<PAGE>
FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1997
------------------
Commission file number 1-13293
-------
SunSource Inc.
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 23-2874736
- ------------------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
3000 One Logan Square
Philadelphia, Pennsylvania 19103
- ---------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
(215) 282-1290
----------------------------------------------------
(Registrant's telephone number, including area code)
Not Applicable
----------------------------------------------------
(Former name, former address and former fiscal year,
if changed from last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES ___ NO _X_
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practical date.
Common Stock, $.01 Par Value--6,418,936 shares as of November 13, 1997.
Page 1 of 21
<PAGE>
SUNSOURCE INC.
INDEX
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION PAGE(S)
<S> <C>
Item 1. Consolidated Financial Statements
Consolidated Balance Sheets as of September 30, 1997,
(Unaudited) and December 31, 1996 3
Consolidated Statements of Income for the Three Months
ended September 30, 1997 and 1996 (Unaudited) 4
Consolidated Statements of Income for the Nine Months
ended September 30, 1997 and 1996 (Unaudited) 5
Consolidated Statements of Cash Flows for the
Three Months ended September 30, 1997 and 1996 (Unaudited) 6
Consolidated Statements of Cash Flows for the
Nine Months ended September 30, 1997 and 1996 (Unaudited) 7
Consolidated Statements of Changes in Partners' Capital/
Shareholders' Deficit for the period ended September 30,
1997 8
Notes to Consolidated Financial Statements (Unaudited) 9-12
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 13-19
PART II. OTHER INFORMATION 20
SIGNATURES 21
</TABLE>
Page 2 of 21
SUNSOURCE INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(dollars in thousands, except for share and interest amounts)
<TABLE>
<CAPTION>
September 30,
1997 December 31,
ASSETS (Unaudited) 1996
------------ ------------
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 2,674 $ 1,666
Accounts and notes receivable, net 90,923 78,578
Inventories 99,872 102,396
Deferred income taxes 11,402 -
Other current assets 4,236 4,672
-------- --------
Total current assets 209,107 187,312
Property and equipment, net 21,285 21,409
Goodwill 63,118 43,036
Other intangibles 886 667
Deferred income taxes 4,471 5,007
Cash surrender value of life insurance policies 5,535 4,566
Other assets 601 558
-------- --------
Total assets $305,003 $262,555
======== ========
LIABILITIES, PARTNERS' CAPITAL, GUARANTEED PREFERRED
BENEFICIAL INTERESTS AND STOCKHOLDERS' DEFICIT
Current liabilities:
Accounts payable, trade $ 55,385 $ 48,557
Notes payable 1,099 2,670
Current portion of senior notes - 6,395
Current portion of capitalized lease obligations 135 107
Distributions payable 17,557 1,857
Accrued expenses:
Salaries and wages 6,393 5,696
Interest on senior notes 13 473
Management fee due the general partner - 3,330
Income and other taxes 4,617 2,695
Other accrued expenses 18,551 14,751
-------- --------
Total current liabilities 103,750 86,531
Senior notes 60,000 57,539
Bank revolving credit 17,000 11,000
Capitalized lease obligations 573 504
Deferred compensation 9,994 8,644
Other liabilities 792 3,718
-------- --------
Total liabilities 192,109 167,936
-------- --------
Commitments and contingencies
Guaranteed preferred beneficial interests in the
Corporation's junior subordinated debentures 115,991 -
-------- --------
Partners' capital:
General partner - 960
Limited partners:
Class A interests; 11,099,573 outstanding - 67,642
Class B interests; 21,675,746 outstanding - 29,040
Class B interests held in treasury - (1,514)
Cumulative foreign translation adjustment - (1,509)
-------- --------
Total partners' capital - 94,619
-------- --------
Stockholders' deficit:
Preferred stock, $.01 par, 1,000,000 shares
authorized, none issued - -
Common stock, $.01 par, 20,000,000 shares authorized,
6,418,936 shares issued and outstanding 64 -
Accumulated deficit (1,485) -
Cumulative foreign translation adjustment (1,676) -
-------- --------
Total stockholders' deficit (3,097) -
-------- --------
Total liabilities, partners' capital,
guaranteed preferred beneficial interests
and stockholders' deficit $305,003 $262,555
======== ========
</TABLE>
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Page 3 of 21
<PAGE>
SUNSOURCE INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
FOR THE THREE MONTHS ENDED
(dollars in thousands, except for common share amounts)
<TABLE>
<CAPTION>
September 30, September 30,
1997 1996
---- ----
<S> <C> <C>
Net sales $178,540 $ 167,125
Cost of sales 105,749 99,655
-------- -----------
Gross profit 72,791 67,470
-------- -----------
Operating expenses:
Selling, general and administrative expenses 59,517 55,033
Management fee to general partner 840 840
Depreciation 1,006 915
Amortization 452 499
-------- -----------
Total operating expenses 61,815 57,287
-------- -----------
Transaction and other costs related to Conversion 2,428 -
-------- -----------
Income from operations 8,548 10,183
Interest income 25 16
Interest expense 1,797 1,779
Other expense, net (63) (37)
-------- -----------
Income before provision for income taxes 6,713 8,383
Income tax provision (benefit) (8,960) 97
-------- -----------
Income before extraordinary loss 15,673 8,286
Extraordinary loss from early extinguishment
of debt, net of deferred income tax
benefit of $951 (3,392) -
-------- -----------
Net income $ 12,281 $ 8,286
======== ===========
Net income allocated to partners:
General partner N/A $ 83
-----------
Class A limited partners N/A $ 3,052
-----------
Class B limited partners N/A $ 5,151
-----------
Net income per limited partnership interest:
- Class A interest N/A $0.27
- Class B interest N/A $0.24
Pro forma earnings per common share - See Note 2 $0.56
Weighted average number of outstanding
limited partnership interests:
- Class A interests N/A 11,099,573
- Class B interests N/A 21,675,746
</TABLE>
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Page 4 of 21
<PAGE>
SUNSOURCE INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
FOR THE NINE MONTHS ENDED
(dollars in thousands, except for common share amounts)
<TABLE>
<CAPTION>
September 30, September 30,
1997 1996
---- ----
<S> <C> <C>
Net sales $529,199 $ 489,517
Cost of sales 315,000 293,748
-------- ---------
Gross profit 214,199 195,769
-------- ---------
Operating expenses:
Selling, general and administrative expenses 178,173 164,231
Management fee to general partner 2,491 2,491
Depreciation 3,024 2,684
Amortization 1,358 1,449
-------- ---------
Total operating expenses 185,046 170,855
-------- ---------
Transaction and other costs related to Conversion 3,053 -
-------- ---------
Income from operations 26,100 24,914
Interest income 80 60
Interest expense 5,587 5,207
Other income (expense), net (83) 470
-------- ---------
Income before provision for income taxes 20,510 20,237
Income tax benefit (8,932) (372)
-------- ---------
Income before extraordinary loss 29,442 20,609
Extraordinary loss from early extinguishment
of debt, net of deferred income tax
benefit of $951 (3,392) -
-------- ---------
Net income $ 26,050 $ 20,609
======== =========
Net income allocated to partners:
General partner N/A $ 206
---------
Class A limited partners N/A $ 9,157
---------
Class B limited partners N/A $ 11,246
Net income per limited partnership interest:
- Class A interest N/A $0.82
- Class B interest N/A $0.52
Pro forma earnings per common share - See Note 2 $1.35
Weighted average number of outstanding
limited partnership interests:
- Class A interests N/A 11,099,573
- Class B interests N/A 21,675,746
</TABLE>
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Page 5 of 21
<PAGE>
SUNSOURCE INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
FOR THE THREE MONTHS ENDED
(dollars in thousands)
<TABLE>
<CAPTION>
September 30, September 30,
1997 1996
<S> <C> <C>
Cash flows from operating activities:
Net income $ 12,281 $ 8,286
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 1,458 1,414
Extraordinary loss 4,343 -
Increase in cash value of life insurance (325) -
Transaction and other costs related to Conversion 2,428 -
Provision (benefit) for deferred compensation 561 (39)
Deferred income tax benefit (10,206) (37)
Changes in current operating items:
Decrease in accounts and notes receivable 4,135 65
Decrease (increase) in inventories 1,697 (3,004)
Decrease (increase) in other current assets 465 (341)
Increase in accounts payable 2,020 1,372
Increase (decrease) in accrued interest (460) 1,561
Decrease in accrued restructuring charges
and transaction costs (1,834) -
Increase in other accrued liabilities 1,446 212
Other items, net (1,087) 128
-------- -------
Net cash provided by operating activities 16,922 9,617
-------- -------
Cash flows from investing activities:
Payment for purchase of assets (704) -
Proceeds from sale of property and equipment 265 18
Investment in life insurance policies (316) (100)
Capital expenditures (1,210) (781)
Other, net (58) (11)
-------- -------
Net cash used for investing activities (2,023) (874)
-------- -------
Cash flows from financing activities:
Early extinguishment of senior notes (63,934) -
Proceeds from issuance of senior notes 60,000 -
Cash distributions to partners (5,105) (5,106)
Prepayment penalty (4,278) -
Repayments under bank credit agreements, net (4,000) (3,000)
Repayments under other credit facilities, net (311) (350)
Principal payments under capitalized lease obligations (36) -
Other, net (646) -
-------- -------
Net cash used for financing activities (18,310) (8,456)
-------- -------
Net (decrease) increase in cash and cash equivalents (3,411) 287
Cash and cash equivalents at beginning of period 6,085 1,442
-------- -------
Cash and cash equivalents at end of period $ 2,674 $ 1,729
======== =======
</TABLE>
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Page 6 of 21
<PAGE>
SUNSOURCE INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
FOR THE NINE MONTHS ENDED
(dollars in thousands)
<TABLE>
<CAPTION>
September 30, September 30,
1997 1996
---- ----
<S> <C> <C>
Cash flows from operating activities:
Net income $26,050 $20,609
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 4,382 4,133
Extraordinary loss 4,343 -
Increase in cash value of life insurance (653) -
Transaction and other costs related to Conversion 3,053 -
Provision for deferred compensation 2,184 898
Deferred income tax benefit (10,866) (903)
Changes in current operating items:
Increase in accounts and notes receivable (12,062) (10,580)
Decrease (increase) in inventories 2,643 (2,132)
Decrease in other current assets 436 112
Increase in accounts payable 6,592 10,342
Increase (decrease) in accrued interest (460) 1,561
Decrease in accrued restructuring charges
and transaction costs (3,402) -
Increase (decrease) in other accrued liabilities 1,400 (3,675)
Other items, net (597) 258
------- -------
Net cash provided by operating activities 23,043 20,623
------- -------
Cash flows from investing activities:
Payment for purchase of assets (704) (673)
Proceeds from sale of property and equipment 695 39
Investment in life insurance policies (316) (100)
Capital expenditures (3,252) (2,713)
Other, net (24) (80)
------- -------
Net cash used for investing activities (3,601) (3,527)
------- -------
Cash flows from financing activities:
Early extinguishment of senior notes (63,934) -
Proceeds from issuance of senior notes 60,000 -
Cash distributions to partners (13,901) (20,535)
Prepayment penalty (4,278) -
Borrowings under bank credit agreements, net 6,000 -
Repayments under other credit facilities, net (1,571) (732)
Principal payments under capitalized lease obligations (104) -
Other, net (646) -
------- -------
Net cash used for financing activities (18,434) (21,267)
------- -------
Net increase (decrease) in cash and cash equivalents 1,008 (4,171)
Cash and cash equivalents at beginning of period 1,666 5,900
------- -------
Cash and cash equivalents at end of period $ 2,674 $ 1,729
======= =======
</TABLE>
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Page 7 of 21
<PAGE>
SUNSOURCE INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN PARTNERS' CAPITAL / STOCKHOLDERS' DEFICIT
FOR THE PERIOD ENDED SEPTEMBER 30, 1997
(dollars in thousands)
<TABLE>
<CAPTION>
PARTNERS' CAPITAL
------------------------------------------------------------------------------
Cumulative
Foreign
General Class A Class B Class B Translation
Partner Limited Limited Treasury Adjustment
------- ------- ------- -------- ----------
<S> <C> <C> <C> <C> <C>
Partners' Capital - December 31, 1996 960 67,642 29,040 (1,514) (1,509)
Net income 260 9,157 16,633
Cash distributions paid and/or
declared to partners (150) (8,140) (6,730)
Change in Cumulative foreign
translation adjustment - - - - (167)
------ -------- ------- -------- --------
Partners' Capital - September 30, 1997 $1,070 $ 68,659 $38,943 $ (1,514) $ (1,676)
Conversion adjustments:
Common Stock (64)
Paid-in capital (1,070) (68,659)
Cumulative foreign translation adjustment 1,676
Retained Earnings (38,879) 1,514
Minority interest (a)
Class A exchange (b)
Goodwill - Minority interest (c)
------ -------- ------- -------- --------
Stockholders' Deficit - September 30, 1997 $ - $ - $ - $ - $ -
====== ======== ======= ======== ========
STOCKHOLDERS' DEFICIT
------------------------------------------------------------------------------
Cumulative
Foreign
Common Paid-in Accumulated Translation
Stock Capital Deficit Adjustment TOTAL
----- ------- ------- ---------- -----
Partners' Capital - December 31, 1996 - - - - 94,619
Net income 26,050
Cash distributions paid and/or
declared to partners (15,020)
Change in Cumulative foreign
translation adjustment - - - - (167)
------ -------- ------- -------- --------
Partners' Capital - September 30, 1997 - - - - $105,482
Conversion adjustments:
Common Stock 64 -
Paid-in capital 68,659 1,070 -
Cumulative foreign translation adjustment (1,676) -
Retained Earnings 37,365 -
Minority interest (a) 1,082 1,082
Class A exchange (b) (68,659) (61,761) (130,420)
Goodwill - Minority interest (c) 20,759 20,759
------ -------- -------- ------- ---------
Stockholders' Deficit - September 30, 1997 $64 $ - $ (1,485) $(1,676) $ (3,097)
====== ======== ======== ======= =========
</TABLE>
(a) Minority interest included as other liabilities by the Partnership.
(b) Each Class A limited partnership interest was exchanged for $1.30 in cash
plus .38 share of Trust Preferred Securities recorded at fair value based
on the price of the Class A interests upon close of trading on the New York
Stock Exchange on September 30, 1997 of $11.75. This fair value of $115,991
is recorded by the Corporation as Guaranteed Preferred Beneficial Interests
in the Corporation's Junior Subordinated Debentures.
(c) Goodwill related to the exchange of the GP minority interest (See Note 1).
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Page 8 of 21
<PAGE>
SUNSOURCE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands)
1. Basis of Presentation:
The accompanying financial statements include the consolidated accounts of
SunSource Inc. (the "Corporation"), its predecessor, SunSource L.P. (the
"Partnership"), and its wholly-owned subsidiaries including SDI Operating
Partners, L.P. (the "Company") and SunSource Capital Trust (the "Trust"). All
significant intercompany balances and transactions have been eliminated. The
Company is one of the largest wholesale distributors of industrial products and
related services in the United States. The Company's three business segments are
Industrial Services, Hardware Merchandising and Glass Merchandising.
On September 25, 1997, the limited partners of the Partnership approved the
conversion of the Partnership to a taxable C corporation (the "Conversion")
effective at the close of business on September 30, 1997. As a result of the
Conversion, each Class A limited partnership interest in the Partnership was
converted into $1.30 of cash and .38 share of 11.6% Guaranteed Preferred
Beneficial Interests in the Corporation's Junior Subordinated Debentures (the
"Trust Preferred Securities"), each Class B limited partnership interest in the
Partnership was converted into .25 share of common stock of the Corporation and
the general and limited partnership interests in the GP were exchanged with the
Corporation for 1,000,000 shares of its common stock (the "GP Exchange"). In
connection with the Conversion, the Company also refinanced all of its
outstanding senior notes and bank revolving credit.
The exchange represented by the GP's 1% interest in the Company (the "Minority
Interest") is subject to purchase accounting in accordance with Accounting
Principles Bulletin ("APB") No. 16. Accordingly, the excess of fair value of the
consideration received for the Minority Interest over its book value has been
recorded by the Corporation as goodwill at September 30, 1997, calculated as
follows:
Fair value of Minority Interest (i) $21,841
Less book value of the GP Minority Interest (ii) 1,082
-------
Excess over book value recorded as Goodwill $20,759
=======
(i) Represents 92.9% of the GP Exchange (the portion allocable to
the Minority Interest) valued at $23,500 in the aggregate for
1,000,000 shares of common stock, based on the closing price
of the Class B interest on the New York Stock Exchange at
September 30, 1997 of $5.875.
(ii) As reported on the pre-conversion balance sheet of the
Partnership at September 30, 1997.
The Trust was organized in connection with the Conversion for the purpose of (a)
issuing (i) its Trust Preferred Securities to the Corporation in consideration
of the deposit by the Corporation of Junior Subordinated Debentures in the Trust
as trust assets, and (ii) its Trust Common Securities to the Corporation in
exchange for cash and investing the proceeds thereof in an equivalent amount of
Junior Subordinated Debentures and (b) engaging in such other activities as are
necessary or incidental thereto. The Trust had no operating history prior to the
issuance of the Trust Preferred Securities. The terms of the Junior Subordinated
Debentures include those stated in the Indenture (the "Indenture") between the
Corporation and the indenture trustee, the form of which was filed as an exhibit
to Registration Statement No. 33319077 of the Corporation and the Trust, as
amended (the "Registration Statement").
Page 9 of 21
<PAGE>
SUNSOURCE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands)
1. Basis of Presentation, continued:
and those made part of the Indenture by the Trust Indenture Act. The Corporation
has guaranteed on a subordinated basis the payment of distributions on the Trust
Preferred Securities and payments on liquidation of the Trust and redemption of
Trust Preferred Securities (the "Preferred Securities Guarantee"). The sole
assets of the Trust are the Junior Subordinated Debentures and the obligations
of the Corporation under the Indenture, the Preferred Securities Guarantee and
the Junior Subordinated Debentures in the aggregate constitute a full and
unconditional guarantee by the Corporation of the Trust's obligations under the
Trust Preferred Securities.
The accompanying consolidated financial statements and related notes are
unaudited; however, in management's opinion all adjustments (consisting of
normal recurring accruals) considered necessary for the fair presentation of
financial position, income and cash flows for the periods shown have been
reflected. Results for the interim period are not necessarily indicative of
those to be expected for the full year.
Certain information in note disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
has been condensed or omitted pursuant to Form 10-Q requirements although the
Corporation believes that disclosures are adequate to make the information
presented not misleading. It is suggested that these financial statements be
read in conjunction with the consolidated financial statements and notes thereto
included in the Partnership's report on Form 10-K for the year ended December
31, 1996, and the Registration Statement.
2. Pro Forma Corporate Basis Financial Information:
As a result of the Conversion, historical net income of the Partnership is not
meaningful in the comparison to net income as recorded by the Corporation. In
order to present financial information for the current reporting periods that
will be comparable prospectively to corporate basis financial information, the
table below reconciles the partnership historical basis net income reported on
the Statements of Income included herein with corporate pro forma basis net
income which assumes the Conversion occurred at the beginning of the year for
each period presented and excludes non-recurring charges and credits related
solely to the Conversion.
Conversion of Class B Limited Partnership Interests to Common Stock:
- --------------------------------------------------------------------
Actual weighted average number of outstanding Class B Interests
during all periods before conversion 21,675,746
Conversion ratio - reverse split of one share of Common Stock for
four Class B interests. X .25
----------
Sub-total - pro forma outstanding common shares 5,418,936
Common shares received by the general and
limited partners of the GP 1,000,000
----------
Pro forma weighted average number of common shares 6,418,936
==========
Page 10 of 21
<PAGE>
SUNSOURCE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands)
2. Pro Forma Corporate Basis Financial Information,(continued):
Reconciliation of historical net income to pro forma basis net income:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
1997 1996 1997 1996
-------- -------- -------- ------
<S> <C> <C> <C> <C>
PARTNERSHIP BASIS HISTORICAL NET INCOME $ 12,281 $ 8,286 $26,050 $20,609
Eliminate extraordinary loss from
early extinguishment of debt, net
of deferred tax benefit of $951 3,392 -- 3,392 --
Eliminate historical income tax
provision (benefit) (8,960) 97 (8,932) (372)
Partnership actual historical income
before provision (benefit) for
income taxes and extraordinary loss
-------- ------- ------- -------
6,713 8,383 20,510 20,237
PRO FORMA ADJUSTMENTS:
Eliminate minority interest 124 84 263 208
Incremental interest expense (331) (331) (994) (994)
Distribution on guaranteed preferred
beneficial interests (3,058) (3,058) (9,174) (9,174)
Eliminate management fee to the GP 840 840 2,491 2,491
Eliminate transaction and other costs
related to Conversion 2,428 -- 3,053 --
Incremental amortization on goodwill (130) (130) (390) (390)
-------- ------- ------- -------
PRO FORMA C CORPORATION BASIS:
Income before provision for income taxes 6,586 5,788 15,759 12,378
Income tax provision 2,978 2,759 7,125 5,900
-------- ------- ------- -------
Pro forma net income $ 3,608 $ 3,029 $ 8,634 $ 6,478
======== ======= ======= =======
Pro forma earnings per common share $ .56 $ .47 $ 1.35 $ 1.01
======== ======= ======= =======
Pro forma weighted average common
shares outstanding 6,418,936 6,418,936 6,418,936 6,418,936
</TABLE>
3. Lines of Credit and Long-Term Debt:
On September 30, 1997, the Company entered into two new financing commitments
which together aggregate $150,000 from lenders. The new financing commitments
consist of a $60,000 five-year fixed rate senior note at 7.66% and a $90,000
five-year bank revolver with terms and conditions more favorable than the
Corporation's previous senior notes and bank credit lines including less
restrictive covenants and an effective interest rate reduction of approximately
1.00%. The Company utilized this debt capacity to fund transaction costs and
other payments related to the Conversion, refinance its current outstanding
senior notes of $63,934 as of September 30, 1997, including interest thereon and
related make-whole amount of approximately $4,343, and outstanding bank revolver
borrowings of $17,000 as of September 30, 1997.
Page 11 of 21
<PAGE>
SUNSOURCE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands)
3. Lines of Credit and Long-Term Debt, continued:
The new credit facilities provide working capital for reinvestment in the
Company's businesses and acquisition capital for future growth. As of September
30, 1997, the Company had $70,818 available under its new bank credit
facilities. The $79,182 outstanding balance consisted of Senior Notes totaling
$60,000, bank borrowings totaling $17,000, and Letter of Credit Commitments
aggregating $2,182.
The Company has another credit facility available in the amount of $500 for
letter of credit commitments only, of which no amount was outstanding as of
September 30, 1997. In addition, an indirect, wholly-owned Canadian subsidiary
of the Company has a $2,500 Canadian dollar line of credit for working capital
purposes of which no amount was outstanding at September 30, 1997.
4. Contingencies:
On February 27, 1996, a lawsuit was filed against the Company by the buyer of
its Dorman Products division for alleged misrepresentation of certain facts by
the Company upon which the buyer allegedly based its offer to purchase Dorman.
The complaint seeks damages of approximately $21,000.
On January 16, 1997, a holder of B Interests filed a purported class action
alleging that the terms of the Conversion unfairly transfer substantial equity
to the GP to the detriment of the B Interests and constitute a breach of
fiduciary duty. A second complaint containing substantially identical
allegations was filed by a limited partner on February 11, 1997. The cases were
consolidated and an amended complaint was filed on April 16, 1997, which added
claims for breach of contract and breach of covenant of good faith and fair
dealing. The Corporation and its co-defendants have reached an agreement in
principle to settle the class action.
Certain other legal proceedings are pending which are either in the ordinary
course of business or incidental to the Company's business. Those legal
proceedings incidental to the business of the Company are generally not covered
by insurance or other indemnity.
In the opinion of management, the ultimate resolution of these matters will not
have a material effect on the consolidated financial position, operations or
cashflows of the Company.
Page 12 of 21
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
- --------------------------------------------------------------------------------
General
SunSource Inc. is a publicly held corporation operating in the wholesale
industrial distribution industry through a subsidiary partnership, SDI Operating
Partners, L.P. (the "Company" or "SunSource"). The Company consists of a
headquarters operation and three business segments which are Industrial
Services, Hardware Merchandising and Glass Merchandising.
The Company's Industrial Services business is comprised of Inventory Management
and Technology Services. The Inventory Management operations provide maintenance
products and inventory management services to both original equipment
manufacturers and maintenance and repair facilities, including in-plant systems.
Technology Services provides fluid power products, engineering design, and
equipment repair services to a wide variety of industrial customers.
The Company's Hardware Merchandising segment consists of the Hillman division.
Hillman distributes hardware items and related products and also provides
merchandising systems service and support to both large and small hardware
retailers.
The Company's Glass Merchandising segment consists of the Harding division.
Harding provides glass products and point-of-sale related services such as the
installation and repair of automobile and flat glass.
Conversion to Corporate Form
On September 25, 1997, the limited partners of SunSource L.P. (the
"Partnership") approved the conversion of the Partnership to a corporation (the
"Conversion") effective at the close of business on September 30, 1997. In
connection with the Conversion, the Company refinanced its outstanding senior
notes and bank revolving credit.
The Company incurred $5.2 million of transaction and other costs related to the
Conversion ($4.7 million of transaction costs and a $.5 million charge for
deferred compensation accelerated as a result of the Conversion). Of this
amount, $1.7 million was paid in 1996, $1.6 million was paid through September
30, 1997, and $1.9 million was accrued as of September 30, 1997. These
non-recurring transaction costs are excluded from the financial statement
presentation included below.
Results of Operations
As a result of the Conversion, historical net income of the Partnership is not
meaningful in the comparison to net income as recorded by the Corporation. In
order to present financial information for the current reporting periods that
will be comparable prospectively to corporate basis financial information, the
following discussion of results of operations is based on pro forma statements
of income which assume the Conversion occurred at the beginning of the year for
each period presented and excludes non-recurring charges and credits related
solely to the Conversion (see Note 2 of Notes to Financial Statements).
Page 13 of 21
<PAGE>
Pro Forma Statements of Income
------------------------------
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
1997 1996 1997 1996
-------- -------- -------- ------
<S> <C> <C> <C> <C>
Net sales $178,540 $167,125 $529,199 $489,517
Cost of sales 105,749 99,655 315,000 293,748
-------- -------- -------- --------
Gross profit 72,791 67,470 214,199 195,769
-------- -------- -------- --------
Operating Expenses:
Selling, general and
administrative expenses 59,517 55,033 178,173 164,231
Depreciation 1,006 915 3,024 2,684
Amortization 582 629 1,748 1,839
-------- -------- -------- --------
Total operating expenses 61,105 56,577 182,945 168,754
-------- -------- -------- --------
Income from operations 11,686 10,893 31,254 27,015
Interest expense, net 2,103 2,094 6,501 6,141
Distributions on Guaranteed
Preferred Beneficial Interests 3,058 3,058 9,174 9,174
Other income, net 61 47 180 678
-------- -------- -------- --------
Income before provision
for income taxes 6,586 5,788 15,759 12,378
Income tax provision 2,978 2,759 7,125 5,900
-------- -------- -------- --------
Net income $ 3,608 $ 3,029 $ 8,634 $ 6,478
======== ======== ======== ========
Net income per common share $ .56 $ .47 $ 1.35 $ 1.01
======== ======== ======== ========
</TABLE>
Three Months Ended September 30, 1997 and September 30, 1996
------------------------------------------------------------
Net income on a pro forma corporate basis for the quarter ended September 30,
1997, was $3.6 million compared with $3.0 million in 1996, an increase of $.6
million or 20.0% over the third quarter of 1996.
Net sales increased $11.4 million or 6.8% over the third quarter of 1996
resulting primarily from an increase in the volume of products sold in existing
product markets as well as additional market penetration as a result of new
product lines and value-added services. Sales recorded in the third quarter of
1997 were $178.5 million compared with the third quarter of 1996 of $167.1
million.
Sales increases (decreases) by business segment are as follows:
Sales Increase (Decrease)
------------------------
Amount %
------ ---
Industrial Services
Technology Services $ 5.5 million 7.5 %
Inventory Management 4.2 million 10.4 %
-------
Total Industrial Services 9.7 million 8.5 %
Hardware Merchandising 1.8 million 6.3 %
Glass Merchandising (.1)million (.5)%
--------
Total Company $ 11.4 million 6.8 %
========
Page 14 of 21
<PAGE>
The increase in sales in the Inventory Management divisions is comprised of
sales growth from maintenance products of $1.2 million or 3.7%, and new in-plant
inventory management programs of $3.0 million or 32%. The sales increase in the
Technology Services divisions is due primarily to continued strengthening in
existing markets while the increase in the Hardware Merchandising segment is
primarily the result of expansion into non-hardware products such as keys;
letters, numbers and signs; and rope and chain.
The decline in sales volume in the Glass Merchandising Segment is attributable
to decreases in wholesale glass and other product line sales aggregating $.7
million, offset by increases in retail auto glass, contract and other retail
sales of $.6 million.
Cost of sales increased $6.1 million or 6.1% from the third quarter of 1996, due
primarily to increased sales levels in the comparison period. The 1996 period
also reflects a reclassification of $.6 million in costs from selling, warehouse
and delivery and general and administrative expense (S,G&A) to cost of sales
which is consistent with accounting initiated in 1997 within the Technology
Services divisions.
Gross margins were 40.8% in the third quarter of 1997 compared with 40.4% in the
third quarter of 1996, comprised by business segment as follows:
3rd Quarter
1997 1996
---- ----
Industrial Services
Technology Services 26.2% 25.8%
Inventory Management 57.7% 60.5%
Total Industrial Services 37.5% 38.0%
Hardware Merchandising 53.6% 50.0%
Glass Merchandising 41.2% 39.9%
The erosion in gross margin in the Inventory Management divisions of Industrial
Services is due mainly to competitive pricing pressures and changes in sales mix
as a result of new inventory management programs.
Gross margins in the Hardware Merchandising segment increased primarily due to
reduced packaging costs from the comparable 1996 period.
The increase in gross margins in the Glass Merchandising segment is due
primarily to improved purchasing management in auto and flat glass and exiting
from low-margin product lines.
S,G&A expenses increased by $4.5 million or 8.2% over the third quarter of 1996.
Selling expenses increased only $.8 million or 3.0%, comprised of increases in
Hardware Merchandising to support expanded sales and Glass Merchandising as a
result of increased marketing efforts in retail glass, offset by a slight
decrease in the Industrial Service segment, reflecting realignment and
restructuring efforts within the sales force. Warehouse and delivery expenses
increased $.8 million or 7.1% to support increased sales in the 1997 quarter.
General and administrative expenses increased $2.9 million or 17.2% consisting
of: (i) an increase of $1.7 million to support the overall increase in 1997
sales levels and the increased number of system accounts in the Industrial
Services segment, and (ii) an increase of $1.2 million in corporate expenses
compared to the 1996 quarter which included an expense reduction of $.8 million
as a result of incentive-based compensation plans and a non-recurring reduction
in insurance reserves of $.4 million.
Page 15 of 21
<PAGE>
S,G&A expenses as a percentage of sales increased .4% in the third quarter of
1997 from the third quarter of 1996, as follows:
3rd Quarter
1997 1996
---- ----
Selling Expenses 15.9% 16.5%
Warehouse and Delivery Expenses 6.3% 6.3%
General and Administrative Expenses 11.2% 10.1%
----- -----
Total S,G&A Expenses 33.4% 32.9%
===== =====
Interest expense increased only marginally in the comparison period due to no
significant change in average borrowing levels and rates.
Commencing on October 1, 1997, the Company incurs federal, state and local
income taxes on its domestic operations and foreign income taxes on its Canadian
and Mexican Operations as determined in accordance with Statement of Financial
Accounting Standard No. 109 ("SFAS #109"). Current and long-term deferred income
taxes represent differences between the book and tax bases of assets and
liabilities as classified on the Company's balance sheet. The Company's pro
forma provision for income taxes in the third quarter of 1997 increased $.2
million from the third quarter of 1996 due to higher income levels in the 1997
period, offset by a decline in the Company's book effective tax rate from 47.7%
in the 1996 period to 45.2% in the comparable 1997 period.
Net income on a pro forma corporate basis per common share was $.56 for the
quarter ended September 30, 1997 compared with $.47 for the 1996 period.
Nine Months Ended September 30, 1997 and September 30, 1996
-----------------------------------------------------------
Net income on a pro forma corporate basis for the nine months ended September
30, 1997, was $8.6 million compared with $6.5 million in 1996, an increase of
$2.1 million or 32.3% over the 1996 period.
Net sales increased $39.7 million or 8.1% over the first nine months of 1996
resulting primarily from an increase in the volume of products sold in existing
product markets as well as additional market penetration from new product lines
and value-added services. Sales recorded in the first nine months of 1997 were
$529.2 million compared with the first nine months of 1996 of $489.5 million.
Sales increases (decreases) by business segment are as follows:
Sales Increase (Decrease)
-------------------------
Amount %
Industrial Services
Technology Services $ 18.3 million 8.1 %
Inventory Management 13.6 million 11.7 %
-------
Total Industrial Services 31.9 million 9.3 %
Hardware Merchandising 9.9 million 12.4 %
Glass Merchandising (2.1)million (3.0)%
--------
Total Company $ 39.7 million 8.1 %
========
The increase in sales in the Inventory Management divisions is comprised of
sales growth from new in-plant inventory management programs of $9.1 million or
35.8% and in maintenance products of $4.5 million or 4.9%. The sales increase in
the Technology Services divisions is due primarily to continued strengthening in
existing markets while the increase in the Hardware Merchandising segment is
primarily the result of expansion into non-hardware products such as keys;
letters, numbers and signs; and rope and chain.
Page 16 of 21
<PAGE>
The decline in sales volume in the Glass Merchandising Segment is attributable
to decreases in wholesale glass and other product line sales aggregating $2.7
million, offset by an increase in retail automotive glass sales of $.6 million.
Cost of sales increased $21.3 million or 7.2% from the first nine months of
1996, due primarily to increased sales levels in the comparison period. The 1996
period also reflects a reclassification of $1.8 million in costs from S,G&A to
cost of sales which is consistent with accounting initiated in 1997 within the
Technology Services divisions.
Gross margins were 40.5% in the first nine months of 1997 compared with 40.0% in
the 1996 period, comprised by business segment as follows:
Nine Months
-----------
1997 1996
---- ----
Industrial Services
Technology Services 26.1% 25.7%
Inventory Management 58.6% 61.4%
Total Industrial Services 37.5% 37.9%
Hardware Merchandising 52.8% 49.9%
Glass Merchandising 40.8% 38.4%
The improvement in gross margin in the Technology Services divisions of
Industrial Services is due primarily to labor efficiencies in its service and
repair business and lower freight costs. The erosion in gross margin in the
Inventory Management divisions of Industrial Services is due mainly to
competitive pricing pressures and changes in sales mix as a result of new
inventory management programs.
Gross margins in the Hardware Merchandising segment increased due primarily to a
significant reduction in packaging costs from the comparable 1996 period.
The increase in gross margins in the Glass Merchandising segment is due
primarily to improved purchasing management in auto and flat glass, exiting from
low-margin product lines and efforts to improve margins in the wholesale flat
glass business.
S,G&A expenses increased by $13.9 million or 8.5% over the first nine months of
1996. Selling expenses increased $4.8 million or 6.0% comprised of increases in
Industrial Services and Hardware Merchandising to support expanded sales and
Glass Merchandising as a result of increased marketing efforts in retail glass.
Warehouse and delivery expenses increased $2.6 million or 8.4% to support
increased sales in the 1997 period. General and administrative expenses
increased $6.5 million or 12.4% consisting of: (i) an increase of $5.3 million
to support the overall increase in 1997 sales levels and the increased number of
system accounts in the Industrial Services segment, and (ii) an increase of $1.3
million in corporate expenses compared to the 1996 period which included an
expense reduction of $.8 million as a result of incentive-based compensation
plans and a non-recurring reduction in insurance reserves of $.4 million.
S,G&A expenses as a percentage of sales increased marginally in the first nine
months of 1997 versus the first nine months of 1996 as follows:
Nine Months
1997 1996
---- ----
Selling Expenses 16.2% 16.5%
Warehouse and Delivery Expenses 6.2% 6.2%
General and Administrative Expenses 11.3% 10.8%
----- -----
Total S,G&A Expenses 33.7% 33.5%
===== =====
Depreciation expense increased by $.3 million in the comparison period due
primarily to an increase in the depreciable asset base.
Page 17 of 21
<PAGE>
Interest expense increased $.4 million in the comparison period due primarily to
a slight increase in borrowing levels.
Other income decreased by $.5 million in the comparison period due primarily to
favorable non-recurring legal settlements and post-closing adjustments from
divisions sold recorded in the 1996 period.
As previously discussed, the Company incurs federal, state, local and foreign
income taxes and provides for deferred income taxes as determined in accordance
with SFAS #109. The Company's pro forma provision for income taxes in the first
nine months of 1997 increased $1.2 million from the first nine months of 1996
due to higher income levels in the 1997 period, offset by a decline in the
Company's book effective income tax rate from 47.7% in the 1996 period to 45.2%
in the comparable 1997 period.
Net income on a pro forma corporate basis per common share was $1.35 for the
nine months ended September 30, 1997 compared with $1.01 for the 1996 period.
Liquidity and Capital Resources
On a historical basis, net cash provided by operations was $23.0 million in the
first nine months of 1997 compared with $20.6 million in the first nine months
of 1996, an increase of $2.4 million. This increase was due primarily to
increased net income of $5.4 million offset by increased working capital
investment in operations in the comparison period of approximately $.5 million,
and other non-cash items of $2.5 million. The Company's net interest coverage
ratio on a pro forma corporate basis (earnings before interest and taxes over
net interest expense and distributions on guaranteed preferred beneficial
interests) improved to 2.01X in the first nine months of 1997 from 1.81X in the
comparable prior year period.
The Company's cash position of $2.7 million as of September 30, 1997, increased
$1.0 million from the balance at December 31, 1996. Cash was provided during
this period primarily from operations of $23.0 million and proceeds from the
sale of property and equipment of $.7 million. Cash was used during this period
predominantly for capital expenditures, cash distributions to partners,
pre-payment penalty on senior notes, and other items of $3.3 million, $13.9
million, $4.3 million and $1.2 million, respectively.
The Company's working capital position of $105.4 million at September 30, 1997,
represents an increase of $4.6 million from the December 31, 1996 level of
$100.8 million on a partnership basis. The increase is attributable to an
increased reinvestment in working capital of $2.5 million and an increase in
distributions payable of $15.7 million, offset by a decrease in management fee
payable of $3.3 million, an increase in deferred tax asset of $11.4 million, a
decrease in accrued interest of $.5 million, a decrease in senior notes of $6.4
million, an increase in cash balance of $1.0 million and an increase in acquired
working capital of $.2 million. The Company's current ratio decreased to 2.02X
at September 30, 1997 from the December 31, 1996 level of 2.16X, principally due
to an increase in distributions payable of $14.4 million related to the
Conversion exchange package for the Class A partnership interests which was paid
in October 1997 through bank revolving credit.
Excluding this item, the Company's current ratio was 2.34X.
In the third quarter of 1997, the Company's Glass Merchandising segment acquired
the assets of two retail glass businesses for net cash consideration of $.7
million. Annual sales of the acquired businesses are $1.8 million.
As of September 30, 1997, the Company's total debt (including distributions
payable) as a percentage of its consolidated capitalization is 46.1% compared
with 45.6% on a partnership basis as of December 31, 1996.
Page 18 of 21
<PAGE>
The Company entered into two new financing commitments totaling $150.0 million
dated September 30, 1997, which provide capital for a five-year term beginning
on that date. The new financing arrangement consists of a Senior Note due 2002
in the amount of $60.0 million at a fixed rate of 7.66% and an amended credit
agreement which increases the aggregate availability under the existing
revolving line of credit to $90.0 million at variable borrowing rates of London
Interbank Offered Rate (LIBOR) plus 1.0% to 1.5%.
As of September 30, 1997, the Operating Partnership had $70.8 million available
under its new bank credit facilities. The $79.2 million outstanding consisted of
the aforementioned $60 million Senior Note, bank borrowings totaling $17.0
million, and Letter of Credit Commitments aggregating $2.2 million. In addition,
an indirect, wholly-owned Canadian subsidiary of the Operating Partnership has a
$2.5 million Canadian dollar line of credit for working capital purposes, of
which no amount was outstanding at September 30, 1997.
See Item 3 - Legal Proceedings, of Form 10-K dated December 31, 1996, and Note 3
of Notes to Consolidated Financial Statements, for the description of a lawsuit
with respect to the sale of the Partnership's Dorman Products Division and
lawsuits involving the Partnership's General Partner related to the Conversion.
See Item 1 of Part II of this report for information regarding the settlement of
the conversion-related lawsuits which is incorporated herein by reference.
Certain other legal proceedings are pending which are either in the ordinary
course of business or incidental to the Partnership's business. Those legal
proceedings incidental to the business of the Partnership are generally not
covered by insurance or other indemnity. In the opinion of management, the
ultimate resolution of these matters will not have a material effect on the
consolidated financial position, operations or cash flows of the Company.
Page 19 of 21
<PAGE>
PART II
OTHER INFORMATION
Item 1 - Legal Proceedings
The Corporation, the Partnership, the General Partner, Lehman/SDI, Lehman
Brothers Holdings Inc. and all of the directors of Lehman/SDI (collectively, the
"Defendants") have reached an agreement in principle to settle the class action
brought by two holders of B Interests which was reported in Form 10-K of the
Partnership for the year ended December 31, 1996. The settlement is subject to
confirmatory discovery by the plaintiffs' counsel, notice to members of the
class and approval by the Delaware Chancery Court. The terms of the settlement
are: (i) the parties acknowledge that certain modifications to the Conversion
Proposal and the disclosures in the Proxy Statement/Prospectus were made, in
material part, as a result of the filing of the complaint and subsequent
consultations with the plaintiffs' counsel; and (ii) management will recommend
to the Board of Directors of the Corporation the payment of an annual dividend
of $.40 per share on SunSource Common Stock, it being understood that (a)
dividends are subject to the discretion of the Board of Directors in accordance
with the ordinary course of business and applicable law (including, without
limitation, Sections 170 and 173 of the Delaware General Corporation Law), (b)
such dividend payment will depend, among other things, on earnings, financial
condition, capital requirements, availability of acquisition candidates, level
of indebtedness, contractual restrictions with respect to the payment of
dividends and other factors that the Board of Directors deems relevant, and (c)
there can be no assurance that the foregoing dividends will be adopted or
maintained by the Board of Directors. In addition, the defendants have agreed
that they will not oppose an award of fees and costs to counsel for the
plaintiffs not to exceed $350,000.
Items 2-6 - None
Page 20 of 21
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SUNSOURCE INC.
BY: /s/ Joseph M. Corvino BY: /s/ John J. Dabrowski
--------------------- ---------------------
Joseph M. Corvino John J. Dabrowski
Vice President - Finance Controller
(Chief Financial Officer) (Chief Accounting Officer)
DATE: November 14, 1997
Page 21 of 21
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the Balance
Sheet as of September 30, 1997 and the related statement of income for the
year-to-date ended September 30, 1997.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> SEP-30-1997
<CASH> 2,674
<SECURITIES> 0
<RECEIVABLES> 90,923
<ALLOWANCES> 2,438
<INVENTORY> 99,872
<CURRENT-ASSETS> 209,107
<PP&E> 52,596
<DEPRECIATION> 31,311
<TOTAL-ASSETS> 305,003
<CURRENT-LIABILITIES> 103,750
<BONDS> 60,000 <F1>
115,991 <F2>
0
<COMMON> 64
<OTHER-SE> (3097)
<TOTAL-LIABILITY-AND-EQUITY> 305,003
<SALES> 529,199
<TOTAL-REVENUES> 529,199
<CGS> 315,000
<TOTAL-COSTS> 185,046
<OTHER-EXPENSES> 83
<LOSS-PROVISION> 1,148
<INTEREST-EXPENSE> 5,587
<INCOME-PRETAX> 20,510
<INCOME-TAX> (8,932)
<INCOME-CONTINUING> 29,442
<DISCONTINUED> 0
<EXTRAORDINARY> (3,392)
<CHANGES> 0
<NET-INCOME> 26,050
<EPS-PRIMARY> 1.35
<EPS-DILUTED> 1.35
<FN>
<F1> Bonds represents all long-term debt for Senior Notes
<F2> Represents Guaranteed preferred beneficial interests in the Corporation's
junior subordinated debentures.
</FN>
</TABLE>
