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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 March 31, 1999
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 March 31, 1999 and December
31, 1998.................................................. 1
Unaudited Consolidated Statements of Income for the three
months ended March 31, 1999
and 1998.................................................. 2
Unaudited Consolidated Statements of Cash Flows for the
three months ended March 31, 1999 and 1998................ 3
Notes to Consolidated Financial Statements.................. 4
ITEM 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations....................... 5
PART II. OTHER INFORMATION
6. Exhibits and Reports on Form 8-K......................... 9
Signatures.................................................. 10
</TABLE>
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SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE INFORMATION)
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1999 1998
--------- ------------
(UNAUDITED)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $ 6,053 $ 5,863
Accounts receivable, net.................................. 38,186 32,710
Inventories, net.......................................... 23,955 19,822
Other current assets...................................... 4,613 5,359
-------- --------
Total current assets........................................ 72,807 63,754
Property, plant, and equipment, net......................... 50,507 49,497
Goodwill, net............................................... 99,924 101,205
Deferred financing costs, net............................... 9,618 9,913
Other assets................................................ 1,691 1,435
-------- --------
Total assets................................................ $234,547 $225,804
======== ========
LIABILITIES AND STOCKHOLDER'S EQUITY
Current liabilities:
Accounts payable.......................................... $ 19,836 $ 16,400
Accrued expenses.......................................... 9,801 13,452
Other current liabilities................................. 2,200 2,200
Current portion of long-term debt......................... 9,745 1,802
Current portion of capital lease obligations.............. 134 161
-------- --------
Total current liabilities................................... 41,716 34,015
Long-term debt, less current portion........................ 126,900 126,900
Capital lease obligations, less current portion............. 3,381 3,401
Other long-term liabilities................................. 6,970 7,294
Stockholder's equity:
Common stock, $.01 par value, 1,000 shares authorized,
issued and outstanding.................................... --
Additional paid-in capital.................................. 55,742 55,652
Retained earnings........................................... 2,329 949
Management notes receivable................................. (2,535) (2,535)
Cumulative translation adjustment........................... 44 128
-------- --------
Total stockholder's equity.................................. 55,580 54,194
-------- --------
Total liabilities and stockholder's equity.................. $234,547 $225,804
======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
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SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
--------------------------------
MARCH 31, 1999 MARCH 31, 1998
-------------- --------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C>
Net sales................................................... $55,632 $51,747
Cost of goods sold.......................................... 37,880 35,360
------- -------
Gross profit................................................ 17,752 16,387
Selling, general and administrative expenses................ 11,804 11,813
------- -------
Operating income............................................ 5,948 4,574
Interest expense, net....................................... 3,462 4,080
------- -------
Income before income taxes.................................. 2,486 494
Income taxes................................................ 1,106 419
------- -------
Net income.................................................. $ 1,380 $ 75
======= =======
</TABLE>
See accompanying Notes to Consolidated Financial Statements
2
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SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
--------------------------------
MARCH 31, 1999 MARCH 31, 1998
-------------- --------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C>
OPERATING ACTIVITIES
Net Income.................................................. $ 1,380 $ 75
Adjustments to reconcile net income to cash used in
operating activities:
Depreciation and amortization............................. 2,451 2,482
Amortization of deferred financing costs.................. 295 315
Compensation expense under management incentive plans..... 90 --
Changes in operating assets and liabilities:
Accounts receivable.................................... (5,476) (4,291)
Inventories............................................ (4,133) (1,062)
Prepaid expenses and other assets...................... 490 1,508
Accounts payable....................................... 3,436 3,729
Accrued expenses and other............................. (3,975) (4,474)
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Net cash used in operating activities....................... (5,442) (1,718)
INVESTING ACTIVITIES
Purchase of property, plant and equipment................. (2,180) (470)
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Net cash used in investing activities....................... (2,180) (470)
FINANCING ACTIVITIES
Deferred financing costs.................................. -- (123)
Payments on capital lease obligations..................... (47) (40)
Proceeds from revolving credit facilities................. 8,000 56
Payments on revolving credit facilities................... (57) --
------- -------
Net cash provided by (used in) financing activities......... 7,896 (107)
Effect of exchange rates on cash............................ (84) 12
------- -------
Net increase (decrease) in cash and cash equivalents........ 190 (2,283)
Cash and cash equivalents at beginning of period............ 5,863 6,413
------- -------
Cash and cash equivalents at end of period.................. $ 6,053 $ 4,130
======= =======
</TABLE>
See accompanying Notes to Consolidated Financial Statements
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SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1999
(Dollars in Thousands)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION AND PRINCIPLES OF CONSOLIDATION
The consolidated financial statements as of and for the periods ended March
31, 1999 and 1998, respectively, include the accounts of Sovereign Specialty
Chemicals, Inc. and its wholly-owned subsidiaries (the "Company"). All
significant intercompany balances and transactions have been eliminated.
Management and the Company's Chief Operating Decision Makers assess performance
and make decisions about resource allocation on a consolidated basis as the
Company is one operating segment. The Company operates in the adhesives sealants
and coatings segment of the specialty chemicals industry.
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 1998 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>
MARCH 31, DECEMBER 31,
1999 1998
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<S> <C> <C>
Raw Materials...................................... $ 8,823 $ 8,515
Work in process.................................... 378 326
Finished Goods..................................... 14,754 10,981
------- -------
$23,955 $19,822
======= =======
</TABLE>
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SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
MARCH 31, 1999
(Dollars in Thousands)
3. SUBSEQUENT EVENT
On April 20, 1999, the Company completed an asset purchase of the flexible
packaging coatings business from The Valspar Corporation for approximately $15.7
million. The allocation of the purchase price is currently being determined by
the Company.
4. COMPREHENSIVE INCOME
For the three months ended March 31, 1999 and 1998, respectively, the
calculation of comprehensive income is as follows:
<TABLE>
<CAPTION>
1999 1998
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Net income as reported..................................... $1,380 $75
Foreign currency translation adjustment.................... (84) 12
------ ---
Comprehensive income....................................... $1,296 $87
====== ===
</TABLE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
The Company exists to acquire, consolidate and operate specialty chemical
businesses in the highly fragmented adhesives, sealants and coatings segment of
the specialty chemicals industry. The Company began operations in March 1996
with the acquisition of SIA Adhesives (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. (OSI), Evode-Tanner Industries, Inc. (Tanner), and Mercer Products
Company, Inc. (Mercer) (collectively, "the Acquired Companies"). These
businesses manufacture, market and distribute adhesives and sealants primarily
utilized in housing repair, remodeling and construction and industrial markets.
In April 1998, the Company sold Mercer to Burke Industries, Inc. In June 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. In August 1998, the
Company acquired the PL Adhesives & Sealants brand and product line. The
operating results of acquired businesses have been included in the consolidated
operating results of the Company for all periods after their respective dates of
acquisition.
RESULTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 1999 COMPARED TO THREE MONTHS ENDED MARCH 31, 1998
Net Sales. Net sales for the first three months of 1999 were $55.6 million,
an increase of $3.9 million, or 7.5%, over the comparable period in 1998.
Excluding the net sales of Mercer for the first three months of 1998, net sales
increased 22.2% due to approximately 9% internal growth and approximately 13%
growth through acquisitions. The net sales increase was the primarily the result
of increased sales for housing repair, remodeling and construction applications,
and industrial and flexible packaging applications. Sales for construction
applications increased due to increased levels of housing starts and increased
market penetration. Industrial sales growth was driven by increased share in
recreation vehicle adhesives applications and continued strong levels of
commercial aircraft production, partially offset by decreased sales to
automotive OEM's due to design-outs. Net sales for flexible packaging
applications increased due to the combined effects of market share gains in the
United States and increased international sales.
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SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
MARCH 31, 1999
(Dollars in Thousands)
Cost of Goods Sold. Cost of goods sold increased 7.1% from first quarter
1998 to $37.9 million. Gross margin for the first quarter improved slightly to
31.9% from 31.7%.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses for the three months ended March 31, 1999 and 1998,
respectively were $11.8 million. As a percentage of net sales, selling, general
and administrative expenses decreased by 7.0% to 21.2% from 22.8% in the first
quarter of 1998 primarily due to expanding net sales as well as efficiencies
achieved in general and administrative expenses.
Interest Expense. Interest expense was $3.5 million for the first three
months of 1999 representing a 13% decrease from the comparable period in 1998.
This decrease was due primarily to the payment of the Company's $30.0 million
term loan in April 1998.
Income Taxes. Income tax expense increased by $.7 million to $1.1 million
in 1999 over 1998, due primarily to an increase in pretax income.
Net Income. Net income was $1.4 million, representing a 1740.0% increase
over 1998. This increase was primarily the result of the factors discussed
above.
YEAR 2000 READINESS DISCLOSURE
The Company is actively addressing the Year 2000 issue. The compliance
program is led by information technology staff at each operating company, with
assistance from the finance and manufacturing staffs and outside technology
consultants where necessary. Progress is being monitored by each operating
company president and reported to Company management.
The Company's Year 2000 efforts focus on three areas: information
technology ("IT") related systems and processes, such as operating systems,
applications and programs; embedded logic ("non-IT") systems and processes, such
as manufacturing machinery, telecommunications equipment and security devices;
and compliance efforts of third parties (such as customers, suppliers and
service providers). Within each of the IT and non-IT areas, the project spans
four phases; assessment of programs and devices to identify those that are
affected by the Year 2000 issue; development of remediation strategies; testing
such strategies; and implementing the solutions. The third party aspect of the
project includes, among other things, obtaining Year 2000 readiness
certifications, obtaining Year 2000 disclosures contained in SEC filings, and
where applicable, testing interfaced systems as well as having discussions with
critical vendors in order to determine and mitigate the risk to the Company from
third parties' failures to satisfactorily address their Year 2000 issues.
The Company has completed an assessment of its critical IT systems and, as
a result, the operating companies have decided to modify, upgrade or replace
portions of their systems. The remediation efforts achieved significant progress
to date, and remain underway. The Company expects that the remediation, testing
and implementation of all critical IT systems will be completed in the third
quarter of 1999. The Company is continuing the process of assessing and
remediating critical non-IT systems, as well, and expects that the assessment,
remediation, testing and implementation phases with respect to such systems will
be completed in the third quarter of 1999. The Company is currently confirming
the state of readiness of its primary vendors. Upon completion of this process,
management will develop and implement any necessary contingency plans.
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 have not been and are not
6
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SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS -- (CONTINUED)
MARCH 31, 1999
(Dollars in Thousands)
expected to be material. Many of the required tasks to determine compliance of
its systems have been completed at May 14, 1999 and the Company estimates that
its effort will be complete by the third quarter of 1999 for both its financial
and operational systems. 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. Because of the difficulty of assessing the Year 2000
compliance of such third parties, the Company considers the potential
disruptions caused by such parties to present the most reasonably likely
worst-case scenarios. Adverse effects on the Company could include business
disruption, increased costs, loss of sales and other similar ramifications.
LIQUIDITY AND CAPITAL RESOURCES
Net cash used in operating activities was $5.4 million in the first quarter
of 1999. Net income, depreciation and amortization, and the increase in accounts
payable provided approximately $4.1 million and $3.5 million of cash flow from
operations, respectively, for the three months ended March 31, 1999. The
increase in accounts payable is at a level consistent with that of the three
months ended March 31, 1998. These increases in cash flow from operations were
offset by increases in accounts receivable of $5.4 million, buildup of inventory
levels in the first quarter of $4.1 million and decreases in accrued expenses of
$3.9 million. The increases in accounts receivable in the first quarter of 1999
are consistent with the percentage sales increases year over year from first
quarter 1998, excluding Mercer which was sold in April 1998. The decrease in
accrued expenses in the first quarter is due primarily to the payment of
approximately $6.0 million of interest in February 1999 on the Company's $125.0
million Senior Subordinated Notes (Notes).
Net cash used in investing activities was $2.2 million and resulted from
capital additions to property plant and equipment in the first quarter of 1999.
Net cash provided by financing activities was $7.9 million for the three
months ended March 31, 1999.
The Company's bank debt at March 31, 1999 consists of $125.0 million Senior
Subordinated Notes (Notes), $8.0 million drawn under its Revolving Credit
Facility and $845 drawn under a $1.0 million facility obtained by its
Singapore-based sales office. The Company has a $21.1 million available under
its Revolving Credit Facility and an additional $20.0 million revolving credit
commitment which is supplemental to the Revolving Credit Facility available for
acquisition financing.
Interest payments on the Notes and under the Revolving Credit Facility
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 that capital expenditures will approximate $7.7 million in 1999,
including approximately $3.3 million of which relates to environmental
expenditures for which the Company has been or will be indemnified pursuant to
acquisition agreements. Exclusive of the impact of any future acquisitions, the
Company does not expect is 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 March 31, 1999, the Company would have
been able to borrow $21.1 million under the Revolving Credit Facility. The
Company has an additional $20.0 million revolving credit commitment which is
supplemental to the Revolving Credit Facility. On April 20, 1999, the Company
completed an asset purchase of the flexible packaging coatings business from the
7
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SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS -- (CONTINUED)
MARCH 31, 1999
(Dollars in Thousands)
Valspar Corporation for approximately $15.7 million. The Company funded the
acquisition through additional borrowings on its Revolving Credit Facility and
internally generated cash. 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, working capital and scheduled interest
payments (including interest payments on the Notes and amounts outstanding under
the Revolving Credit Facility). 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.
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;
Uncertainties relating to the Company's ability to consummate
its business strategy, including realizing synergies and cost
savings from the integration of its acquired businesses.
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 May 14, 1999. All written and oral
forward-looking statements attributable to the Company are expressly qualified
in their entirety by the foregoing factors. We have no obligation to revise or
update these forward-looking statements to reflect events or circumstances that
arise after May 14, 1999 or to reflect the occurrence of unanticipated events.
8
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PART II -- OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
27 Financial Data Schedule
(b) Reports on Form 8-K
None.
9
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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/ ROBERT B. COVALT
--------------------------------------
Robert B. Covalt, Chief Executive
Officer
/s/ JOHN R. MELLETT
--------------------------------------
John R. Mellett, Chief Financial
Date: May 14, 1999 Officer
10
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<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED SOVERIEGN
SPECIALTY CHEMICALS INC.'S MARCH 31, 1999 FINANCIAL STATEMENTS AND IS QUALIFIED
IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> MAR-31-1999
<CASH> 6053
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<RECEIVABLES> 38186
<ALLOWANCES> 0
<INVENTORY> 23955
<CURRENT-ASSETS> 72807
<PP&E> 59443
<DEPRECIATION> (8936)
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0
0
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<TOTAL-LIABILITY-AND-EQUITY> 234547
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<OTHER-EXPENSES> 11804
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