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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
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(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934.
For the quarterly period ended September 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934.
For the transition period from to
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Commission File Number 333-39373
SOVEREIGN SPECIALTY CHEMICALS, INC.
(Exact Name of Registrant as Specified in Its Charter)
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DELAWARE
36-4176637
(State or Other Jurisdiction of Incorporation or Organization)
(IRS Employer Identification No.)
225 W. Washington St. - Ste. 2200, Chicago, IL 60606
(Address of Principal Executive Offices)
(Zip Code)
Registrant's Telephone Number, Including Area Code: (312) 419-7100
INDICATE BY CHECK MARK WHETHER THE REGISTRANT: (1) HAS FILED ALL REPORTS
REQUIRED TO BE FILED BY SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF
1934 DURING THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE
REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH
FILING REQUIREMENTS FOR THE PAST 90 DAYS. YES [X] NO [ ]
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SOVEREIGN SPECIALTY CHEMICALS, INC.
FORM 10-Q
TABLE OF CONTENTS
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PAGE NUMBER
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PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements:
Consolidated Balance Sheets at September 30, 1998 and
December 31, 1997......................................... 1
Consolidated Statements of Operations for the Three and Nine
Months Ended September 30, 1998 and 1997.................. 2
Consolidated Statements of Cash Flows for the Nine Months
Ended September 30, 1998
and 1997.................................................. 3
Notes to Consolidated Financial Statements.................. 4
ITEM 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations....................... 7
PART II. OTHER INFORMATION
6. Exhibit and Reports on Form 8-K.......................... 12
Signatures.................................................. 13
</TABLE>
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SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997
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(UNAUDITED)
<S> <C> <C>
ASSETS
Current assets:
Cash and Cash Equivalents................................. $ 4,299 $ 6,413
Accounts receivable, net.................................. 36,821 26,824
Inventories............................................... 19,740 21,042
Other current assets...................................... 5,042 5,483
-------- --------
Total current assets........................................ 65,902 59,762
Property, plant and equipment, net.......................... 48,564 48,308
Goodwill, net............................................... 102,401 123,177
Deferred financing costs, net............................... 10,203 11,137
Other assets................................................ 3,014 375
-------- --------
Total assets................................................ $230,084 $242,759
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................... $ 18,133 $ 13,008
Accrued expenses.......................................... 12,885 14,023
Current portion of long-term debt......................... 5,016 2,400
Current portion of capital lease obligations.............. 82 120
-------- --------
Total current liabilities................................... 36,116 29,551
Long-term debt, less current portion........................ 127,888 153,193
Capital lease obligations, less current portion............. 3,491 3,564
Other long-term liabilities................................. 6,817 4,398
Stockholder's equity:
Common stock, $.01 par value, 1,000 shares authorized,
issued and outstanding.................................... -- --
Additional paid-in capital.................................. 54,787 52,479
Accumulated deficit......................................... 851 (522)
Cumulative translation adjustment........................... 135 96
-------- --------
Total stockholder's equity.................................. 55,773 52,053
-------- --------
Total liabilities and stockholder's equity.................. $230,084 $242,759
======== ========
</TABLE>
See accompanying Notes to Consolidated Financial Statements
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SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
SEPTEMBER 30, 1998 SEPTEMBER 30, 1997
-------------------------- --------------------------
THREE MONTHS NINE MONTHS THREE MONTHS NINE MONTHS
ENDED ENDED ENDED ENDED
------------ ----------- ------------ -----------
(UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
Net Sales..................................... $55,445 $158,115 $42,999 $86,158
Cost of Goods Sold............................ 37,721 107,683 29,172 59,610
------- -------- ------- -------
Gross Profit.................................. 17,724 50,432 13,827 26,548
Selling, general and administrative
expenses.................................... 11,436 34,514 9,480 18,540
------- -------- ------- -------
Operating income.............................. 6,288 15,918 4,347 8,008
Other income, (expense)
Interest income............................. 88 279 -- --
Interest expense............................ (3,738) (11,545) (2,924) (4,772)
Loss on sale of business.................... -- (1,110) -- --
------- -------- ------- -------
Other (expense), net.......................... (3,650) (12,376) (2,924) (4,772)
Income before income taxes and extraordinary
loss........................................ 2,638 3,542 1,423 3,236
Income taxes.................................. 1,238 1,992 1,225 1,300
------- -------- ------- -------
Income before extraordinary loss.............. 1,400 1,550 198 1,936
Extraordinary loss (net of tax benefit)....... -- (176) (837) (837)
------- -------- ------- -------
Net income (loss)............................. $ 1,400 $ 1,374 $ (639) $ 1,099
======= ======== ======= =======
Pro forma (See Note 6):
Income before income taxes and extraordinary
loss, as stated............................. $ 1,423 $ 3,236
Income taxes:
Income taxes as stated...................... 1,225 1,300
Additional pro forma income taxes........... (656) (6)
------- -------
Net income before extraordinary loss.......... 854 1,942
Extraordinary loss (net of tax benefit)....... 837 837
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Net income.................................... $ 17 $ 1,105
======= =======
</TABLE>
See accompanying Notes to Consolidated Financial Statements
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SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
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SEPTEMBER 30, 1998 SEPTEMBER 30, 1997
------------------ ------------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C>
OPERATING ACTIVITIES
Net Income............................................... $ 1,374 $ 1,099
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization.......................... 6,907 4,321
Amortization of deferred financing costs............... 881 761
Extraordinary loss..................................... 176 1,387
Changes in operating assets and liabilities:
Accounts receivable................................. (11,321) (3,533)
Inventories......................................... (277) (290)
Prepaid expenses and other current assets........... 230 317
Other assets........................................ (2,469) --
Accounts payable.................................... 5,690 (485)
Accrued expenses and other.......................... (673) 1,331
-------- ---------
Net cash provided by operating activities................ 518 4,907
INVESTING ACTIVITIES
Proceeds from sale of business......................... 35,258 --
Acquisition of businesses (net of acquired cash)....... (17,658) (132,806)
Purchase of property, plant and equipment.............. (2,109) (1,519)
-------- ---------
Net cash provided by (used in) investing activities...... 15,491 (134,325)
FINANCING ACTIVITIES
Deferred financing costs............................... (282) (12,765)
Capital contributions.................................. 2,308 33,800
Issuance of acquisition related notes.................. 2,800 --
Proceeds from environmental settlement................. 2,693 --
Payments on capital lease obligations.................. (111) (292)
Proceeds from revolving credit facility................ 6,511 4,078
Payments on revolving credit facility.................. (2,000) (5,136)
Proceeds from long-term debt........................... -- 160,565
Payments on long-term debt............................. (30,081) (47,300)
Distributions to partners.............................. -- (269)
-------- ---------
Net cash used in financing activities.................... (18,162) (132,681)
Effect of exchange rates on cash......................... 39 (27)
-------- ---------
Net increase in cash and cash equivalents................ (2,114) 3,236
Cash and cash equivalents at beginning of period......... 6,413 104
-------- ---------
Cash and cash equivalents at end of period............... $ 4,299 $ 3,340
======== =========
Supplemental cash flow information:
Cash paid for interest.............................. $ 12,398 $ 2,596
Cash paid for income taxes.......................... $ 815 $ 42
</TABLE>
See accompanying Notes to Consolidated Financial Statements
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SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1998
(DOLLARS IN THOUSANDS)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
REORGANIZATION AND BASIS OF PRESENTATION
Effective July 31, 1997, Sovereign Specialty Chemicals, L.P. (the Parent
Partnership) reorganized its corporate structure. The Parent Partnership
purchased the outstanding minority interests in its majority-owned subsidiaries
through the exchange of partnership units for the outstanding membership
interests in Sovereign Engineered Adhesives, L.L.C. (SEA) and common stock in
P&S Holdings, Inc. which were not previously owned. The acquisition of minority
interests was accounted for as a purchase in accordance with Accounting
Principles Board Opinion No. 16, "Business Combinations", and goodwill in the
amount of $990 was recognized. Concurrently, SEA was merged with and into SIA
Adhesives, Inc. (SIA), a newly formed C corporation and SEA was dissolved. Also,
P&S Holdings, Inc., was merged into its wholly owned subsidiary, Pierce &
Stevens Corp. (P&S). At the same time, Sovereign Specialty Chemicals, Inc.
(Sovereign) was formed as a wholly owned subsidiary of the Parent Partnership.
The initial capitalization of Sovereign was comprised of a $33.8 million
contribution from investors through the Parent Partnership. Additionally, the
Parent Partnership contributed its wholly owned subsidiaries, SIA and P&S, to
Sovereign. The contribution of the Subsidiaries was accounted for at historical
book value (after accounting for the purchase of the minority interests) in a
manner similar to pooling of interests. Upon the consummation of the
transactions, SIA, P&S and the Acquired Companies (as defined below) became
wholly owned subsidiaries of Sovereign.
On August 5, 1997, the Company purchased from Laporte plc, the net assets
of Laporte Construction Chemicals North America, Inc., Evode-Tanner Industries,
Inc., and Mercer Products Company, Inc. (the Division). The Division was
affiliated by common control as wholly owned subsidiaries of Laporte plc. The
purchase price of the Division was approximately $133.3 million including
expenses relating to the purchase of $1.5 million and net acquired cash of $707.
The purchase was funded through the issuance of $125 million of subordinated
notes payable, a $30 million term note, and a capital contribution of $33.8
million. Excess of funding over the purchase price was used to retire long-term
debt.
The acquisitions were accounted for as purchases and, as such; the results
of the operations of the Division from August 5, 1997 (date of acquisition) have
been included in the consolidated results of operations of the Company. Goodwill
recognized in connection with the acquisitions was approximately $108 million
and is being amortized over a twenty-five year period. The Companies that
formerly comprised the Division are wholly owned subsidiaries of Sovereign
Specialty Chemicals, Inc. and operate as OSI Sealants, Inc. (OSI), Tanner
Chemicals, Inc. (Tanner), and Mercer Products Company, Inc. (Mercer).
On April 21, 1998, the Company sold Mercer to Burke Industries, Inc.. On
June 12, 1998, the Company acquired the net assets of the Coatings and Adhesives
Division of K.J. Quinn & Co., Inc. (C&A Division), a developer and manufacturer
of specialty polyurethane formulations for adhesives and coatings. The C&A
Division has become an operating division of P&S. On August 3, 1998, the Company
acquired the PL Adhesives and Sealants product line (the "Product Line") from
ChemRex Inc. in Shakopee, Minnesota and merged it into OSI. The Product Line
consists of solvent-based and polyurethane adhesives and sealants.
Unless otherwise noted, all references to "the Company" herein refer to
Sovereign and its wholly owned subsidiaries.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements as of and for the period ended
September 30, 1998, include the accounts of the Company and its wholly-owned
subsidiaries, SIA, P&S, OSI, Tanner, Mercer (for the period
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SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
SEPTEMBER 30, 1998
(DOLLARS IN THOUSANDS)
prior to its disposition), Sovereign Specialty Chemicals, Pte. Ltd., a
Singapore-based sales office and the C&A Division and the Product Line (for the
period subsequent to their dates of acquisition). The financial statements for
the period ended September 30, 1997 are presented on a basis "as if" the Company
existed prior to July 31, 1997 and included the operations of P&S and SEA; and
OSI, Tanner, Mercer Sovereign Specialty Chemicals, Pte. Ltd. (for the periods
subsequent to their acquisition or inception for the period then ended. All
significant intercompany balances and transactions have been eliminated.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts reported in the financial
statements and accompanying notes. Actual results could differ from those
estimates.
INTERIM FINANCIAL INFORMATION
The unaudited interim consolidated financial statements of the Company, in
the opinion of management, reflect all necessary adjustments, consisting only of
normal recurring adjustments, for a fair presentation of results as of the dates
and for the interim periods covered by the financial statements. The results for
the interim periods are not necessarily indicative of the results of operations
to be expected for the entire year.
The unaudited interim consolidated financial statements have been prepared
in conformity with generally accepted accounting principles and reporting
practices. Certain information in footnote disclosures normally included in
financial statements prepared in accordance with generally accepted accounting
principles has been condensed or omitted pursuant to the rules and regulations
of the Securities and Exchange Commission; however the Company believes the
disclosures are adequate to make the information not misleading. The unaudited
interim consolidated financial statements contained herein should be read in
conjunction with the audited financial statements and notes thereto included in
our 1997 Annual Report on Form 10-K.
RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform to current
year presentation.
2. INVENTORIES
Inventories are summarized as follows:
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997
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<S> <C> <C>
Raw Materials.................................... $ 9,007 $10,908
Work in process.................................. 354 141
Finished Goods................................... 10,379 9,993
------- -------
$19,740 $21,042
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</TABLE>
3. SALE OF MERCER
Effective April 21, 1998, the Company sold Mercer to Burke Industries, Inc.
Net proceeds from the sale were approximately $35.3 million (sales price of
$36.2 million less selling expenses of $850). The book value of the net assets
sold was $36.4 million and the Company recognized a book loss on the sale of
$1.1 million before taxes. Proceeds from the sale were used by the Company to
pay down $30 million of senior bank debt, for the acquisition of the C&A
Division and for general corporate purposes.
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SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
SEPTEMBER 30, 1998
(DOLLARS IN THOUSANDS)
4. ACQUISITIONS
On June 12, 1998, the Company acquired the net assets of the C&A Division,
a Seabrook, New Hampshire developer and manufacturer of specialty polyurethane
formulations for adhesives and coatings. The C&A Division became an operating
division of P&S. The transaction was accounted for as a purchase. The Company
paid cash and issued $2.8 million in notes payable, $800 of which are current
liabilities. The purchase price exceeded the fair value of net assets acquired
by approximately $800 which is recorded as goodwill and is being amortized on a
straight-line basis over 25 years.
On August 3, 1998, the Company acquired the PL Adhesives and Sealants
product line (the "Product Line") from ChemRex Inc. in Shakopee, Minnesota and
merged it into OSI. The Product Line consists of solvent-based and polyurethane
adhesives and sealants.
5. NEW ACCOUNTING PRONOUNCEMENT
The Company adopted Statement of Financial Accounting Standards No. 130,
"Reporting Comprehensive Income" (SFAS 130) in 1998. This statement establishes
standards for reporting and display of comprehensive income and requires that
all components of comprehensive income be reported in a financial statement
having the same prominence as other financial statements. For the three and six
months ended June 30, 1998 and 1997, respectively, the calculation of
comprehensive income is as follows:
<TABLE>
<CAPTION>
SEPTEMBER 30, 1998 SEPTEMBER 30, 1997
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THREE MONTHS NINE MONTHS THREE MONTHS NINE MONTHS
------------ ----------- ------------ -----------
<S> <C> <C> <C> <C>
Net income (loss) as reported........... $1,400 $1,374 $ (639) $1,737
Add: Foreign currency translation
adjustment............................ 31 39 (68) (27)
------ ------ ------ ------
Comprehensive income.................... $1,431 $1,413 $ (707) $1,710
</TABLE>
6. INCOME TAXES
Prior to its restructuring on July 31, 1997 (Note 1), the consolidated
entity was composed of various types of entities including a limited partnership
and a limited liability company. Income tax liabilities for such entities
generally "pass through" to their owners. Subsequent to the restructuring, the
Company and its subsidiaries file a consolidated federal tax return. The
financial statements for the nine and three months ended September 30, 1997,
include pro forma income taxes as if the companies had been subject to income
taxes for the period presented. Amortization of goodwill related to an
acquisition structured to be tax-free is not deductible for tax purposes. The
amount of this amortization was approximately $1 million in the first half of
1998. This has the effect of increasing tax expense for the three and nine
months ended September 30, 1998. The tax effect of the book loss on the sale of
Mercer decreased income tax expense by $444 in the first nine months of 1998.
7. EXTRAORDINARY LOSS
The extraordinary loss of $176, net of the income tax benefit of $117,
relates to the write-off of deferred financing costs associated with the $30
million of senior bank debt extinguished on April 21, 1998.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
(DOLLARS IN THOUSANDS)
GENERAL
The Company exists to acquire and consolidate specialty chemical businesses
in the highly fragmented adhesives, sealants and coatings industry business
segment. The Company began operations in March 1996 with the acquisition of SIA,
a manufacturer of specialty adhesives used primarily in the automotive,
aerospace and general industrial markets. In August 1996, the Company acquired
Pierce & Stevens (P&S), a developer and manufacturer of specialty coatings and
adhesives for performance-oriented niche applications. In August 1997, the
Company acquired in a single transaction the net assets of Laporte Construction
Chemicals North America, Inc., Evode-Tanner Industries, Inc., and Mercer
Products Company, Inc. (the Division). These businesses manufacture, market and
distribute adhesives and sealants primarily utilized in housing repair,
remodeling and construction and industrial markets. On April 21, 1998, the
Company sold its stock in Mercer to Burke Industries, Inc. On June 12, 1998, the
Company acquired the net assets of the Coatings and Adhesives Division of K.J.
Quinn & Co., Inc. (the C&A Division), a developer and manufacturer of specialty
polyurethane formulations for adhesives and coatings. The C&A Division has
become an operating division of P&S. On August 3, 1998, the Company acquired the
PL Adhesives and Sealants product line (the "Product Line") from ChemRex, Inc.
and merged it into OSI. The Product Line consists of solvent-based and
polyurethane adhesives and sealants. The operating results of acquired
businesses have been included in the consolidated operating results of the
Company for all periods subsequent to their respective dates of acquisition.
RESULTS OF OPERATIONS
NINE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30,
1997
Net Sales. Net sales for the first nine months of 1998 were $158.1 million,
an increase of $71.9 million, or 83.5%, over the comparable period in 1997,
primarily due to the acquisition of the Division in August, 1997, the C&A
Division in June, 1998 and the Product Line in August, 1998, offset somewhat by
the sale of Mercer in April, 1998. Excluding acquisitions, net sales increased
$1.5 million or 2.6%. The sales increase was the result of increased sales for
industrial and flexible packaging applications partially offset by declines in
overprint coatings sales. Industrial sales increases were driven by increased
share in recreation vehicle adhesive applications and continued strong levels of
commercial aircraft production, offset by continued weakness in sales to
automotive OEM's due to design-outs and the effects of the strike at General
Motors. Sales for flexible packaging applications increased due to the combined
effects of market share gains in the United States and increased international
sales.
Cost of Goods Sold. Cost of goods sold was $107.7 million for the first
nine months of 1998, an increase of $48.1 million, or 80.6%, over 1997. As a
percentage of net sales, cost of goods sold decreased to 68.1% from 69.2% in the
same period of 1997 primarily as a result of the inclusion of the generally
higher gross margin Housing Repair, Remodeling and Construction applications
acquired with the Division in August 1997. Consequently, gross profit margin
increased to 31.9% from 30.2% in the first nine months of 1998. The improved
margin in 1998 was primarily the result of an improvement in the product mix
with increased sales of construction adhesives (the Division acquisition). Gross
profit margin, net of acquisitions, remained relatively constant at 29.5% of net
sales.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses for the nine months ended September 30, 1998 were $34.5
million, representing a $15.9 million, or 86.2%, increase from the same period
in 1997. As a percentage of net sales, selling, general and administrative
expenses increased to 21.8% for the nine months ended September 30, 1998 from
21.5% in 1997. Net of acquisitions, as a percentage of net sales, selling,
general and administrative expenses increased from 21.1% in 1997 to 22.8% in
1998. This is due primarily to an increase in foreign exchange losses resulting
primarily from operations in Mexico,
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management severances recorded in 1998 and the recording of a reserve for
expenses associated with potential acquisition activity which is not probable of
realization at September 30, 1998.
Operating Income. As a result of the above factors, operating income
increased $7.9 million and 98.7% from the same period in 1997.
EBITDA. Earnings before interest expense, taxes, depreciation and
amortization (EBITDA) were $22.8 million in 1998 compared to $12.3 for the same
period in 1997. EBITDA is calculated as net income plus interest expense, taxes,
depreciation, amortization, extraordinary loss and loss on sale of business.
EBITDA provides additional information for determining the Company's ability to
meet debt service requirements. EBITDA does not represent and should not be
considered as an alternative to net income, any other measure of performance as
determined by generally accepted accounting principles, as an indicator of
operating performance, as an alternative to cash flows from operating, investing
or financing activities or as a measure of liquidity.
Interest Expense. Interest expense was $11.5 million for the first nine
months of 1998 representing a $5.9 million, or 141.9%, increase over the
comparable period in 1997. This increase was the result of increased debt
incurred as a result of the acquisition of the Division.
Loss on Sale of Business. On April 21, 1998, the Company consummated a
stock purchase agreement for the sale of its Mercer Products Company, Inc.,
subsidiary to Burke Industries, Inc. Net proceeds from the sale were
approximately $35.3 million (sales price of $36.2 million less selling expenses
of $850). The Company recognized a book loss on the sale of $1.1 million.
Income Taxes. Income tax expense increased by $700 to $2.0 million in the
first nine months of 1998 over the comparable period in 1997 primarily due to
the fact that prior to its restructuring on July 31, 1997, the consolidated
entity was composed of various types of entities including a limited partnership
and a limited liability company. Income tax liabilities for such entities
generally "pass through" to their owners. Subsequent to the restructuring, the
Company and its subsidiaries file a consolidated federal tax return. See
Footnote 6 in the Notes to the Consolidated Financial Statements for pro forma
income taxes for the nine months ended September 30, 1997, as if the companies
had been subject to income taxes for the period presented.
The tax effect of the book loss on the sale of Mercer decreased income tax
expense by $444 in 1998. Amortization of goodwill related to an acquisition
structured to be tax-free is not deductible for tax purposes. The amount of this
amortization was approximately $1.5 million in 1998. This has the effect of
increasing tax expense for the nine months ended September 30, 1998.
Income before extraordinary loss. Income before extraordinary loss for the
first nine months of 1998 was $1,550 representing a $386 decrease from the
comparable period in 1997. This decrease was primarily the result of the factors
discussed above. Excluding the loss on the sale of Mercer, income before
extraordinary loss for the nine months ended September 30, 1998 was $2,660.
Extraordinary Loss (net of tax benefit). The extraordinary loss of ($176),
net of the income tax benefit of 117, on the extinguishment of the $30 million
Senior Term Loan on April 21, 1998, relates to the write-off of deferred
financing costs related to the Term Loan.
Net Income. Net income year to date in 1998 was $1,374 representing a $285
increase from the comparable period in 1997. This decrease was primarily the
result of the factors discussed above.
THREE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO THREE MONTHS ENDED SEPTEMBER
30, 1997
Net Sales. Net sales for the third quarter of 1998 were $55.5 million, an
increase of $12.5 million, or 28.9%, over the comparable period in 1997,
primarily due to the acquisition of the Division in August, 1997, Quinn in June,
1998 and the Product line in August, 1998, offset somewhat by the sale of Mercer
Products Co. in April, 1998. Excluding acquisitions, net sales increased 2.7% to
$22.3 million for the quarter ended September 30, 1998.
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Cost of Goods Sold. Cost of goods sold was $37.7 million for third quarter
of 1998, an increase of $8.5 million, or 29.3%, over 1997. Gross profit margin
for the quarter remained constant from the prior year at 32%. Net of
acquisitions, gross profit margins were at 30.0% for the quarters ended
September 30, 1998 and 1997, respectively.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses for the third quarter of 1998 were $11.4 million,
representing a $1.9 million, or 20.6%, increase from the same three-month period
in 1997. As a percentage of net sales, selling, general and administrative
expenses decreased to 20.6% from 22% in the third quarter in 1997. Net of
acquisitions, selling, general and administrative expenses as a percentage of
net sales was 23.7% for the third quarter of 1998 as compared to 21.3 for the
comparable period in 1997. See discussion of nine months ended variance for
primary reasons for increase.
Operating Income. As a result of the above factors, operating income for
the three months ended September 30, 1998 increased $1.9 million and 44.7% over
the same period in 1997.
EBITDA. Earnings before interest expense, taxes, depreciation and
amortization (EBITDA) were $8.5 million and $6.8 million for the three months
ended September 30, 1998 and 1997, respectively.
Interest Expense. Interest expense was $3.7 million for the third quarter
of 1998 representing a $0.8 million, or 27.8%, increase over the comparable
period in 1997. This increase was the result of increased debt incurred as a
result of the acquisition of the Division in August 1997.
Income Taxes. Income tax expense was $1.2 million for the third quarter of
1998 and 1997, respectively. Amortization of goodwill related to a portion of
the acquisition of the Division structured to be tax-free is not deductible for
tax purposes. The amount of this amortization was approximately $500 and $275 in
the third quarter of 1998 and 1997, respectively. This has the effect of
increasing tax expense for the three month periods presented.
Income before extraordinary loss. Income before extraordinary loss for
third quarter 1998 was $1,400 representing a $1,200 increase from the comparable
period in 1997. This increase was primarily the result of the factors discussed
above.
Extraordinary Loss (net of tax benefit). The extraordinary loss of ($837),
net of the income tax benefit, for the three months ended September 30, 1997,
related to the loss on early extinguishment of debt associated with the
Company's financial restructuring in August of 1997.
Net Income (Loss). Net income for the third quarter of 1998 was $1,400
representing a $761 increase form the comparable period in 1997. This increase
was primarily the result of the factors discussed above.
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operating activities totaled $518 in the first nine
months of 1998 as compared to net cash provided by operations of $4,907 for the
comparable period in 1997. The decrease in net cash from operating activities
was due primarily to the decrease in accrued expenses and other of $2.0 million
and the increase in accounts receivable and other assets of $7.8 million and
$2.5 million, respectively, over the same period in 1997. The increase in
accounts receivable was due primarily to increased sales volume primarily due to
acquisitions and the timing of those acquisitions in 1998 and 1997. The increase
in accounts receivable in 1997 was net of acquired accounts receivable of
approximately $16.0 million. The increase in other assets was due primarily to a
contribution by the Parent Partnership in 1998 of $2.9 million in long-term
notes receivable from management. These decreases in net cash were partially
offset by increased depreciation and amortization in 1998 of $2.6 million, due
primarily to increased fixed assets and goodwill associated with acquisitions
and an increase in accounts payable of $6.1 million.
Net cash provided by investing activities in the first nine months of 1998
was $15.5 million. Capital additions to property, plant and equipment totaled
$2.1 million in the first nine months of 1998. The sale of Mercer in April,
1998, provided $35.3 million and the acquisitions of Quinn in June, 1998 and PL
in August, 1998 resulted in the recognition of $17.7 million in additional net
assets to the Company. See the Notes to Consolidated Statements for additional
details regarding the acquisitions.
9
<PAGE> 12
Net cash used in financing activities was $18.2 million in 1998. The
Company used proceeds from the Merger sale to repay its $30.0 million Term Loan
on April 21, 1998. The company received $2.7 million from the previous owners of
a certain subsidiary as indemnification for environmental matters in May 1998
for which the Company established a long-term liability. The Company issued $2.8
million in notes payable as part of the purchased price in the Quinn acquisition
and borrowed $6.2 million under its revolving credit facility for the PL
acquisition in August, 1998. The Company subsequently repaid $2.0 million under
that facility prior to September 30, 1998. Effective January 1, 1998, the Parent
Partnership made a $2.3 capital contribution of long-term notes receivable from
management of the Company for their purchase of units of the Parent Partnership.
The Company's debt at June 30, 1998 consists of the $125.0 million Notes,
$888 under a $1.0 letter of credit supported working capital facility obtained
by its Singapore-based sales office, $4.2 million drawn under its revolving
credit facility and $2.8 million of notes payable related to the Quinn
acquisition, $800 of which are current liabilities. The Company has $24.8
million remaining under its $30.0 million Revolving Credit Facility at September
30, 1998 and an additional $20.0 million revolving credit commitment which is
supplemental to the Revolving Credit Facility available for acquisition
purposes. Subsequent to September 30, 1998, the Company repaid the $4.2 million
drawn under its Revolving Credit Facility.
The sale of Mercer in April 1998 demonstrates the Company's focus on the
adhesives, sealants and coatings industry, as Mercer was not a strategic fit for
the Company. Mercer is a manufacturer of extruded vinyl flooring profiles and
related products for the commercial and residential construction and renovation
markets. Mercer was acquired in August 1997, as part of Sovereign's acquisition
of the Division.
On June 12, 1998, the Company acquired the net assets of the Coatings and
Adhesives Division of K.J. Quinn & Co., Inc. (Quinn), a Seabrook, New Hampshire
developer and manufacturer of specialty polyurethane formulations for adhesives
and coatings. Quinn has become an operating division of P&S. The Company paid
cash and issued $2.8 million in notes payable as part of the purchase price,
$800 of which are current liabilities.
On August 3, 1998, the Company's wholly owned subsidiary, OSI Sealants,
Inc. acquired the PL Adhesives and Sealants product line and brand (the "Product
Line") from ChemRex Inc. in Shakopee, Minnesota. The Product Line consists of
solvent-based and polyurethane adhesives and sealants and will expand the
Company's offerings in the retail distribution channel for its Housing Repair,
Remodeling and Construction products. The Company borrowed $6.2 million under
its Revolving Credit Facility to finance the acquisition. Production of the
Product Line will be transferred to OSI's headquarters in Mentor, Ohio. It is
anticipated that this transfer will be completed early in the first quarter of
1999. Approximately $2.6 million of capital expenditures will be required in the
remainder of 1998 related to the integration of the Product Line into the
Company's Mentor, Ohio facility.
Interest payments on the Notes represent significant obligations of the
Company. The Notes require semiannual interest payments on February 1, and
August 1. The Company's remaining liquidity demands relate to capital
expenditures and working capital needs. The Company anticipates capital
expenditures totaling $5.3 million in 1998, including $2.6 million due to
acquisitions and approximately $600 of which relates to environmental
expenditures for which the Company has been indemnified pursuant to acquisition
agreements. Of this amount, $2.1 million had been spent through September 30,
1998. Exclusive of the impact of any future acquisitions, the Company does not
expect its capital expenditure requirements to increase materially in the
foreseeable future.
The Company's primary sources of liquidity are cash flows from operations
and borrowings under the Revolving Credit Facility. The Revolving Credit
Facility provides the Company with $30.0 million of borrowings, subject to
availability under its borrowing base. At September 30, 1998, the Company would
have been able to borrow $24.8 million under the Revolving Credit Facility with
$1 million of letters of credit outstanding. The repayment of the $30 million
Term Loan in April 1998, triggered an additional $20 million revolving credit
commitment which is supplemental to the Revolving Credit Facility. The Company
believes that, based on current and anticipated financial performance, cash flow
from operations and borrowings under the Revolving Credit Facility will be
adequate to meet anticipated requirements for capital expenditures,
10
<PAGE> 13
working capital and scheduled interest payments. However, the Company's capital
requirements may change, particularly if the Company should complete any
additional material acquisitions. The ability of the Company to satisfy its
capital requirements will be dependent upon the future financial performance of
the Company, which in turn will be subject to general economic conditions and to
financial, business and other factors, including factors beyond the Company's
control.
The Company's future operating performance and ability to repay or
refinance the Notes will also be subject to future economic conditions and to
financial, business and other factors, many of which are beyond the Company's
control.
YEAR 2000 COMPLIANCE BY THE COMPANY AND OTHERS
The Company has conducted a review of systems serving its financial and
operational activities and is in various stages of developing and implementing
plans to resolve all year 2000 issues. The potential effect of year 2000 issues
as it pertains to primary third-party vendors is also being considered. The
Company believes that, with modification of existing computer systems, updates
by vendors and conversion to new software in the ordinary course of business,
the year 2000 issue will not have a material impact on the Company's operations.
The costs of modifications and conversions are not expected to be material. The
Company estimates that this effort will be materially complete by September 30,
1999. There can be no assurance, however, that as a result of the failure of
major customers or suppliers to properly address their year 2000 issues, or as a
result of a delay or oversight in the Company's efforts, that the year 2000
issue will not have a material impact on the business and operations of the
Company.
PRIVATE SECURITIES LITIGATION REFORM ACT SAFE HARBOR STATEMENT
Some of the information presented in, or connection with, this report may
constitute "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995 that involve potential risks and
uncertainties. Our future results could differ materially from those discussed
here. Some of the factors that could cause or contribute to such differences
include:
Changes in economic and market conditions that impact the demand for
our products and services;
Risks inherent in international operations, including possible
economic, political or monetary instability;
The impact of new technologies and the potential effect of delays in
the development or deployment of such technologies; and,
The potential impact of issues related to Year 2000 software
compliance.
You should not place undue reliance on these forward-looking statements,
which are applicable only as of November 16, 1998. We have no obligation to
revise or update these forward-looking statements to reflect events or
circumstances that arise after November 16, 1998 or to reflect the occurrence of
unanticipated events.
11
<PAGE> 14
PART II -- OTHER INFORMATION
ITEM 6. EXHIBIT AND REPORTS ON FORM 8-K
(a) Exhibit
27 Financial Data Schedule
(b) Reports on Form 8-K
None
12
<PAGE> 15
SOVEREIGN SPECIALTY CHEMICALS, INC.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
SOVEREIGN SPECIALTY CHEMICALS, INC.
s/b Robert B. Covalt
--------------------------------------
Robert B. Covalt, Chairman, Chief
Executive Officer
and President
s/b Patrick W. Stanton
--------------------------------------
Date: November 16, 1998 Patrick W. Stanton
Principal Accounting Officer
13
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED SOVEREIGN
SPECIALTY CHEMICALS INC.'S SEPTEMBER 30, 1998 FINANCIAL STATEMENTS AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
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