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EXHIBIT T3E-10
SAN JACINTO HOLDINGS INC.
SAFEGUARD BUSINESS SYSTEMS, INC.
1996 ANNUAL REPORT
[SAFEGUARD LOGO]
2
SAN JACINTO HOLDINGS INC. AND SUBSIDIARY
CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
TABLE OF CONTENTS
PAGE
----
Chairman's Letter 1 - 3
Attachment to Chairman's Letter 4 - 6
Safeguard Business Systems, Inc.
Chief Executive Officer and Chief Financial Officers' Letter 7 - 10
Independent Auditors' Report 11
Consolidated Financial Statements and Related
Notes to the Consolidated Financial Statements 12 - 27
Management's Discussion and Analysis of Financial
Condition and Results of Operations 28 - 31
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SAN JACINTO HOLDINGS INC.
March 18, 1997
TO ALL STOCKHOLDERS AND BONDHOLDERS:
Enclosed are audited consolidated financial statements for Fiscal Year
1996. Additionally, we are including a comprehensive operational report from
the senior management of Safeguard Business Systems, Inc.
Substantial progress was achieved in 1996 in the implementation of
previously announced operating strategies and objectives. We are clearly
moving in the right direction with Safeguard. As previously reported to you,
our expectations were that the benefits of these changes would not be evident
in operating results until 1997 and beyond. That remains our view.
SIGNIFICANT DEVELOPMENTS IN 1996
- Doug Reiter was named Chief Executive Officer of Safeguard and is
providing superb leadership in this transition. The Company now has the most
experienced, competent and professional management team in its history. I
believe they can and will succeed in making the turn-around so badly needed.
- The new centralized sales & marketing division established in
Dallas in 1996 is largely in place and reflecting continuing improvement in its
operations. These newly structured functions are central to transforming the
Company into a market driven enterprise as was set forth in our September,
1995 announcement. That decision was sound and absolutely necessary for the
future success of the Company.
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- The AS400 project, as discussed in more detail in Safeguard's
management report, has now become a reality and will provide the systems and
information base to run the Company in its new environment. Much remains to be
done in this arena, but the big conversion has been made. We must now build on
that base to further develop the Company's future operations and capabilities.
- The long-standing California litigation was settled in the fourth
quarter. This removes a major contingency from the Company's financial
statements and eliminates a continuing drain on resources that has extended
over a period of several years. In 1995 and 1996, the Company expensed
approximately $1.5 million annually defending these unwarranted claims. (copy
of December 6, 1996 letter enclosed).
- A broad range of new programs and policies were developed, to be
implemented in 1997, designed to enhance the success and profitability of our
independent distributor network. These changes have been developed in
cooperation with distributor leadership and are expected to produce new and
improved opportunities for both our distributors and the Company.
- Further operating efficiencies and cost reductions were introduced
in several areas. The most apparent such move was the decision to close the
Addison manufacturing facility which was discussed in the December 6, 1996
letter.
OPERATING RESULTS
The Company continues to have a solid base of operating earnings.
For two consecutive years now, earnings have been impacted by special charges
and non-recurring expenses to implement the Company's new and restructured
operating strategy. Please refer to the Safeguard management letter for a full
discussion of
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earnings and related topics. Management is also presenting a "normalized"
earnings summary for 1995 and 1996 to reflect more clearly non-recurring
expenses and the underlying operating earnings of the Company. I believe you
will find that presentation interesting and encouraging.
SUMMARY
We were pleased to welcome Kim Morris, Portfolio Manager, R. H.
Capital in New Jersey, as a new director in January, 1997. She was elected to
fill an existing vacancy on the board. Kim's broad experience and professional
background will provide an additional strength to the Company and we are
pleased to have her as a member of the board.
Much has been accomplished in 1996 to move Safeguard toward a brighter
and more profitable future. Much remains to be done to achieve the desired
results in future years. Our management team is working diligently and
professionally to achieve the desired objectives.
We appreciate your continued interest and support.
Sincerely,
/s/ ELVIS L. MASON
Elvis L. Mason
Chairman
Enclosure
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[SAFEGUARD LETTERHEAD]
December 6, 1996
TO ALL STOCKHOLDERS AND BONDHOLDERS;
Company management is continually examining opportunities to insure
competitive capabilities now and in the future in a market place that is
undergoing rapid and substantial change. It is management's philosophy to
mitigate risk and reduce exposure when appropriate. With this in mind the
Company's Board of Directors has approved a special charge to be made in the
fourth quarter of $5.1 million consisting of; 1) the anticipated cost of
closing the Addison, Illinois manufacturing plant and 2) a provision for the
settlement of certain California litigation that the Company has been defending
since December 1992. The Company has reached an agreement in principle with
its lenders to provide the funds needed to both close the plant and settle the
litigation.
PLANT CLOSING
Company management has recently reviewed the manufacturing plant
capacity needs of the Company. Upon completion of that review it has been
determined that the
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closing of the plant in Addison, Illinois would be cost effective. New
technological changes soon to be available with the implementation of the
AS/400 computer platform will allow this plant's output to be absorbed by the
remaining manufacturing facilities and generate an approximate $2.0 million
future annual savings in both manpower and expenses. Production will be phased
out in stages, beginning in April 1997, with permanent closure planned in
September 1997.
LITIGATION SETTLEMENT
The Company has reached a tentative agreement to settle a lawsuit in
California brought by ten plaintiffs, both individually and on behalf of a
putative class of Safeguard Distributors that it has been defending for the
last four years. In previous annual reports the Company has disclosed the
status of the litigation to you. The financial terms of the settlement are
confidential, except as may be required to be disclosed by the court, but are
satisfactory to the Company. In determining to settle this lawsuit, Company
management considered the additional years of protracted litigation, the future
legal costs associated with the continued defense of this case, and the
distraction that the litigation has become to the Company employees and the
Distributor organization. The potential settlement is still subject to the
approval by both the plaintiff class members and the California court.
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The resolution of this litigation will allow Safeguard and the Distributors to
focus on growth and profitability.
SUMMARY
The closing of the Addison, Illinois manufacturing plant is part of
Safeguard's on-going effort within manufacturing to improve efficiency. The
settlement of the California litigation allows the Company to eliminate both
the high cost of litigation and the distraction this litigation has had on the
total Safeguard community. We are very positive about the benefits of these
actions and will keep you informed on our progress in the months ahead.
Sincerely,
/s/ DOUGLAS REITER /s/ JAMES R. BRAUN
G. Douglas Reiter James R. Braun
Vice Chairman and Executive Vice President - Finance
Chief Executive Officer Chief Financial Officer
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[SAFEGUARD LETTERHEAD]
March 18, 1997
TO ALL STOCKHOLDERS AND BONDHOLDERS:
Enclosed are the consolidated financial statements of San Jacinto
Holdings Inc. and its operating subsidiary, Safeguard Business Systems, Inc.,
for the years ended December 31, 1996 and 1995.
FINANCIAL AND OPERATING HIGHLIGHTS
Net sales in 1996 are $206.8 million, reflecting an increase of $5.0
million (or 2.5%) above 1995. The sales increase reflects growth in sales of
computer forms (7.9%), sourced products (16.8%) and payroll processing service
(15.1%). This growth is off-set by a 6.0% decline in manual form sales. The
changes in sales trends from manual forms to computer forms, sourced products
and payroll processing continue to be addressed strategically and operationally
throughout the Company.
Earnings from operations before amortization, depreciation, interest
and income taxes (EBITDA) in 1996 are $13.9 million compared to $15.1 million
in 1995, a $1.2 million (or 7.8%) decline. The decline in earnings is
attributable to planned increases in selling expenses, partially offset by a
$1.3 million increase in gross profit. The increased selling costs are in
support of the establishment of a sales/marketing function positioned to meet
the needs of the small business marketplace. The improvement in gross profit
is a result of operating efficiencies implemented to reduce manufacturing costs
of certain growing product lines. This was the first year since 1992 that the
Company's gross profit has increased.
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Excluding the impact of non-recurring expenses {income} noted below,
the Company's earnings from operations in 1996 approximates the earnings level
in 1996, and were in both years significantly above reported levels.
{$000 Omitted} 1996 1995
---- ----
EBITDA $13,919 $15,102
Non-Recurring Operating Costs{Income}:
-Special Charges 5,100 5,700
-Sales/Marketing Centralization Start-up 2,429 --
-Litigation (excluding settlement) 1,197 1,611
-Computer System Duplication 1,200 799
-Gain on Sale of Facility in Europe {675} --
--- --
Adjusted EBITDA $23,170 $23,212
====== ======
Each non-recurring item listed above represents investments made by
the Company to improve long term operating earnings via sales growth,
operational efficiencies and cost avoidance. The Company has sacrificed short
term results to provide a foundation for long term growth.
In December 1996 the Company announced a special charge of $5.1
million consisting of the anticipated cost of closing the Addison, Illinois
manufacturing plant and a provision for the settlement of certain California
litigation that the Company has been defending since 1992. The Company's
lenders have agreed to provide the funds needed to both close the plant and
settle the litigation.
As a result of technological advances made possible by the conversion
and redesign of the Company's computer system hardware and software which
became operational in February 1997, the Company's Addison, Illinois
manufacturing facility will be consolidated with the East coast facilities.
The consolidation will begin April 1997 and is expected to be completed by the
end of the third quarter of 1997.
The Company has reached an agreement to settle its California
litigation. The financial terms of the settlement are confidential, except as
may be required to be disclosed by the court, but are satisfactory to the
Company. In determining to settle this lawsuit, Company management considered
the additional years of protracted litigation, the future legal costs
associated with the continued defense of this case, and the distraction that
the litigation has become to the Company employees and the Distributor
organization.
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The special charge of $5.7 million in 1995 reflected the cost to
centralize the sales and marketing function, the first step in creating a
technologically advanced customer support center, and a loss on the sale of two
real estate properties owned by the Company. The grand opening of the Dallas
support center in June 1996 marked the substantial completion of the
sales/marketing centralization. The two properties held for sale were sold in
the third and fourth quarters of 1996 at adjusted net book value.
The Company's net loss before special charge and extraordinary item is
$19.6 million in 1996 compared to $12.9 million in 1995. The increased loss is
attributable to increased selling costs, an increase in interest expense which
were partially offset by an increase in gross profit and a reduction in
administrative expenses. The increase in interest expense is due to a rise in
the Company's effective borrowing rate from 8% to 12%, as more fully described
in the notes to the consolidated financial statements. These losses include
amortization (non-cash) charges of $19.2 million for 1996 and $19.3 million for
the same period in 1995.
The Company's operations in Europe remain strong. Net sales in 1996
are 9.4% above 1995 levels. This growth is in both manual and computer form
sales. Earnings from operations are $2.2 $1.9 million, a $0.6 million
increase. The earnings growth includes a $0.7 million gain on the sales of an
existing manufacturing facility in June 1996, off-set by increased
administrative expenses.
FOCUS IN 1997
By opening the North American Sales and Marketing Division,
implementing the new AS/400 computer system, settling the California
litigation, and continuing the consolidation and implementation of operational
improvements within the manufacturing facilities, the Company has made
significant investments in 1996 to lay the foundation for growth in 1997 and
beyond.
With a number of basis tools now in place the focus in 1997 is to
attain sales growth by focusing: sales support through Distributor training,
counseling and recruiting efforts, market research, Distributor sales
incentives, new product development, innovative marketing techniques, major
accounts implementation and expansion of the Company's referral sources.
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Ongoing transformation of the Distributor organization to a more
dynamic channel to the customer is very substantial and is progressing. We are
gratified in seeing the major time commitment that a number of our Distributors
have made by participating in the shaping of a more effective sales channel.
CHANGE IN FISCAL YEAR
The Company's business cycle has historically begun in the third
calendar quarter. This is a result of Accountants, a major referral source,
visiting their clients and referring new customers and repeat business to the
Company. To properly kickoff this cycle and in recognition of a stronger
emphasis in sales and marketing, the Company will change its year end to June
30, effective June 30, 1997.
The Company has celebrated 40 years of leadership in the small
business arena serving the marketplace as an information systems company with a
total service approach. Safeguard's management and employees are dedicated to
maintaining and expanding this preeminent position in the small business
marketplace in the coming years. We appreciate your continuing support.
Sincerely,
/s/ DOUGLAS REITER /s/ JAMES R. BRAUN
G. Douglas Reiter James R. Braun
Vice Chairman and Executive Vice President
Chief Executive Officer Chief Financial Officer
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[DELOITTE & TOUCHE LLP LETTERHEAD]
INDEPENDENT AUDITORS' REPORT
Board of Directors
San Jacinto Holdings Inc.
Dallas, Texas
We have audited the accompanying consolidated balance sheets of San Jacinto
Holdings Inc. and subsidiary as of December 31, 1996 and 1995, and the related
consolidated statements of operations, stockholders' equity (deficiency) and
cash flows for each of the three years in the period ended December 31, 1996.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements.
An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of San Jacinto Holdings Inc.
and subsidiary as of December 31, 1996 and 1995, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1996 in conformity with generally accepted accounting principles.
/s/ DELOITTE & TOUCHE LLP
Deloitte & Touche LLP
Philadelphia, Pennsylvania
February 27, 1997
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SAN JACINTO HOLDINGS INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
($000 omitted)
December 31,
------------------------------
1996 1995
----- ----
ASSETS
Current assets:
Cash and cash equivalents $ 482 $ 2,802
Receivables less allowances 27,912 27,072
Inventories 8,678 8,809
Other current assets 2,480 2,248
-------- --------
Total current assets 39,552 40,931
Property, plant and equipment 20,855 17,739
Excess of purchase price over net assets acquired 43,225 44,671
Customer list 17,273 34,545
Other assets 2,813 4,973
-------- --------
Total assets $123,718 $142,859
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIENCY)
Current liabilities:
Current debt obligations $ 8,708 $ 7,395
Accounts payable 14,476 9,741
Accrued expenses 16,572 14,612
-------- ---------
Total current liabilities 39,756 31,748
Long-term debt 110,017 100,853
Deferred interest - 14,805
Other liabilities 7,631 7,183
Commitments and contingencies
Stockholders' equity (deficiency)
Preferred stock:
$5.00 Junior Preferred Stock, par value $.01 a share;
Authorized 1,000,000 shares, $5 cumulative
No shares issued and outstanding
Common stockholders' equity:
Common stock, par value $.01 a share:
Authorized 2,000,000 shares,
Issued and outstanding 1,052,834 shares in 1996 and
999,960 shares in 1995 11 10
Additional paid-in capital 94,143 94,143
Deficit (126,880) (104,591)
Foreign currency translation (960) (1,292)
-------- ---------
Total stockholders' equity (deficiency) (33,686) (11,730)
-------- ---------
Total liabilities and stockholders' equity (deficiency) $123,718 $142,859
======== =========
See notes to consolidated financial statements.
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SAN JACINTO HOLDINGS INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
($000 omitted)
Years Ended December 31,
-------------------------
1996 1995 1994
---- ---- ----
Net sales $206,751 $201,734 $198,108
Costs of sales 96,567 92,827 86,968
-------- -------- --------
Gross profit 110,184 108,907 111,140
Selling expense 81,807 77,312 76,394
General and administrative expense 16,461 17,796 15,618
Special Charges 5,100 5,700 -
Financing costs - - 1,117
Other income - Distributor receivables (2,100) (2,465) (2,599)
Amortization expense 19,182 19,337 19,231
Interest expense 14,112 9,607 10,359
-------- -------- --------
Loss from operations before income taxes (24,378) (18,380) (8,980)
and extraordinary item
Income tax provision 312 174 352
-------- -------- --------
Loss from operations before extraordinary item (24,690) (18,554) (9,332)
Extraordinary item:
Gain on early extinguishment of 2,401 - -
-------- -------- --------
Net loss $(22,289) $(18,554) $(9,332)
======== ======== ========
See notes to consolidated financial statements.
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SAN JACINTO HOLDINGS INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIENCY)
THREE YEAR PERIOD FROM JANUARY 1, 1994
TO DECEMBER 31, 1996
($000 omitted)
Foreign
Additional Currency
Preferred Stock Commmon Stock Paid in Translation
Shares Amount Shares Amount Capital Deficit Adjustment
------ ------ ------ ------ ------- ------- ----------
Balance -
January 1, 1994 - $ - 999,960 $ 10 $ 94,143 $ (76,705) $ (1,320)
Net loss (9,332)
Unrealized loss on
Foreign currency
Translation (104)
------- ------ -------- ------ -------- --------- -----
Balance -
December 31, 1994 - - 999,960 10 94,143 (86,037) (1,424)
Net loss (18,554)
Unrealized gain on
Foreign currency
Translation 132
------- ------ -------- ------ -------- --------- ---
Balance -
December 31, 1995 - - 999,960 10 94,143 (104,591) (1,292)
Issuance of common
stock in conjunction
with exchanage offer - - 52,424 1 - - -
Net loss (22,289)
Unrealized gain on
Foreign currency
Translation 332
------- ------ -------- ------ -------- --------- ---
Balance -
December 31, 1996 - $ - 1,052,834 $11 $ 94,143 $(126,880) $(960)
======= ====== ========= ====== ======== ========= =====
See notes to consolidated financial statements.
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SAN JACINTO HOLDINGS INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
($000 omitted)
Years ended December 31,
------------------------
1996 1995 1994
----- ----- -----
Cash flows from operating activities:
Net loss $(22,289) $(18,554) $ (9,332)
Adjustments to reconcile net loss to
net cash provided by operating activities:
Extraordinary item (2,401) - -
Amortization 19,182 19,337 19,231
Depreciation 5,003 4,538 4,367
Unrealized exchange gain (loss) 332 132 (104)
Net gain on sale of assets (727) - -
Provision for loss on sale of real estate - 1,700 -
Write-off of financing costs - - 1,117
(Increase) decrease in operating assets:
Receivables (840) 248 (1,102)
Inventories 131 (602) (772)
Other assets 1,462 (759) (1,146)
Increase (decrease) in operating liabilities:
Accounts payable 4,735 3,923 (212)
Accrued expenses and other liabilities 2,408 4,226 1,118
Deferred interest - 2,072 2,906
------- ------- ------
Net cash provided by operating activities 6,996 16,261 16,071
Cash flows from investing activities:
Purchase of machinery and equipment (6,831) (5,593) (2,566)
Proceeds from sale of assets 2,727 - -
Adjustment due to currency fluctuations
and foreign purchase price (477) (18) 87
------- ------- ------
Net cash used in investing activities (4,581) (5,611) (2,479)
------- ------- ------
Cash flows from financing activities:
Repayment of long-term debt and
capital lease obligations (22,978) (15,082) (12,586)
Borrowings from revolving loans 19,724 1,600 1,700
Net proceeds from (repayment of)
foreign obligations 49 3,298 (86)
Financing costs (1,530) (380) (1,117)
------- ------- ------
Net cash used in financing activities (4,735) (10,564) (12,089)
------- ------- ------
Net increase (decrease) in cash and cash
equivalents (2,320) 86 1,503
Cash and cash equivalents at beginning of year 2,802 2,716 1,213
------- ------- ------
Cash and cash equivalents at end of year $ 482 $ 2,802 $ 2,716
======= ======= ======
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SAN JACINTO HOLDINGS INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
($000 omitted)
(Continued)
Supplemental disclosure of noncash investing and financing activities:
PIK ("Payment in Kind") Debentures totaling $24, $1,644, and $1,521, were
issued in 1996, 1995 and 1994, respectively. The PIK Debentures are in
payment of accrued interest on the Company's 8% Subordinated Debentures,
as more fully described in note G.
Capital lease obligations of $2,137, $1,408, and $2,824 were incurred
during 1996, 1995 and 1994, respectively, to acquire certain machinery and
equipment.
Supplemental disclosure of cash flow information:
Cash paid during the year for:
1996 1995 1994
---- ---- ----
Interest $14,267 $7,177 $7,459
Income taxes 334 266 -0-
See notes to consolidated financial statements.
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SAN JACINTO HOLDINGS INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
A. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
PRINCIPLES OF CONSOLIDATION - The consolidated financial statements
include the accounts of San Jacinto Holdings Inc. and its subsidiary (the
"Company"), Safeguard Business Systems, Inc. and its subsidiaries
("Safeguard"). All material intercompany accounts and transactions have
been eliminated.
CASH AND CASH EQUIVALENTS - Excess funds are invested in short-term
interest bearing instruments consisting principally of commercial paper,
certificates of deposit and time deposits with maturities of 30 days or
less. Due to the short-term nature of these investments, the carrying
amount approximates their fair value.
RECEIVABLES - Receivables are presented net of allowances of $796,000 in
1996 and $708,000 in 1995.
INVENTORIES - Inventories are stated at the lower of cost (first-in,
first-out method) or market.
PROPERTY, PLANT AND EQUIPMENT - Property, plant and equipment is stated at
cost less accumulated depreciation and amortization. The provision for
depreciation and amortization is based on the estimated useful lives of
the related assets computed principally by the straight-line method.
INTANGIBLE ASSETS - Excess of purchase price over net assets acquired is
net of accumulated amortization of $16,658,000 in 1996 and $15,212,000 in
1995. This asset is amortized by the straight-line method over forty
years. Customer list is net of accumulated amortization of $172,727,000 in
1996 and $155,455,000 in 1995. The customer list is amortized by the
straight-line method over eleven years.
OTHER ASSETS - Other assets includes deferred financing costs which are
being amortized over the life of the related indebtedness.
ASSET IMPAIRMENT - The carrying value of property, plant and equipment,
and intangible assets, including customer list and excess of purchase
price over net assets acquired, is evaluated based upon current and
anticipated undiscounted operating cash flows before debt service charges.
An impairment is recognized when it is probable that such estimated future
cash flows will be less than the carrying value of the assets.
Measurement of the amount of impairment, if any, is based upon the
difference between the net carrying value and the fair value, which is
estimated based on anticipated undiscounted operating cash flows before
debt service charges.
BUSINESS AND REVENUE RECOGNITION - The Company provides business
information systems and services to businesses in North America and
Europe. Revenues are recognized as products are shipped or as services
are performed.
STOCK BASED COMPENSATION - The Company applies the disclosure-only
provisions of SFAS No. 123, "Accounting for Stock-Based Compensation," and
applies Accounting Principles Board Opinion No. 25, "Accounting for Stock
Issued to Employees" and related interpretations in accounting for stock
based compensation.
MANAGEMENT'S USE OF ESTIMATES - The preparation of financial statements in
conformity with generally accepted accounting principles requires the use
of estimates and assumptions that affect the reported amounts of assets
and liabilities and disclosure of contingent assets and liabilities, and
the reported amounts of revenues and expenses. Actual results could
differ from those estimates.
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SAN JACINTO HOLDINGS INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
(Continued)
B. FINANCIAL RESTRUCTURING:
On January 26, 1996, the Company consummated an exchange offer of its
existing 8% Senior Subordinated Notes due December 31, 2000 (the "Existing
Notes") and 8% Subordinated Debentures due December 31, 2000 for 12%
Senior Subordinated Notes due December 31, 2002 (the "New Notes"). Of the
Existing Notes and the associated deferred interest, 99.99% were tendered;
the tendering existing Notes were exchanged at a rate of $1,000 in New
Notes for each $1,000 in tendering Existing Notes and deferred interest.
Of the Existing Debentures, 98.6% were tendered; the tendering existing
Debentures were exchanged at a rate of $850 in New Notes for each $1,000
in tendering Existing Debentures. In addition to New Notes, each
tendering Existing Note and Existing Debenture Holder was issued a pro
rata share of Common Stock of the Company equal to 5% of the outstanding
Capital Stock after giving effect to this exchange offer. The exchange
offer, based upon its terms, is accounted for as an extinguishment and
resulted in an extraordinary gain of $2,401,000 after deducting related
expenses.
In conjunction with the Exchange Offer described above, on January 26,
1996 the Company and Safeguard also refinanced existing bank debt. The
refinancing plan included payment in full of the Revolving Credit Loan and
unpaid deferred interest on an existing Term Loan, and the amendment of
the existing Exchange Loan Agreement. Safeguard also entered into a loan
and security agreement which included a Revolving Loan and a Term Loan.
C. SPECIAL CHARGES:
In December 1996 the Company announced a special charge of $5.1 million
consisting of the anticipated cost of closing a manufacturing facility
and a provision for the settlement of certain California litigation that
the Company has been defending since 1992. The Company's Addison,
Illinois manufacturing facility will be consolidated with its East coast
facilities. The consolidation will begin during the second quarter of
1997 and is expected to be completed by the end of the third quarter of
1997. The cost associated with the consolidation include severance,
recruiting and relocation costs. The Company has reached an agreement to
settle its California litigation. The financial terms of the settlement
are confidential, except as may be required to be disclosed by the court,
but are satisfactory to the Company.
In September 1995 the Company announced its decision to centralize the
North America sales and marketing function, and create a new sales and
marketing division. The centralization was completed in 1996. The
estimated cost, including severance, recruiting and relocation costs, to
complete this centralization was $5,700,000 which includes a $1,700,000
provision for a probable book loss on the planned sale of certain real
estate owned by the Company. The real estate properties were sold in 1996
at approximately adjusted net book value.
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SAN JACINTO HOLDINGS INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
(Continued)
D. FINANCING COSTS:
The Company filed an initial registration statement with the
Securities and Exchange Commission on March 11, 1994 to register new
senior notes, the proceeds of which would have been used to refinance
the Company's existing debt. On May 13, 1994 the Company announced
the termination of the offering and tender offer, due to prevailing
market conditions. The Company incurred $1,117,000 in costs
associated with the proposed offering which were expensed in 1994.
E. INVENTORIES:
December 31,
------------
1996 1995
---- ------
($000 omitted)
Raw materials $ 5,327 $ 5,661
Work-in-process 352 629
Finished goods 2,999 2,519
----- -----
Total Inventories $ 8,678 $ 8,809
===== =====
F. PROPERTY, PLANT AND EQUIPMENT:
December 31,
------------
1996 1995
---- ----
($000 omitted)
Land $ 761 $ 234
Building and improvements 9,441 10,469
Machinery and equipment 44,457 36,579
------ ------
54,659 47,282
Less accumulated depreciation and amortization (33,804) (29,543)
------ ------
Total Property, Plant and Equipment $20,855 $17,739
====== ======
19
22
SAN JACINTO HOLDINGS INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
(Continued)
G. DISTRIBUTORSHIP ACCOUNTS:
Safeguard markets substantially all of its products through a network
of independent distributors who are compensated on a commission basis.
Safeguard sells and ships its products directly to the end-users
(customers). The invoicing to and collection of the related
receivables from the customers is performed by Safeguard. The
distributors have contracts granting them either exclusive geographic
or account protection rights. The distributors holding these rights
may, at some point, desire and be eligible to transfer their
commission rights to buyers who agree to make payments out of future
commissions or who accept reduced commissions. Prior to its
acquisition in 1986, Safeguard facilitated the transfer of selling
distributors' rights (primarily sellers with exclusive geographic
territories) to buyers who were granted account protection rights, by
offering the sellers incentives to transfer their commission rights.
Most often the incentives were the providing of down payments or a
guarantee of payments to sellers. The transfers between the buyers
and sellers typically relate solely to account protection rights.
Safeguard's incentive in facilitating the transfer of or in acquiring
distributors' rights was to obtain the opportunity to increase the
number of distributors marketing its products. Safeguard, for the
same business purpose, also made cash advances to distributors, who
agreed to repay all such amounts from future commissions. In
connection with the Company's purchase price allocation for the
acquisition of Safeguard as of December 31, 1986, the value assigned
to distributor receivables associated with account protection rights
and advances was $4,837,000, net of deferred interest income of
approximately $7,811,000. This value was primarily based on the
evaluation of an independent valuation firm of the distributor
receivables which aggregated approximately $26,000,000 as of December
31, 1986.
Due to the effect of collection and distributor advance policies
instituted in 1988, the net distributor receivables balance was
reduced to zero by early 1992. Subsequent cash collections of these
receivables have been recorded as other income totaling $2,100,000 in
1996, $2,465,000 in 1995 and $2,599,000 in 1994.
Indebtedness of present distributors to selling distributors totaling
$687,000 at December 31, 1996, is guaranteed by Safeguard. In
addition, Safeguard has guaranteed $98,000 of bank borrowings of its
distributors. No claims have been made against Safeguard to honor
such guarantees and management believes that the likelihood that these
guarantees will result in a liability which would be material is
remote.
H. ACCRUED EXPENSES:
December 31,
-----------------------
1996 1995
---- ----
($000 omitted)
Litigation and facility closure costs $ 4,714 $ -
Centralization costs 1,363 3,399
Distributor commissions 4,529 4,380
Sales and other taxes 1,802 1,847
Salaries and wages 1,309 849
Interest 588 743
Other 2,267 3,394
------- -------
Total Accrued Expenses $16,572 $14,612
======= =======
20
23
SAN JACINTO HOLDINGS INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
(Continued)
I. DEBT:
As more fully described in Note B, on January 26, 1996 the Company and
Safeguard consummated a refinancing plan. The Company's debt
outstanding at December 31, 1996 and 1995 is as follows:
December 31,
-------------
1996 1995
---- ----
($000 omitted)
New Revolving Loan $17,525 $ -
New Term Loan 6,500 -
Revolving Credit Loan - 15,582
Amended Exchange Loan 22,633 24,656
12% Senior Subordinated Notes 65,878 -
8% Senior Subordinated Notes 3 39,998
8% Subordinated Debentures 321 21,801
Capital Lease Obligations 2,519 2,913
Foreign Obligations 3,346 3,298
------- ------
118,725 108,248
Less current debt obligation (8,708) (7,395)
------ -----
Total Long-term Debt $110,017 $100,853
======= =======
Safeguard entered into a Loan and Security Agreement which includes a
Revolving Loan and a Term Loan. The new Revolving Loan allows for
borrowing against eligible accounts receivable and inventories up to a
maximum of $23,500,000. At December 31, 1996, an additional $2,600,000 was
available under the terms of the Revolving Loan. Outstanding borrowing
bears interest at the prime lending rate plus 1%, or Eurodollar Rate plus
2.75% for a five year term, with automatic renewal for successive one year
periods. The effective interest rate for such borrowings at December 31,
1996 was 11.4 %. The new Term Loan is payable in monthly installment
through January 25, 2001. The loan bears interest at the rate of 12% per
annum.
Safeguard has granted the bank under the Loan and Security Agreement a
first lien security interest in certain assets of Safeguard, including the
accounts receivable, inventory, and property and equipment. The Loan and
Security Agreement contains certain covenants relating to, among other
restrictions; maintenance of a prescribed level of net worth, maintenance
of prescribed ratios of current assets to current liabilities and of cash
flow to interest expense, limitations on additional indebtedness, and
limitations on capital expenditures.
On December 23 1996, Safeguard entered into an additional $4,000,000
Revolving Loan with its bank. The outstanding borrowings against this loan
bears interest at a rate of 14% per annum, and are payable monthly in
arrears. The outstanding principal balance is due on January 25, 2001.
There were no borrowing against this loan in 1996.
The existing Exchange Loan was amended and converted to a $25,750,000 term
loan bearing interest at 12% per annum (12.2% effective December 23, 1996).
The amended Exchange Loan is payable in monthly installments over a five
year period beginning March 1996, payable in full November 1, 2000. All
issued and outstanding stock of Safeguard is pledged as collateral under
the amended Exchange Loan Agreement.
21
24
SAN JACINTO HOLDINGS INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
I. DEBT (Continued):
In January 1996 the Company issued 12% Senior Subordinated Notes (the
"New Notes") due December 31, 2002, in conjunction with the refinancing.
The interest on the Notes is payable semi-annually on June 30 and
December 31 commencing June 30, 1996. The New Notes are subordinate to
the revolving loans, Term Loan, amended Exchange Loan, capital lease
obligations and foreign obligation. The New Notes contain various
covenants relating to, among others, restrictions on issuance of or
redemption of capital stock, issuance of additional indebtedness,
limitations on dividend payments, limitations on disposition of assets
and changes in control of the Company.
The Company's 8% Senior Notes (the "Existing Notes") due December 31,
2000 after the refinancing totaled $3,200. Interest on such existing
Notes is payable in cash semiannually on June 5 and December 5. The
refinanced 8% Senior Subordinated Notes are subordinate to the 12%
Senior Subordinated Notes, revolving loans, Term Loan, amended Exchange
Loan, capital lease obligations and foreign obligations.
The Company's 8% Subordinated Debentures after the refinancing totaled
$296,700. Interest on such debentures accrues and is evidenced by PIK
("Payment In Kind") Debentures. Interest deferred but not yet converted
totaled $2,000 at December 31, 1996. The Debentures are subordinate to
senior indebtedness (which includes the existing Notes and new Notes).
Safeguard's subsidiary in the United Kingdom ("SSGB") has a pound
sterling 1,200,000 (converted to $2,056,000 at December 31, 1996)
short-term line of credit of which $873,000 was outstanding at December
31, 1996. The effective rate of interest as of December 31, 1996 under
the short-term line of credit was 11.0%. SSGB also obtained a
construction loan to finance the construction of a manufacturing
facility. The construction of the facility was completed in March 1996
and the loan was converted to a 30 year mortgage. The mortgage balance
outstanding was $2,474,000 at December 31, 1996.
The aggregate maturities of long-term debt, exclusive of capital lease
obligations, during the next five years are: 1997 - $6,853,000; - 1998 -
$6,755,000; 1999 - $6,755,000; 2000 - $6,755,000; and 2001 -
$20,908,000.
22
25
SAN JACINTO HOLDINGS INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
(Continued)
J. FAIR VALUE OF FINANCIAL INSTRUMENTS:
The following disclosure of the estimated fair value of financial
instruments is made in accordance with the requirements of SFAS No. 107,
"Disclosure About Fair Value of Financial Instruments". Estimates of
fair value have been determined by the Company using available market
information and appropriate methodologies. However, considerable
judgment is necessarily required in interpreting market data to develop
these estimates. Accordingly, the estimates presented herein are not
necessarily indicative of the amounts that the Company could realize in
a current market exchange.
The estimated fair values of the Company's Revolving Loans, Term Loan,
Revolving Credit Loan and amended Exchange Loan approximate their
carrying values due to the variable rate nature of these instruments.
It was not practicable to estimate the fair value of the Company's 12%
Senior Subordinate Notes, 8% Senior Subordinated Notes and 8%
Subordinated Debentures without incurring excessive costs.
K. LEASES:
Safeguard conducts a portion of its operations in leased facilities,
vehicles,machinery and equipment. Operating leases expire at various
dates through 1999. Leased property under capital leases at December
31, 1996, has a net carrying value of $4,622,000 and consists
principally of machinery and equipment.
Future minimum lease payments, by year and in the aggregate, under
capital leases and under operating leases with initial or remaining
terms of one year or more at December 31, 1996 are:
Capital Operating
Leases Leases
------- -------
($000 omitted)
1997 $2,114 $ 4,086
1998 615 2,947
1999 176 2,430
2000 - 1,718
2001 - 1,378
Thereafter - 3,044
------ -------
2,905 $15,603
=======
Minimum lease payments:
Amount representing interest (386)
------
Present value of net minimum
lease payments $2,519
======
Total rental expense for all operating leases (including leases with
initial or remaining terms of one year or less) is $4,924,000 in 1996,
$4,036,00 in 1995 and $4,246,000 in 1994.
23
26
SAN JACINTO HOLDINGS INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
(Continued)
L. INCOME TAXES:
Effective January 1, 1994, Statement of Financial Accounting Standards
No. 109, "Accounting for Income Taxes" was adopted. As prescribed by
this statement the deferred tax provision is determined under the
liability method. This method requires deferred tax assets and
liabilities to be recognized based on the estimated future tax effects
of temporary differences and tax carryforwards using presently enacted
marginal tax rates. There was no cumulative effect on the financial
statements upon adoption of this standard.
The domestic and foreign components of income (loss) from continuing
operations before income taxes are as follows:
($000 Omitted)
1996 1995 1994
---- ---- ----
Domestic $ (25,363) $(18,652) $(9,680)
Foreign 985 272 700
-------- -------- -------
Loss before income taxes $(24,378) $(18,380) $(8,980)
======== ======== =======
The income tax provision (benefit) relates solely to Safeguard's
foreign operations in all years presented. The effective tax rate
analysis is not meaningful since there was no domestic taxable income
in 1996, 1995, and 1994.
Items that gave rise to a deferred tax asset (liability) are as
follows:
December 31,
------------
1996 1995
---- ----
($000 omitted)
Net operating loss carryforwards $68,564 $60,089
Property, plant and equipment 2,908 2,210
Deferred compensation 1,730 1,970
Capital loss carryforwards 1,669 1,669
Other 773 1,925
------- -------
Total 75,644 67,863
Less: valuation allowance (75,644) (67,863)
------ -------
Net deferred tax asset (liability) $ -- $ --
======= =======
At December 31, 1996, the Company has, for federal income tax purposes,
net operating loss carryforwards of $186,460,000 which expire between
the years 2001 and 2011, and capital loss carryforwards of $4,500,000
which expire in 1997. Changes in the Company's ownership could result
in an annual limitation on the amount of the net operating loss
carryforward which can be utilized. In accordance with Section
108(e)(8) of the Internal Revenue Code, the Company has applied the
stock for debt exception in conjunction with its financial
restructuring in 1991. The Company reduced its net operating loss
carryforward by $18,600,000 as a result of the 1991 restructuring.
24
27
SAN JACINTO HOLDINGS INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
(Continued)
M. EMPLOYEE BENEFIT PLANS:
Safeguard has a contributory savings plan for employees meeting certain
requirements. The plan allows eligible employees to contribute from 2%
to 12% (effective January 1, 1997 contributions to 15%) of their
compensation, including overtime, bonuses and shift differential.
Safeguard contributes an amount equal to 50% of the first 5%
(effective January 1, 1997, 100% of the first 3% and 50% of the next 2%)
of an employee's salary contributed under the Plan. Contributions are
invested in various fixed income, securities or equity funds as
designated by the employee. Safeguard's matching contributions were
$654,000 in 1996, $639,000 in 1995, and $592,000 in 1994.
Safeguard also has a noncontributory profit-sharing plan for the benefit
of eligible full-time employees. Safeguard's contributions are
voluntary and at the discretion of the Board of Directors. The
provision for profit-sharing contributions amounted to $290,000 in 1995,
and $480,000 in 1994. The profit-sharing plan contributions were
suspended in 1996.
N. OTHER LIABILITIES:
In April 1986, Safeguard entered into agreements with eight of its
executive officers, providing certain payments in the event of
termination of employment occurring after a change in ownership or
control. All eight of the officers employment did terminate subsequent
to the acquisition of Safeguard by the Company in December 1986.
Payments are due to the former officers in varying amounts through 2008.
Aggregate payments due during the next five years are: 1997 - $389,000;
1998 - $25,000, 1999 - $25,000, 2000 - $25,000, and 2001- $-0-.
O. STOCK OPTION PLAN:
In July 1995, the Company adopted a 1995 Option Plan pursuant to which
key employees of the Company may be granted non-qualified stock options.
At that time, the Board also approved the conversion of all of the
currently outstanding units under the existing Equity Compensation Plan
to stock options under the 1995 Option Plan. Under the Plan, options
granted to participants vest over three years or upon a change of
Company ownership or effective control. The units had an exercise price
of $10.00 per unit, with the ability effective October 29, 1996, to
exchange the options for new options with an exercise price of $5.25 per
unit. The new options vest over three years beginning as of October
29, 1996. The number of shares (or units as described in Equity
Compensation Plan - see Note P) permitted to be outstanding at any one
time under the combined Stock Option and Equity Compensation plans is
limited to not more than 200,000 shares, or the equivalent of 20% of the
common stock of the Company. Had the Company applied the accounting
provisions of SFAS No. 123 to the 1995 Option Plan, net income would not
have been materially different from the amount presented in these
financial statements.
Vested Non-Vested Total
------ ---------- -----
Units Converted - 1996 33,333 86,667 120,000
Units Issued - 1996 - 58,500 58,500
------ --------- -------
December 31, 1996 33,333 145,167 178,500
====== ======= =======
As of December 31, 1996, 33,333 fully vested shares and 1,667 non-vested
shares are at an exercise price of $10.00 per unit; 143,500 non-vested
shares are at a $5.25 per unit exercise price.
25
28
SAN JACINTO HOLDINGS INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
(Continued)
P. EQUITY COMPENSATION PLAN:
The Equity Compensation Plan, adopted effective January 1, 1993 and
amended March 1, 1994, provides for the issuance of "Equity
Compensation Units" to certain senior management. The units entitle
recipients to the appreciation in value of the common stock of the
Company, the units granted to each participant vested over three years
or upon a change in the Company's ownership or effective control. The
units in total provide the economic benefit of 15% (effective March 1,
1994) of the Company's common stock value in excess of a prescribed
calculated value, and can only be exercised upon a change in the
Company's ownership or control. A maximum of 1,500 (effective March
1, 1994) units may be outstanding at any one time. Outstanding units
totaling 1,480 were converted to stock option on October 29, 1996.
The summary of the units activity, is as follows:
Vested Non-Vested Total
------ ---------- -----
UNITS OUTSTANDING, JANUARY 1, 1994 450 367 817
Units issued - 700 700
Units canceled (7) (30) (37)
Units vested 234 (234) -
--- --- -----
UNITS OUTSTANDING, DECEMBER 31, 1994 677 803 1,480
Units issued - - -
Units canceled - (135) (135)
Units vested 268 (268) -
--- --- ----
UNITS OUTSTANDING, DECEMBER 31, 1995 945 400 1,345
Units issued - 313 313
Units canceled - (45) (45)
Units vested 172 (172) -
Units converted (984) (496) (1,480)
--- --- -----
UNITS OUTSTANDING, DECEMBER 31, 1996 133 -0- 133
=== ==== =====
26
29
SAN JACINTO HOLDINGS INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
(Continued)
Q. GEOGRAPHIC SEGMENTS:
The Company's foreign operations are in Canada, the United Kingdom and
Belgium. Operations by geographic area are as follows:
1996 1995 1994
---- ---- ----
($000 omitted)
NET SALES:
United States $184,094 $180,614 $177,848
Foreign 22,657 21,120 20,260
-------- -------- --------
Total $206,751 $201,734 $198,108
======== ======== ========
INCOME (LOSS) FROM OPERATIONS:
United States $(25,362) $(18,652) $ (9,680
Foreign 673 98 348
-------- -------- --------
Total $(24,690) $(18,554) $ (9,332
======== ======== ========
TOTAL ASSETS:
United States $106,085 $126,373 $146,846
Foreign 17,633 16,486 12,990
-------- -------- --------
Total $123,718 $142,859 $159,836
======== ======== ========
R. CONTINGENCIES:
The Company is involved in various legal proceedings incidental to the
conduct of its business. These actions when ultimately concluded and
determined will not, in the opinion of management, have a material
effect on results of operations or the financial condition of the
Company and Safeguard.
27
30
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
RESULTS OF OVERVIEW
The following table sets forth, for the periods indicated, selected
financial data as a percentage of net sales.
Year Ended December 31,
-----------------------
1996 1995 1994
---- ---- ----
Net sales 100.0% 100.0% 100.0%
Cost of sales 46.7 46.0 43.9
---- ---- ----
Gross profit 53.3 54.0 56.1
Selling expense 39.5 38.3 38.6
General and administrative expense 8.0 8.8 7.9
Special charges 2.5 2.8 -
Refinancing costs - - 0.5
Other income - Distributor receivables (1.0) (1.2) (1.3)
Amortization expense 9.3 9.6 9.7
Interest expense 6.8 4.8 5.2
---- ---- ---
Loss from operations before income taxes
and extraordinary item (11.8) (9.1) (4.5)
Income tax provision 0.1 0.1 0.2
---- ---- ---
Loss from operations before extraordinary item (11.9) (9.2) (4.7)
Extraordinary Item (1.1) - -
---- ---- ---
Net loss (10.8)% (9.2)% (4.7)%
==== === ===
COMPARISON OF THE YEAR ENDED DECEMBER 31, 1996 TO THE YEAR ENDED DECEMBER 31,
1995
NET SALES. Net sales were $206.8 million in 1996 compared to $201.7 million in
1995, representing an increase of 2.5%. This sales growth reflected an 7.9%
growth in computer forms, partially offset by a 6.0% decline in manual forms
sales. Approximately 73% of the growth in computer forms sales was related to
volume increases, with the remainder attributable to price increases. The
decline in manual forms sales in 1996 was offset in part by a 3.7% average
price increase.
GROSS PROFIT. Gross profit margin was 53.3% of net sales in 1996 compared to
54.0% in 1996. The decline in margin was a result of the change in the
Company's product mix from manual forms to computer forms and sourced products.
Computer forms and sourced products carry greater material, direct labor and
overhead costs (as a percentage of sales), resulting in a lower gross profit
margin than for manual forms.
SELLING EXPENSE. Selling expense was $81.8 million in 1996 compared to $77.3
million in 1995, representing 39.5% and 38.3% of net sales in each year.
Commissions to independent distributors account for approximately one-third of
net sales and, as a percent of total sales, have remained fairly constant over
the last several years. The increase in selling expenses was attributable to
increased commission costs associated with the sales growth noted above, in
addition to a planned increased in sales support costs associated with
establishment of a new sales/marketing location.
28
31
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(continued)
GENERAL AND ADMINISTRATIVE. General and administrative expenses were $16.5
million in 1996 compared to $17.8 million in 1995, representing 8.0% and 8.8%
of net sales in each year. The decrease in costs is attributable to a
reduction in benefit and insurance costs, and the gain on the sale of a
manufacturing facility in the United Kingdom.
SPECIAL CHARGES - CLOSURE OF MANUFACTURING FACILITY AND LITIGATION SETTLEMENT.
In December 1996 the Company announced its decision to close a manufacturing
plant in Addison, Illinois, and the settlement of certain California litigation
that the Company has been defending since 1992. The Company's Addison,
Illinois manufacturing facility will be consolidated with its East coast
facilities. The consolidation will begin during April of 1997 and is expected
to be completed by the end of the third quarter of 1997. The cost associated
with the consolidation include severance, recruiting and relocation costs. The
Company has reached an agreement to settle its California litigation. The
financial terms of the settlement are confidential, except as may be required
to be disclosed by the court, but are satisfactory to the Company.
OTHER INCOME - DISTRIBUTOR RECEIVABLES. Other income (cash received greater
than carrying value of distributor receivables) was $2.1 million in 1996
compared to $2.5 million in 1995, representing 1.0% and 1.2% of net sales in
each year. In connection with the Company's purchase price allocation for the
acquisition of Safeguard as of December 31, 1986, the value assigned to
distributor receivables associated with loans and advances previously made by
Safeguard to facilitate purchase of account protection rights by distributors
was $4.8 million, net of deferred interest income of approximately $7.8
million. This value was primarily based on the evaluation of an independent
valuation firm of the distributor receivables which aggregated approximately
$26.0 million as of December 31, 1986. Due to the effect of collection and
distributor advance policies instituted in 1988, the net distributor
receivables balance was reduce to zero by early 1992. Cash collection of this
distributor receivable are expected to continue in amounts approximating $2.0
through the year 2000.
AMORTIZATION EXPENSE. Amortization expense was $19.2 million in 1996 and $19.3
million in 1995. The expense consists of the amortization of intangible assets
including the customer list, excess purchase price over net assets acquired and
deferred financing costs.
INTEREST EXPENSE. Interest expense was $14.1 million in 1996 and $9.6 million
in 1995, including $14.3 million and $7.2 million, respectively, of cash
interest. The increase in interest expense was attributable to a rise in the
interest rate of the Company's long term debt.
INCOME TAX. The Company's provision for income tax related to its foreign
operations in the United Kingdom. No tax liability was generated in the United
States as a result of net losses from operations.
COMPARISON OF THE YEAR ENDED DECEMBER 31, 1995 TO THE YEAR ENDED DECEMBER 31,
1994
NET SALES. Net sales were $201.7 million in 1995 compared to $198.1 million in
1994, representing an increase of 1.8%. This sales growth reflected an 13.2%
growth in computer forms, partially offset by a 7.4% decline in manual forms
sales. Approximately 70% of the growth in computer forms sales was related to
volume increases, with the remainder attributable to price increases. The
decline in manual forms sales in 1995 was offset in part by a 3.9% average
price increase.
GROSS PROFIT. Gross profit margin was 54.0% of net sales in 1995 compared to
56.1% in 1995. The decline in margin was a result of the change in the
Company's product mix from manual forms to computer forms and brokerage
products. Computer forms and brokerage products carry greater material, direct
labor and overhead costs (as a percentage of sales), resulting in a lower gross
profit margin than for manual forms. Additionally, in 1995 paper and paper
related supply costs, the primary material in the Company's products, increased
significantly. These price increases have been partially passed through to
customers.
SELLING EXPENSES. Selling expense was $77.3 million in 1995 compared to $76.4
million in 1994, representing 38.3% and 38.6% of net sales in each year.
Commissions to independent distributors account for approximately one-third of
net sales and, as a percent of total sales, have remained fairly constant over
the last several years. The increasing selling expenses was attributable
primarily to increased commission costs associated with the sales growth noted
above.
29
32
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(continued)
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses were
$17.8 million in 1995 compared to $15.6 million in 1994, representing 8.8% and
7.9% of net sales in each year. The increase in costs was primarily in legal
costs associated with the pending litigation, in addition to software
development costs.
SPECIAL CHARGES - CENTRALIZATION COSTS AND LOSS ON REAL ESTATE. In September
1995 the Company announced its decision to centralize the North America sales
and marketing function and create a new sales and marketing division. The
centralization was completed in 1996. The estimated costs, including
severance, recruiting and relocation costs, to complete this centralization are
$5.7 million, which includes a $1.7 million provision for a probable loss on
the planned sale of certain real estate owned by the Company. The Company sold
the real estate in 1996, at approximately adjusted net book value.
OTHER INCOME - DISTRIBUTOR RECEIVABLES. Other income (cash received greater
than carrying value of distributor receivables) was $2.5 million in 1995
compared to $2.6 million in 1994, representing 1.2% and 1.3% of net sales in
each year. In connection with the Company's purchase price allocation for the
acquisition of Safeguard as of December 31, 1986, the value assigned to
distributors receivable associated with loan and advances previously made by
Safeguard to facilitate the purchase of account protection rights by
distributors was $4.8 million, net of deferred interest income of approximately
$7.8 million. This value was primarily based on the evaluation of an
independent valuation firm of the distributor receivables which aggregated
approximately $26.0 million as of December 31, 1986. Due to the effect of
collection and distributor advance policies instituted in 1988, the net
distributor receivables balance was reduced to zero by early 1992. Cash
collection of this distributor receivable are expected to continue in amounts
approximating $2.0 million through the year 2000.
AMORTIZATION EXPENSES. Amortization expense was $19.3 million in 1995 and
$19.2 million in 1994. The expense consists of the amortization of intangible
assets including the customer list, excess purchase price over net assets
acquired and deferred financing costs.
INTEREST EXPENSE. Interest expense was $9.6 million in 1995 and $10.4 million
in 1994, including $7.2 million and $7.5 million, respectively, of cash
interest. The decline in interest expense was attributable to the reduction in
the Company's indebtedness as a result of scheduled long term debt repayments,
partially off-set by a rise in the interest rate of the Company's bank debt
during the second six-months of 1995.
INCOME TAX. The Company's provision for income tax related to its foreign
operations in the United Kingdom. No tax liability was generated in the United
States as a result of net losses from operations.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary sources of liquidity are cash flows generated from
operations, cash on hand and borrowing capacity under the Revolving Loans. The
Company's cash flow from operating activities was $7.0 million in 1996. As of
December 31, 1996, the Company had $0.5 million in cash and cash equivalents,
and $6.6 million in availability under the new revolving loans and the
equivalent of $1.2 million available through a line of credit maintained by the
Safeguard's subsidiary in the United Kingdom. At that date, the Company had a
working capital deficiency of $0.2 million and a ratio of current assets to
current liabilities of approximately 1.0:1.
The Company's ongoing liquidity requirements arise primarily from capital
expenditures, working capital needs and debt service. The Company's capital
expenditures in 1996 were $5.9 million in machinery, equipment and software
purchases, in addition to $3.1 million in costs associated with the
construction of a new production facility in the United Kingdom. This new
facility was financed by a construction loan, the proceeds from the sale of the
existing facility and cash flow from operations. A significant portion of the
capital investment in machinery, equipment and software in 1996 was for the
installation of an integrated computerized manufacturing system, and the
upgrade of existing manufacturing production equipment. These expenditures,
excluding the new facility in the United Kingdom, were funded substantially
through additional capital lease obligations and cash flow from operations.
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MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
LIQUIDITY AND CAPITAL RESOURCES (continued)
As more fully described in the Notes to the Consolidated Financial Statements,
on January 26, 1996, the Company consummated an exchange of substantially all
of its existing 8% Senior Subordinated Notes due December 31, 2000 and 8%
Subordinated Debentures due December 31, 2000, for 12% Senior Subordinated
Notes due December 31, 2002 tendering note and debenture holders were also
issued commons stock of the Company equal to 5% of the outstanding capital
stock. In conjunction with Exchange Offer, the Company and Safeguard
refinanced its existing bank debt. The refinancing included payment in full of
a bank loan and deferred interest, the amendment of an existing bank loan , and
entering into a new revolving and term loan facility. The exchange and
refinancing provided an extension of the average life of the Company's
indebtedness and increased the Company's financial resources to support
operations.
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