous four quarters.
At the Company's option, the loans may bear interest based on a designated
London Interbank Offering Rate ("LIBOR") plus a margin ranging from 75 to 200
basis points, depending on the ratio noted above. Commitment fees of 17.5 to 30
basis points are payable on the unused portion of the line of credit. The Credit
Facility contains a limit for standby letters of credit up to $10 million. There
were letter of credit commitments of approximately $ 3.0 million outstanding
under the Credit Facility at June 28, 1998. The Credit Facility prohibits the
payment of dividends by the Company, restricts the Company's incurrence or
assumption of other indebtedness and requires the Company to comply with
financial covenants, including fixed charge coverage, certain funded debt to
earnings before taxes, depreciation, interest, amortization and tangible assets
to liabilities ratios. The Company was in compliance with the covenants at June
28, 1998. The Credit Facility will terminate and all amounts outstanding
thereunder, if any, will be due and payable January 29, 2003. The approximate
level of borrowings available under the Credit Facility at June 28, 1998 was
$17.0 million. The Company's subsidiaries have guaranteed the repayment, and the
outstanding stock of each of the Company's subsidiaries has been pledged to
secure the repayment, of all amounts due under the Credit Facility.
The Company issued approximately $8.4 million in subordinated convertible notes
to certain former owners of companies acquired during 1998. These notes, which
bear interest at rates ranging from seven to eight percent, include provisions
that allow conversion into shares of the Company's common stock beginning on the
first anniversary date of the notes at conversion prices ranging from $12.45 to
$15.86 per share. If the notes are not converted, they become due and payable on
the second anniversary of the notes. At the Company's option, the notes may be
prepaid at any time during the conversion period.
4. CAPITAL STOCK
On March 25, 1997, PalEx completed the Offering, which involved the sale by
PalEx of 3,000,000 shares of Common Stock at a price to the public of $7.50 per
share. The net proceeds to PalEx from the Offering (after deducting underwriting
discounts, commissions and offering expenses) were approximately $20.1 million.
Of this amount, $3.4 million was used to pay the cash portion of the purchase
prices relating to the acquisitions of the Founding Companies with the remainder
being used to pay certain indebtedness of the Founding Companies.
9
<PAGE>
On April 22, 1997, the Company sold an additional 450,000 shares of Common Stock
at a price to the public of $7.50 per share (generating net proceeds to the
Company of approximately $3.1 million after underwriting discounts and
commissions) pursuant to an over-allotment option granted by the Company to the
underwriters in connection with the Offering.
5. EARNINGS PER SHARE
In February 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 128 ("SFAS No. 128"), "Earnings Per Share."
The Company adopted SFAS No. 128 for the year ended December 28, 1997. SFAS No.
128 simplifies the standards required for computing earnings per share and
replaces the presentation of primary net income per share and fully diluted net
income per share with a presentation of basic net income per share ("Net income
per share") and diluted net income per share ("Net income per share - diluted").
Net income per share excludes dilution and is determined by dividing income
available to common stockholders by the weighted average number of common shares
outstanding during the period. Net income per share - diluted reflects the
potential dilution that could occur if securities and other contracts to issue
common stock were exercised or converted into common stock. Net income per share
- - diluted is computed similarly to fully diluted net income per share under
previous accounting rules. Net income per share and net income per share -
diluted amounts for the three and six month periods ended June 30, 1997 have
been restated in accordance with SFAS No. 128.
Net income per share was computed using 17,250,054 and 14,236,928 shares,
respectively (the weighted average number of shares attributable to Fraser and
the other Founding Companies, the shares issued in acquisition of the Pooled and
1998 Pooled Companies, the shares issued pursuant to the Offering, the shares
issued to Main Street Capital Partners, L.P. and PalEx management and the shares
issued to the profit sharing plans of the Founding Companies) for the three and
six month periods ended June 29, 1997. Net income per share for the three and
six month periods ended June 28, 1998 is based on 18,463,796 and 18,192,330
weighted average outstanding shares, respectively, which, in addition to the
aforementioned shares, includes shares issued in consideration for the
acquisition of Summers, the 1998 Purchased Companies, shares issued in
connection with the exercise of stock options, as well as the weighted average
outstanding shares issued and pursuant to the over-allotment option. The shares
used in computing net income per share-diluted also includes the effect of
unexercised stock options under the treasury method.
6. INCOME TAXES
Prior to the Acquisitions, the stockholders of Fraser elected to be taxed under
the provisions of Subchapter S of the Internal Revenue Code. Under these
provisions, Fraser did not pay federal and certain state income taxes because
their stockholders paid income taxes on their proportionate share of Fraser's
earnings. Commencing with the Acquisitions and the Offering, the Company began
to be taxed at applicable federal and state income tax rates.
The Pooled Companies were S Corporations for income tax purposes and,
accordingly, any income tax liabilities for the periods prior to the acquisition
date are the responsibility of the respective stockholders. For purposes of
these consolidated financial statements, federal and state income taxes have
been provided as if these companies had filed C Corporation tax returns for the
preacquisition periods. The current income tax expense of these S Corporations
is reflected in the consolidated financial statements in the provision for
income taxes and as an increase to capital in excess of par.
The Company intends to file a consolidated federal income tax return which
includes the operations of the Founding, Pooled, 1998 Pooled, and Purchased
Companies for periods subsequent to the respective acquisitions. Each of the
Companies will file a "short period" federal income tax return through their
respective acquisition dates.
Fraser recorded a charge to income tax expense of approximately $488,000 on
March 25, 1997 representing deferred income taxes at that date which were not
previously recorded because of Fraser's status under Subchapter S.
10
<PAGE>
7. COMMITMENTS AND CONTINGENCIES
LITIGATION
In February 1998, the Company acquired DSF, a steel drum reconditioning company
with a facility in Florida. DSF is a wholly-owned subsidiary of the Company. In
1982, DSF was notified by the U.S. Environmental Protection Agency (the "EPA")
that it believed that DSF might be a potentially responsible party ("PRP")
regarding the Zellwood Groundwater Contamination Site in Orange County, Florida
(the "Zellwood Site"). The Zellwood Site was designated a "Superfund"
environmental clean-up site after the Florida Department of Environmental
Regulation discovered arsenic contamination in a shallow monitoring well
adjacent to it. The DSF facility is a portion of the 57 acres constituting the
Zellwood Site. The Company believes that DSF and its former sole shareholder
were among approximately 25 entities and individuals identified as PRPs by the
EPA.
Between March 1990 and July 1996, the EPA issued various unilateral
administrative orders and notices to DSF and various other PRPs. Those orders
and notices demanded reimbursement from PRPs of approximately $2 million of the
EPA's costs regarding the Zellwood Site and requested the PRPs to accept
financial responsibility for additional clean-up efforts. During that time, the
EPA estimated that the cost of the selected remedy for soil at the Zellwood Site
would be approximately $1 million and the cost of the selected remedy for
groundwater at the Zellwood Site would be approximately $5.1 million. DSF and
the other PRPs did not agree to the EPA's demands or agree to fund any
additional clean-up. In April 1997, the EPA issued an order unilaterally
withdrawing its previous orders.
On June 12, 1998 a suit was filed in the United States District Court for the
Middle District of Florida (Orlando Division) against DSF and certain other
PRPs with respect to the Zellwood Site (United States of America v. Drum
---------------------------------
Service Co. of Florida, John Michael Murphy, Douglass Fertilizer & Chemical,
- ----------------------------------------------------------------------------
Inc., et, al., Civil No. 98-687-Civ-Orl-22C) (the "Zellwood Suit"). In this
- --------------
lawsuit, the EPA is seeking reimbursement of past costs incurred at the Zellwood
Site during the past 17 years and a declaratory judgment for future response
costs.
DSF has maintained comprehensive general liability insurance coverage for over
25 years, and a number of the policies providing such coverage did not contain
exclusions for environmental contamination. DSF has notified the insurers that
issued such policies of the EPA's claims regarding the Zellwood Site and the
commencement of the Zellwood Suit. To the extent DSF's liabilities and expenses
with respect to the Zellwood Site and Zellwood Suit exceed its insurance
recoveries, the former shareholders of DSF have agreed to indemnify DSF and the
Company and hold them harmless.
DSF and several other PRP's are currently negotiating with the EPA to settle
the Zellwood Suit. DSF intends to vigorously defend the Zellwood Suit and pursue
its insurance coverage with respect to losses and expenses incurred in
connection with the Zellwood Site. Although there can be no assurance as to any
ultimate liability of DSF under the Zellwood Suit, the amount of recoveries from
other PRPs or the insurance coverage, or the amount of insurance recoveries, the
Company's management believes that DSF's insurance coverage, recoveries from
other PRPs and the indemnification obligations of DSF's former shareholders will
be adequate to cover any liability or expenses of DSF arising from the Zellwood
Suit.
The Company is involved in various other legal proceedings that have arisen in
the ordinary course of business. While it is not possible to predict the outcome
of such proceedings with certainty, in the opinion of the Company's management,
all such proceedings are either adequately covered by insurance or, if not so
covered, should not ultimately result in any liability which would have a
material adverse effect on the financial position, liquidity or results of
operations of the Company.
INSURANCE
The Company carries a broad range of insurance coverage, including general and
business auto liability, commercial property, workers' compensation and a
general umbrella policy.
The Company is self-insured for certain medical claims up to $50,000 per person
per year. Provisions for expected future payments are accrued and are based on
the Company's estimate of its aggregate liability for all open and unreported
claims.
11
<PAGE>
OPERATING LEASE AGREEMENTS
The Company conducts a portion of its operations and warehouses certain of its
products in leased facilities under leases accounted for as operating leases.
The leases provide for payment of taxes and other expenses by the Company. Rent
expense for operating leases was approximately $1,335,000 and $1,326,000 for the
six month periods ended June 29, 1997 and June 28, 1998, respectively.
12
<PAGE>
8. BUSINESS SEGMENTS
The company has two business segments, one operating in the pallet industry and
the other in the steel drum reconditioning industry. The Pallet segment
produces, recycles and sells wooden pallets in the United States primarily for
use in agricultural and industrial markets. The Drum segment reconditions steel
drums in the United States primarily for use in agricultural and industrial
markets. There were no significant intercompany sales between the two segments
for the three and six month periods ended June 29, 1997 and June 28, 1998.
<TABLE>
<CAPTION>
For the three month periods ended
---------------------------------
June 29, 1997 June 28, 1998
------------- -------------
Pallet Drum Consolidated Pallet Drum Consolidated
------ ---- ------------ ------ ---- ------------
<S> <C> <C> <C> <C> <C> <C>
Revenues $47,679 $16,187 $ 63,866 $ 60,489 $22,873 $ 83,362
======== ======== ======== ========= ======== ========
Earnings contribution $ 5,326 $ 228 $ 5,554 $ 3,084 $ 3,656 $ 6,740
======== ======== ========= ========
Corporate expenses (526) (1,307)
Interest expense (553) (1,960)
Amortization of goodwill (145) (691)
Restructuring charge -- (2,834)
Other income (expenses) 40 346
-------- --------
Income before provision for income taxes $ 4,370 $ 294
======== ========
</TABLE>
<TABLE>
<CAPTION>
For the six month periods ended
-------------------------------
June 29, 1997 June 28, 1998
------------- -------------
Pallet Drum Consolidated Pallet Drum Consolidated
------ ---- ------------ ------ ---- ------------
<S> <C> <C> <C> <C> <C> <C>
Revenues $74,253 $29,410 $103,663 $112,442 $39,890 $152,332
======== ======== ======== ========= ======== ========
Earnings contribution $ 8,226 $ (176) $ 8,050 $ 7,617 $ 3,180 10,797
======== ======== ========= ========
Corporate expenses (526) (2,057)
Interest expense (771) (2,897)
Amortization of goodwill (145) (1,033)
Restructuring charge -- (2,834)
Other income (expenses) (25) 353
-------- --------
Income before provision for income taxes $ 6,583 $ 2,329
======== ========
</TABLE>
<TABLE>
<CAPTION>
As of June 29, 1997 As of June 28, 1998
------------------- -------------------
Pallet Drum Consolidated Pallet Drum Consolidated
------ ---- ------------ ------ ---- ------------
<S> <C> <C> <C> <C> <C> <C>
Operating assets -
Accounts receivable $ 7,800 $16,586 $ 24,386 $ 22,828 $11,603 $ 34,431
======= ======= ======== =======
Inventories $13,693 $ 2,158 15,851 $ 22,336 $ 3,565 $ 25,901
======= ======= ======== =======
Property and equipment, net $28,339 $ 6,032 34,371 $ 42,491 $10,468 $ 52,959
======= ======= ======== =======
Other assets 26,920 $116,614
-------- --------
Total assets $101,528 $229,905
======== ========
</TABLE>
Earnings contribution for the Drum segment for the six month period ended June
28, 1998 includes charges of approximately $1.8 million for investment advisory
fees related to the acquisition of one of the 1998 Pooled Companies and
compensation differential (the difference between previous owners' and officers'
compensation before the acquisitions and the amounts to which they have
contractually agreed) of approximately $1.1 million incurred in conjunction with
the acquisition of Acme and Western. There were no pooling expenses for the
three and six month periods ended June 29, 1997. Pooling expenses for the three
month period ended June 28, 1998 were approximately $190,000. Compensation
differential
13
<PAGE>
was approximately $337,000 and $635,000 for the three and six month periods
ended June 29, 1997, respectively.
Earnings contribution for the Pallet segment for the three and six month periods
ended June 28, 1998 include an inventory valuation adjustment of $2,183,000.
9. RESTRUCTURING CHARGE
On April 29, 1998, the Company notified its largest customer, CHEP USA ("CHEP"),
that PalEx was terminating all existing agreements with CHEP. Effective that
date, the Company ceased supplying CHEP with new pallets and provided advance
notice (generally, ten to sixty days) under contractual arrangements to
discontinue repair and depot services for CHEP.
The termination of the Company's relationship with CHEP affected the operations
of certain of the Company's facilities in the southeastern and western United
States. As a result, management has adopted a restructuring plan, which was
approved by the Board of Directors, to evaluate closure, curtail operations,
and/or convert to alternative business activities for eight facilities dedicated
to CHEP production.
The Company's results of operations for the three and the six month periods
ended June 28, 1998 include a charge to continuing operations of approximately
$5.0 million, which represents management's estimate of the restructuring costs
associated with the closure, curtailment, and conversion of facilities. Of the
$5.0 million charge to continuing operations, approximately $2.2 million relates
to an inventory valuation adjustment to reduce CHEP-related raw and partially
processed lumber and supplies to net realizable value. Approximately $2.0
million of the charge to continuing operations relates to facility closure costs
such as lease cancellation fees and penalties for the facilities and other
potential operating costs and expenses. The remaining $0.8 million charge to
continuing operations relates to severance pay associated with termination of
employees at the CHEP-related facilities. Approximately $172,000 and $31,000 has
been charged to the accrual for inventory write down and other restructuring
expenses, respectively. The Company has laid off approximately 225 employees
to date and expects to lay off 225 additional employees over the next few
months. The majority of the employees laid off or expected to be laid off are
production employees. Management believes that all CHEP related restructuring
will be completed by the end of its current fiscal year.
The results of operations for the three and the six month periods ended June 29,
1997 includes revenues of approximately $16.7 million and $31.3 million,
respectively, relating to CHEP, while revenues for the three and six month
periods ended June 28, 1998 includes revenues of approximately $10.0 million and
$24.6 million, respectively.
14
<PAGE>
10. PRO FORMA RESULTS OF OPERATIONS
The following unaudited pro forma combined statements of income for the three
and six month periods ended June 29, 1997 and June 28, 1998 includes the results
of PalEx combined with the Founding Companies, the Pooled Companies, the 1998
Pooled Companies, Summers and the 1998 Purchased Companies as if the
acquisitions had occurred as of January 1, 1997. The unaudited pro forma
combined statements of income include the effects of certain reductions in
salaries and benefits to the former owners of the Founding, Pooled, 1998 Pooled
and 1998 Purchased Companies and Summers to which they have contractually
agreed, adjustment for pooling expenses and compensation differential incurred
in conjunction with the acquisition of Acme and Western, amortization of
goodwill resulting from the acquisitions, income tax expense as if income was
subject to federal and state income taxes during the period, and changes in
interest expense resulting from the repayment or refinancing of debt. The
unaudited pro forma combined statements of income may not be comparable to and
may not be indicative of the Company's post- acquisition results of operations
because, among other matters, (i) the Founding, Pooled, 1998 Pooled and 1998
Purchased Companies and Summers were not under common control or management and
(ii) the Company used the purchase method to establish a new basis of accounting
to record the acquisition of Ridge, Interstate, and the Purchased Companies.
PALEX, INC. AND SUBSIDIARIES
STATEMENTS OF PRO FORMA COMBINED INCOME
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTH PERIOD ENDED SIX MONTH PERIOD ENDED
------------------------------ ------------------------------
JUNE 29, 1997 JUNE 28, 1998 JUNE 29, 1997 JUNE 28, 1998
-------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
REVENUES........................................................ $ 89,220 $ 91,554 $ 169,598 $ 180,532
COST OF GOODS SOLD.............................................. 71,426 73,270 136,302 144,650
INVENTORY VALUATION ADJUSTMENT.................................. -- 2,183 -- 2,183
----------- ----------- ----------- -----------
Gross profit................................................ 17,794 16,101 33,296 33,699
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES.................... 7,857 10,036 14,216 19,308
GOODWILL AMORTIZATION........................................... 784 794 1,567 1,586
RESTRUCTURING EXPENSE........................................... -- 2,834 -- 2,834
----------- ----------- ----------- -----------
Income from operations...................................... 9,153 2,437 17,513 9,971
INTEREST EXPENSE................................................ (1,678) (2,197) (3,274) (3,728)
OTHER INCOME (EXPENSE), NET..................................... (238) 344 (466) 392
----------- ----------- ----------- -----------
INCOME BEFORE INCOME TAXES...................................... 7,237 584 13,773 6,635
PROVISION FOR INCOME TAXES...................................... 2,879 246 5,615 2,786
----------- ----------- ----------- -----------
NET INCOME...................................................... $ 4,358 $ 338 $ 8,158 $ 3,849
=========== =========== =========== ===========
NET INCOME PER SHARE - DILUTED.................................. $ .23 $ .02 $ .43 $ .20
NET INCOME PER SHARE - DILUTED, EXCLUDING AFTER TAX EFFECT OF
INVENTORY VALUATION ADJUSTMENT AND
RESTRUCTURING EXPENSE........................................ $ .23 $ .17 $ .43 $ .35
Shares used in computing net income per share - diluted......... 19,140,593 19,287,582 19,132,037 19,349,462
</TABLE>
15
<PAGE>
11. SUBSEQUENT EVENTS
Between June 28, 1998 and August 10, 1998, the Company acquired certain assets
and liabilities and the ongoing businesses of Continental Pallet Company, a
pallet recycler, McCook Drum & Barrel Co., Inc., a steel drum reconditioner and
Duckert Pallet, Inc., a manufacturer of new pallets, for approximately $5.4
million in cash, convertible notes and the Companys common stock in
transactions which will be accounted for as purchase business combinations.
16
<PAGE>
PALEX, INC.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
INTRODUCTION
The following discussion should be read in conjunction with the Supplemental
Consolidated Financial Statements of the Company and related notes thereto which
are included in the Company's Form 8-K, as amended. Statements contained in this
discussion regarding future financial performance and results and other
statements that are not historical facts are forward-looking statements. The
forward-looking statements are subject to numerous risks and uncertainties to
the Company, including but not limited to the availability of attractive
acquisition opportunities, the successful integration and profitable management
of acquired businesses, improvement of operating efficiencies, the availability
of working capital and financing for future acquisitions, the Company's ability
to grow internally through expansion of services and customer bases and
reduction of overhead, conditions in lumber markets, seasonality, weather
conditions and other risk factors discussed in the Company's Annual Report on
Form 10-K.
RESULTS OF OPERATIONS
The results of operations for the periods presented include Fraser, the Pooled
Companies and the 1998 Pooled Companies. In addition, the Purchased Companies
are included from their respective dates of acquisition.
Quarterly results may be materially affected by the timing and magnitude of
acquisitions, assimilation costs, costs of opening new facilities, gain or loss
of a material customer, variation in product mix and weather conditions.
Accordingly, the operating results for any interim period are not necessarily
indicative of the results that may be achieved for any subsequent interim period
or for a full fiscal year.
THREE MONTH PERIODS ENDED JUNE 29, 1997 AND JUNE 28, 1998
The following table sets forth certain selected financial data as a percentage
of revenues for the periods indicated (dollars in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED
------------------
JUNE 29, 1997 JUNE 28, 1998
------------- -------------
<S> <C> <C> <C> <C>
Revenues.......................................................... $63,866 100.0% $83,362 100.0%
Cost of Sales..................................................... 52,947 82.9 67,093 80.5
Inventory Valuation Adjustment.................................... -- -- 2,183 2.6
------- ----- ------- -----
Gross profit...................................................... 10,919 17.1 14,086 16.9
Selling, general and administrative expenses...................... 5,554 8.7 8,463 10.2
Pooling expenses.................................................. -- -- 190 .2
Compensation differential......................................... 337 .5 -- --
Amortization of goodwill.......................................... 145 .2 691 .8
Restructuring charge.............................................. -- -- 2,834 3.4
------- ----- ------- -----
Income from operations............................................ 4,883 7.7 1,908 2.3
Interest expense.................................................. (553) (.9) (1,960) (2.4)
Other income, net................................................. 40 -- 346 .4
------- ----- ------- -----
Income before income taxes........................................ 4,370 6.8 294 .3
Provision for income taxes........................................ 1,752 2.7 125 .1
------- ----- ------- -----
Net income........................................................ $ 2,618 4.1% $ 169 .2%
======= ===== ======= =====
</TABLE>
17
<PAGE>
Revenues increased 30.5% from approximately $63.9 million in the three month
period ended June 29, 1997 to $83.4 million in the three month period ended June
28, 1998. This increase was primarily attributable to revenues of the Purchased
Companies acquired subsequent to June 29, 1997.
Pro Forma unit sales of new pallets decreased from approximately 3.8 million
units for the three month period ended June 29, 1997 to approximately 3.5
million units for the three month period ended June 28, 1998. Pro Forma unit
sales of repaired and used pallets increased from approximately 3.6 million
units for the three month period ended June 29, 1997 to approximately 4.2
million units for the three month period ended June 28, 1998. Pro Forma unit
sales of agricultural harvesting boxes and specialty bins increased from
approximately 22,000 units for the three month period ended June 29, 1997 to
approximately 48,000 units for the three month period ended June 28, 1998. Pro
Forma unit sales of reconditioned drums were relatively unchanged at 1.5 million
units for the three month periods ended June 29, 1997 and June 28, 1998.
Gross profit increased from approximately $10.9 million for the three month
period ended June 29, 1997 to $14.1 million for the three month period ended
June 28, 1998, primarily as a result of increased volumes due to the acquisition
of the Purchased Companies. Gross profit as a percentage of revenues decreased
from 17.1% for the three month period ended June 28, 1997 to 16.9% for the three
month period ended June 28, 1998. Gross profit, excluding the inventory
valuation adjustment attributable to the termination of the Company's
relationship with CHEP, increased from $10.9 million or 17.1% of sales for the
three month period ended June 29, 1997 to $16.3 million or 19.5% of sales for
the three month period ended June 28, 1998, an increase primarily attributable
to the higher gross margins that accompany sales of repaired and used pallets
and from reconditioned drum sales. The Company's gross profit as a percentage of
revenues may fluctuate as a result of competitive pricing in different market
areas in which it operates, continued changes in product mix and changes in raw
materials costs. Gross profit for the drum segment increased because of
increases in sales prices, lower costs for raw drums and improvements in
reconditioning methods.
Selling, general and administrative costs increased from approximately $5.6
million, or 8.7% of revenues, in the three month period ended June 29, 1997 to
$8.5 million, or 10.2% of revenues, in the three month period ended June 28,
1998. This increase is generally attributable to the Purchased Companies
acquired subsequent to June 29, 1997 and to the increased costs associated with
being a public company.
The termination of the Company's relationship with CHEP affected the operations
of certain of the Company's facilities in the southeastern and western United
States. Three facilities dedicated to CHEP production are being evaluated for
closure. Operations at certain facilities were reduced, while others are being
converted to alternative business activities. As of June 28, 1998 approximately
225 employees have been laid off due to the termination of the CHEP
relationship. The Company anticipates that an additional 225 employees will be
laid off. The Company's results of operations for the three month period ended
June 28, 1998 includes an after tax charge to continuing operations of
approximately $2.9 million, or $.15 per diluted common share, which represents
the effect of management's estimate of costs associated with the conversion or
closing of facilities.
Interest expense increased to approximately $2.0 million for the three month
period ended June 28, 1998, primarily as a result of the additional borrowings
related to the acquisitions of the Purchased Companies and the 1998 Purchased
Companies.
Federal and state income taxes have been provided on the earnings of Fraser, the
Pooled Companies and the 1998 Pooled Companies for the three month periods ended
June 29, 1997 and June 28, 1998 and on Ridge, Interstate and the Purchased
Companies from their respective dates of acquisition.
As a result of the foregoing, net income for the three month period ended June
28, 1998 decreased from $2.6 million for the three month period ended June 29,
1997 to approximately $0.2 million.
18
<PAGE>
SIX MONTH PERIODS ENDED JUNE 29, 1997 AND JUNE 28, 1998
The following table sets forth certain selected financial data as a percentage
of revenues for the periods indicated (dollars in thousands):
<TABLE>
<CAPTION>
SIX MONTHS ENDED
--------------------------------------
JUNE 29, 1997 JUNE 28, 1998
------------------ ------------------
<S> <C> <C> <C> <C>
Revenues.......................................................... $103,663 100.0% $152,332 100.0%
Cost of Sales..................................................... 86,784 83.7 123,463 81.0
Inventory Valuation Adjustment.................................... -- -- 2,183 1.4
-------- ----- -------- -----
Gross profit...................................................... 16,879 16.3 26,686 17.6
Selling, general and administrative expenses...................... 8,720 8.4 15,043 9.9
Pooling expenses.................................................. -- -- 1,841 1.2
Compensation differential......................................... 635 .6 1,062 .7
Amortization of goodwill.......................................... 145 .1 1,033 .7
Restructuring charge.............................................. -- -- 2,834 1.9
-------- ----- -------- -----
Income from operations............................................ 7,379 7.2 4,873 3.2
Interest expense.................................................. (771) (.7) (2,897) (1.9)
Other income (expense), net....................................... (25) -- 353 .2
-------- ----- -------- -----
Income before income taxes........................................ 6,583 6.5 2,329 1.5
Provision for income taxes........................................ 2,623 2.7 1,000 .6
-------- ----- -------- -----
Net income........................................................ $ 3,960 3.8% $ 1,329 0.9%
======== ===== ======== =====
</TABLE>
Revenues increased 46.9% from approximately $103.7 million in the six month
period ended June 29, 1997 to $152.3 million in the six month period ended June
28, 1998. This increase was primarily attributable to the acquisition of Ridge,
Interstate and the Purchased Companies.
Pro forma unit sales of new pallets decreased from approximately 7.2 million
units for the six month period ended June 29, 1997 to approximately 7.0 million
units for the six month period ended June 28, 1998. Pro Forma unit sales of
repaired and used pallets increased from approximately 7.0 million units for the
six month period ended June 29, 1997 to approximately 8.3 million units for the
six month period ended June 28, 1998. Pro Forma unit sales of agricultural
harvesting boxes and specialty bins increased from approximately 29,000 units
for the six month period ended June 29, 1997 to approximately 92,000 units for
the six month period ended June 28, 1998. Pro Forma unit sales of reconditioned
drums increased from approximately 2.9 million for the six month period ended
June 29, 1997 to approximately 3.0 million for the six month period ended June
28, 1998.
Gross profit increased from approximately $16.9 million for the six month period
ended June 29, 1997 to $26.7 million for the six month period ended June 28,
1998, primarily as a result of increased volumes due to the acquisition of the
Purchased Companies. Gross profit as a percentage of revenues increased from
16.3% for the six month period ended June 29, 1997 to 17.6% for the six month
period ended June 28, 1998. Gross profit, excluding the inventory valuation
adjustment attributable to the termination of the Company's relationship with
CHEP, increased from $16.9 million or 16.3% of sales for the six month period
ended June 28, 1997 to $28.9 million or 19.0% of sales for the six month period
ended June 28, 1998, an increase primarily attributable to the higher gross
margins that accompany sales of repaired and used pallets and from reconditioned
drum sales. The Company's gross profit as a percentage of revenues may
fluctuate as a result of competitive pricing in different market areas in which
it operates, continued changes in product mix and changes in raw materials
costs. Gross profit for the drum segment increased because of increases in sales
prices, lower costs for raw drums and improvements in reconditioning methods.
Selling, general and administrative costs increased from approximately $8.7
million, or 8.4% of revenues, in the six month period ended June 29, 1997 to
$15.0 million, or 9.9% of revenues, in the six month period ended June 28, 1998.
This increase is generally attributable to the Purchased Companies and to the
increased costs associated with being a public company.
The termination of the Company's relationship with CHEP affected the operations
of certain of the Company's facilities in the southeastern and western United
States. Three facilities dedicated to CHEP production are being evaluated for
closure.
19
<PAGE>
Operations at certain facilities were reduced, while others are being converted
to alternative business activities. As of June 28, 1998, approximately 225
employees have been laid off due to the termination of the CHEP relationship.
The Company anticipates that an additional 225 employees will be laid off. The
Company's results of operations for the six month period ended June 28, 1998
includes an after tax charge to continuing operations of approximately $2.9
million or $.15 per diluted common share, which represents management's estimate
of costs associated with the conversion or closing of facilities.
Interest expense increased to approximately $2.9 million for the six months
ended June 28, 1998, primarily as a result of the additional borrowings related
to the acquisitions of the Purchased Companies and the 1998 Purchased Companies.
Federal and state income taxes have been provided on the earnings of Fraser, the
Pooled Companies and the 1998 Pooled Companies for the six month periods ended
June 29, 1997 and June 28, 1998 and on Ridge, Interstate and the Purchased
Companies from their respective dates of acquisition. The provision for income
taxes for the six month period ended June 29, 1997 includes a charge of
approximately $488,000 representing deferred income taxes for Fraser at the time
of the Offering which were not previously recorded because of Fraser's status
under Subchapter S of the Internal Revenue Code.
As a result of the foregoing, net income for the six month period ended June 28,
1998 decreased from $4.0 million for the six month period ended June 29, 1997 to
approximately $1.3 million.
The results of operations for the six month period ended June 28, 1998 include
charges of approximately $1.8 million and $1.1 million for pooling expenses and
compensation differential, respectively. There were no pooling expenses for the
six month period ended June 29, 1997. Compensation differential was
approximately $635,000 for the six months ended June 29, 1997.
LIQUIDITY AND CAPITAL RESOURCES
On March 25, 1997, PalEx completed the Offering, which involved the sale of
3,000,000 shares of Common Stock at a price to the public of $7.50 per share.
The net proceeds to PalEx from the Offering (after deducting underwriting
discounts, commissions and offering expenses) were approximately $20.1 million.
Of this amount, $3.4 million was used to pay the cash portion of the purchase
prices relating to the Acquisitions with the remainder being used to repay
certain indebtedness of the Founding Companies.
On April 22, 1997, the Company sold an additional 450,000 shares of Common Stock
at a price to the public of $7.50 per share (generating net proceeds to the
Company of $3.1 million after underwriting discounts and commissions) pursuant
to an over-allotment option granted by the Company to the underwriters in
connection with the Offering. The net proceeds were used to repay debt borrowed
under the Credit Facility.
On March 25, 1997, the Company entered into a credit agreement with Bank One,
Texas, N.A., which was amended on January 29, 1998 (the "Credit Facility"). The
Credit Facility provides the Company with a revolving line of credit of up to
$125.0 million which may be used for general corporate purposes, including the
repayment or refinancing of indebtedness of the Founding, Pooled, Summers, and
the 1998 Pooled and 1998 Purchased Companies, future acquisitions, capital
expenditures, letters of credit and working capital. Advances under the Credit
Facility bear interest at designated variable rates plus margins ranging from 0
to 25 basis points, depending on the ratio of the Company's interest bearing
debt to its pro forma trailing earnings before interest, taxes, depreciation and
amortization for the previous four quarters. At the Company's option, the loans
may bear interest based on a designated London Interbank Offering Rate ("LIBOR")
plus a margin ranging from 75 to 200 basis points, depending on the ratio noted
above. Commitment fees of 17.5 to 30 basis points are payable on the unused
portion of the line of credit. The Credit Facility contains a limit for standby
letters of credit up to $10 million. There were letter of credit commitments of
approximately $3.0 million outstanding under the Credit Facility at June 28,
1998. The Credit Facility prohibits the payment of dividends by the Company,
restricts the Company's incurrence or assumption of other indebtedness and
requires the Company to comply with financial covenants, including fixed charge
coverage, certain funded debt to earnings before taxes, depreciation, interest,
amortization and tangible assets to liabilities ratios. The Company was in
compliance with the covenants at June 28, 1998. The Credit Facility will
terminate and all amounts outstanding thereunder, if any, will be due and
payable January 29, 2003. The approximate level of borrowings available under
the Credit Facility at June 28, 1998 was approximately $17.0 million. The
Company's subsidiaries
20
<PAGE>
have guaranteed the repayment, and the outstanding stock of each of the
Company's subsidiaries has been pledged to secure the repayment, of all amounts
due under the Credit Facility.
The Company issued approximately $8.4 million in subordinated convertible notes
to certain former owners of PalEx subsidiaries acquired during 1998. These
notes, which bear interest at rates ranging from seven to eight percent, include
provisions that allow conversion into shares of the Company's common stock
beginning on the first anniversary date of the notes at conversion prices
ranging from $12.45 to $15.86 per share. If the notes are not converted, they
become due and payable on the second anniversary of the notes. At the Company's
option, the notes may be prepaid at any time during the conversion period. The
notes mature in 2000.
The Company intends to pursue acquisitions. The timing, size or success of any
acquisitions and the resulting additional capital commitments are unpredictable.
The Company expects to fund future acquisitions primarily through a combination
of issuances of additional equity, working capital, cash flow from operations
and borrowings, including the unused portion of the Credit Facility. To the
extent new sources of financing are necessary to fund future acquisitions, there
can be no assurance that the Company can secure such additional financing if and
when it is needed or on terms deemed acceptable to the Company.
SEASONALITY
The pallet manufacturing business can be subject to seasonal variations in
operations and demand. The Company has a significant number of agricultural
customers and typically experiences the greatest demand for new pallets from
these customers during the citrus and produce harvesting seasons (generally
October through May) with significantly lower demand in the summer months.
Yearly results can fluctuate significantly in this region depending on the size
of the citrus and produce harvests, which, in turn, largely depend on the
occurrence and severity of freezing weather and changes in rainfall. Adverse
weather conditions may also affect the Company's ability to obtain adequate
supplies of lumber at a reasonable cost. The Company's locations serving
predominantly manufacturing and industrial customers experience less
seasonality. Management believes that the effects of such seasonality will
diminish as the Company grows and expands its customer base both internally and
through acquisition.
The Company's drum reconditioning segment is seasonally impacted in the
southeastern and western United States by the agricultural industries.
Reconditioned drum sales are strongest during a period generally beginning in
April and extending through September, with preseason production for this period
running from January through March.
YEAR 2000 ISSUES
The Company uses software and related technologies throughout its businesses
that will be affected by the "Year 2000 Problem", which is common to most
businesses and relates to the inability of information systems and computer
software programs to properly recognize and process date-sensitive information
as the year 2000 approaches. The Company is in the process of modifying the
software in its information technology systems so that all of such software will
be Year 2000 compliant. The Company believes that it and its vendors will be
able to modify all such software in time to minimize any detrimental effects to
its operations. There can be no assurance, however, that the Company or its
software vendors will complete all modifications to all material information
technology systems in a timely manner. The Company's non-information technology
systems that may be affected by the Year 2000 Problem continue to be studied,
including those non-information technology features that are used directly in
the Company's manufacturing processes.
The Company will continue to consider the likelihood of a material business
interruption due to the Year 2000 Problem, and if necessary implement an
appropriate contingency plan.
Although it is not possible to accurately estimate the costs of this information
systems analysis, the Company expects that such costs will not be material to
the Company's financial position or the results of operations. Failure of the
Company, its vendors or its customers to have Year 2000 compliant systems in
place could have a material adverse effect on the Company.
21
<PAGE>
PALEX, INC.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In February 1998, the Company acquired DSF, a steel drum reconditioning company
with a facility in Florida. DSF is a wholly-owned subsidiary of the Company. In
1982, DSF was notified by the U.S. Environmental Protection Agency (the "EPA")
that it believed that DSF might be a potentially responsible party ("PRP")
regarding the Zellwood Groundwater Contamination Site in Orange County, Florida
(the "Zellwood Site"). The Zellwood Site was designated a "Superfund"
environmental clean-up site after the Florida Department of Environmental
Regulation discovered arsenic contamination in a shallow monitoring well
adjacent to it. The DSF facility is a portion of the 57 acres constituting the
Zellwood Site. The Company believes that DSF and its former sole shareholder
were among approximately 25 entities and individuals identified as PRPs by the
EPA.
Between March 1990 and July 1996, the EPA issued various unilateral
administrative orders and notices to DSF and various other PRPs. Those orders
and notices demanded reimbursement from PRPs of approximately $2 million of the
EPA's costs regarding the Zellwood Site and requested the PRPs to accept
financial responsibility for additional clean-up efforts. During that time, the
EPA estimated that the cost of the selected remedy for soil at the Zellwood Site
would be approximately $1 million and the cost of the selected remedy for
groundwater at the Zellwood Site would be approximately $5.1 million. DSF and
the other PRPs did not agree to the EPA's demands or agree to fund any
additional clean-up. In April 1997, the EPA issued an order unilaterally
withdrawing its previous orders.
On June 12, 1998 a suit was filed in the United States District Court for the
Middle District of Florida (Orlando Division) against DSF and certain other
PRPs with respect to the Zellwood Site (United States of America v. Drum
---------------------------------
Service Co. of Florida, John Michael Murphy, Douglass Fertilizer & Chemical,
- ----------------------------------------------------------------------------
Inc., et, al., Civil No. 98-687-Civ-Orl-22C) (the "Zellwood Suit"). In this
- --------------
lawsuit, the EPA is seeking reimbursement of past costs incurred at the Zellwood
Site during the past 17 years and a declaratory judgment for future response
costs.
DSF has maintained comprehensive general liability insurance coverage for over
25 years, and a number of the policies providing such coverage did not contain
exclusions for environmental contamination. DSF has notified the insurers that
issued such policies of the EPA's claims regarding the Zellwood Site and the
commencement of the Zellwood Suit. To the extent DSF's liabilities and expenses
with respect to the Zellwood Site and Zellwood Suit exceed its insurance
recoveries, the former shareholders of DSF have agreed to indemnify DSF and the
Company and hold them harmless.
DSF and several other PRP's are currently negotiating with the EPA to settle
the Zellwood Suit. DSF intends to vigorously defend the Zellwood Suit and pursue
its insurance coverage with respect to losses and expenses incurred in
connection with the Zellwood Site. Although there can be no assurance as to any
ultimate liability of DSF under the Zellwood Suit, the amount of recoveries from
other PRPs or the insurance coverage, or the amount of insurance recoveries, the
Company's management believes that DSF's insurance coverage, recoveries from
other PRPs and the indemnification obligations of DSF's former shareholders will
be adequate to cover any liability or expenses of DSF arising from the Zellwood
Suit.
The Company is involved in various other legal proceedings that have arisen in
the ordinary course of business. While it is not possible to predict the outcome
of such proceedings with certainty, in the opinion of the Company's management,
all such proceedings are either adequately covered by insurance or, if not so
covered, should not ultimately result in any liability which would have a
material adverse effect on the financial position, liquidity or results of
operations of the Company.
ITEM 2. RECENT SALES OF UNREGISTERED SECURITIES
Set forth below is certain information concerning all sales of securities by
the Company during the quarter ended June 28, 1998 that were not registered
under the Securities Act of 1933, as amended (the "Securities Act").
The Company acquired the stock of Shipshewana Pallet Co., Inc. and Valley
Pallets, Inc. and its related companies on May 21, 1998 and June 17, 1998,
respectively, for aggregate consideration consisting of approximately $9.0
million in cash and 576,000 shares of the Company's common stock, par value $.01
per share. The shares of common stock were issued without registration under the
Securities Act in reliance on the exemption provided by Section 4(2) of the
Securities Act.
22
<PAGE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) EXHIBITS
Exhibit
No.
---
27.0 Financial Data Schedule
b) Reports on Form 8-K
On February 27, 1998, the Company filed a Current Report on Form 8-K, which
was amended on Form 8-K/A on April 28, 1998, to report the Company's acquisition
of CDR and Acme in two separate transactions on February 12, 1998 and February
23, 1998, respectively. CDR was accounted for as a purchase and Acme was
accounted for as a pooling-of-interests.
23
<PAGE>
SIGNATURE
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.
PALEX, INC.
Date: August 11, 1998 By: /s/ Casey A. Fletcher
---------------------
Casey A. Fletcher
Chief Accounting Officer
24
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