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EXHIBIT TE3-14
SAN JACINTO HOLDINGS INC.
SAFEGUARD BUSINESS SYSTEMS, INC.
1997 ANNUAL REPORT
[SAFEGUARD LOGO]
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SAN JACINTO HOLDINGS INC. AND SUBSIDIARY
CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
TABLE OF CONTENTS
Page
----
Chairman's Letter 1 - 3
Safeguard Business Systems, Inc.
Chief Financial Officers' Letter 4 - 7
Independent Auditors' Report 8
Consolidated Financial Statements and Related
Notes to the Consolidated Financial Statements 9 - 24
Management's Discussion and Analysis of Financial
Condition and Results of Operations 25 - 29
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San Jacinto Holdings Inc.
March 31, 1998
TO ALL STOCKHOLDERS AND BONDHOLDERS:
Enclosed are the audited financial statements of San Jacinto Holdings
Inc. (the "Company") and its operating subsidiary, Safeguard Business Systems,
Inc. ("Safeguard") for the fiscal year ended December 31, 1997. Additionally, an
in-depth financial report from the Company's Senior Vice President and Chief
Financial Officer, Mike Magill, is also included.
Substantial changes occurred in Safeguard during the past year, some of
which resulted in management changes and operating problems during the first
three quarters of the year. I am pleased to report that by the end of 1997, the
Company had been returned to a much more stable operating environment with
considerable progress being made in all sectors. Please refer to previous
reports for the second and third quarter for a detailed accounting of those
developments and the changes that were made in senior management. The Company
now has a very capable, dedicated and effective management team.
OPERATING RESULTS
Operating earnings (EBITDA) totaled $14.6 million in 1997 compared to
the 1996 level of $20.2 million, excluding non-recurring gains and special
charges in each year. Earnings for the past year were negatively impacted in
several ways including: expenses and problems associated with completing
conversion to the AS/400 computer system; management problems in working with
our independent distributor network; and a much higher level of overall
operating expenses than Safeguard can afford to sustain. All of these negative
issues have been addressed and were turned to a positive direction before
year-end.
The outlook for 1998 is quite promising at this time. We conducted a
national meeting with our distributors in November and introduced a number of
new programs and products that have been well received. We are intensifying our
training programs for both company
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employees and distributors which we believe will have a positive impact in the
months ahead. In total, we have entered 1998 with a very high level of
confidence and enthusiasm with respect to the anticipated results for this year
and beyond.
FOCUS ON CORE OPERATIONS
When the management changes occurred in August, we set in motion a
number of significant efforts to focus more clearly on the Company's core
operations which are basically North America, including the U.S. and Canada. We
deemed it advisable and timely to consider a sale of the Company's foreign
operations headquartered in the United Kingdom. This divestiture was completed
in the fourth quarter and you were provided, at that time, a summary of the
results of the divestiture with respect to the use of the proceeds to reduce
debt and improve working capital. A further discussion of these numbers appears
in the report of the Chief Financial Officer. Additionally, at the end of the
year we completed a divestiture of an operating unit in California which was not
core to the Company's fundamental business. That function is a data services
group which was sold to the management. This will permit the Company to further
focus its attention and use of resources to achieve maximum benefit from its
basic business.
We also set in motion, during the fourth quarter of last year,
exploration of the possibility of selling the Company's automated payroll
services line of business and entering into a Strategic Alliance with a provider
of payroll services that would strengthen the Company's market position in that
product line. Safeguard has not been able to expand that line of business to a
level of annual sales that would permit the future investments necessary to
remain competitive in the marketplace. During the last five years, Safeguard
recorded losses of approximately $8 million attempting to develop this line of
business which never reached a critical mass. We announced, recently, that the
Company has executed a Letter of Intent to sell its four payroll operating
centers and the customer base to Advantage, a company headquartered in Maine
with a nationwide operation that is particularly suited to Safeguard, its
customers and our independent distributor network. Additionally, we are entering
into a "Strategic Alliance" with Advantage which will permit our distributors to
continue making this product available to our customers. We believe this action
best serves the interests of all parties.
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SAFEGUARD'S 1998 PRIORITIES
In my letter to you last August, as part of the second quarter report,
I set forth three priorities that would guide the Company's direction and focus
for the foreseeable future. Those priorities remain very much in tact with a
recent addition of a fourth priority relating to new products. Safeguard's 1998
Priorities are:
1. All operations must be at high levels of quality, performance and
reliability
2. We remain committed to our independent distributor network,
implementing effectively mutually agreed upon changes
3. We must achieve improvements in sales and profitability for Safeguard
Business Systems and its independent distributors, and
4. We must identify and integrate new products which will meet the ever
changing needs of our clients.
SUMMARY
At this stage, we are very encouraged about the progress of Safeguard.
We believe that a positive and constructive relationship now exists with our
independent distributor network which can and will be maintained into the
future. Safeguard continues to have an outstanding business opportunity based on
the Company's 40 year record of service to the small business markets where
Safeguard enjoys a relationship with approximately 850,000 customers. We thank
you for your continued support and we will keep you informed on developments
during 1998.
Sincerely,
/s/Elvis L. Mason
Elvis L. Mason
Chairman & CEO
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[LOGO - LETTERHEAD]
March 31, 1998
TO ALL STOCKHOLDERS AND BONDHOLDERS:
Enclosed are the consolidated financial statements of San Jacinto
Holdings Inc. and its operating subsidiary, Safeguard Business Systems, Inc.
("Safeguard") for the years ended December 31, 1997 and 1996. Of significant
interest in 1997 is the sale of Safeguard Systems Europe Limited ("SSGB"), and
the election, in the fourth quarter of 1997, to discontinue data services and
payroll operations. Since SSGB was not a separate line of business, it could not
be accounted for as a discontinued operation under current accounting
principles. Payroll operations and data services, however, are distinct lines of
business and therefore qualify as discontinued operations. Thus all references
to payroll operations and data services have been removed from comparative
financial statements for the periods in questions and are now contained in a
single line representing the results from discontinued operations.
FINANCIAL AND OPERATING HIGHLIGHTS
Net sales in 1997 were $193.3 million, down .7% from net sales in 1996
of $194.6 million. The change in reported net sales from previous years reflects
the sale of the Data Services Group at year end 1997 and the decision of the
Company to sell its payroll services operations (See Subsequent Event Footnote).
Therefore all revenues from these two operations, $11.9 million for 1997 and
$12.1 million for 1996, have been removed from previously reported net sales
figures. However, revenues from SSGB, $18.3 million in 1997 and $18.2 million in
1996, have been included in the reported sales figures even though the
subsidiary was sold. The combined revenue from discontinued operations and sale
of business amount to $30.2 million in 1997 and $30.3 million for 1996. The
Company recorded a gain of $2.5 million on the sale of SSGB.
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Revenues in 1997 from North American operations are as follows.
One-Write systems (manual forms) continued to decline from $76.9 million in 1996
to $69.5 million in 1997, a 9.7% decline. Computer forms declined by 3.3%, from
$52.7 million in 1996 to $50.9 million in 1997. Filing systems also declined by
5.8%, from $7.7 million to $7.2 million. Laser forms continued to grow, however,
at a 30.1% level, from $16.3 million in 1996 to $21.2 million in 1997. Safeguard
believes that laser form sales will continue to grow in the small business
market, as small businesses move toward computerization and more affordable
technology. Sourced product sales were up 15%, from $22.7 million in 1996 to
$26.2 million in 1997. Sourced product sales represents sales through strategic
alliances with other companies and sales of products and services which are
sourced through the Safeguard distribution channel. Safeguard is committed to
supporting this product segment through the distribution channel to serve the
small business customer.
Earnings from operations before amortization, depreciation, interest
and income taxes (EBITDA) in 1997 was $14.6 million compared to $20.2 million in
1996 (before special charges and extraordinary gains). During 1997 and 1996 a
significant amount of unusual charges had an impact on EBITDA as the following
table indicates.
Descriptions ($ in millions) 1997 1996
---------------------------- ---- ----
EBITDA $14,641 $20,219
Non-Recurring operating costs:
Computer system conversion costs 3,406 -
Computer system duplication 100 1,200
UPS strike costs 500 -
Sales & Marketing centralization costs 658 2,429
Litigation Costs - California litigation - 1,197
------ -----
Adjusted EBITDA $19,305 $25,045
====== ======
The conversion to the AS/400 computer system; the closing of the
Addison, Illinois plant; and the consolidation of the customer service and
photo-composition areas were major events which tended to affect customer
service levels and negatively impact cash flow from operations during 1997.
These events were part of the problem which impacted revenues and EBITDA from
1996 to 1997. This impact is readily apparent from the data above based upon the
number and amount of non-recurring expenses during
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1997. Furthermore the management changes and operating problems had the effect
of slowing the level of sales through the distribution channel and polarizing
relations between Safeguard and its independent distributors. As was set forth
in the Chairman's letter, much of this discord has been resolved, and much of
the operations issues have greatly improved.
As indicated earlier, the Company decided to divest its European
operations, which was accomplished in the fourth quarter of 1997. The Company
recognized financial gain of $2.5 million, net of associated costs. The proceeds
from the sale were used to retire consolidated debt and offset some of the
extraordinary expenses as outlined above. In discontinuing its payroll
operations the Company has recognized that this line of business has been
unprofitable for a number of years and that a potential sale of the business
would recoup some of the Company's invested capital. The Company has lost over
$8 million during the previous five years, and the sale of this business will
not adversely affect EBITDA on an ongoing basis due to the lack of ongoing
profits. Proceeds from this transaction will be utilized to reduce debt and
improve the Company's overall cash position. The sale of the data services group
which occurred at year end 1997, will have no impact on EBITDA. There were no
proceeds generated from this sale, although the Company anticipates future
revenue streams through royalty payments which will begin in 1999.
The AS/400 computer system conversion also had the effect of increasing
the number of days sales outstanding (receivable turn) due to the suspension of
the Company's traditional means of collection notices occasioned by unreliable
data. This issue was one of many that weakened the Company's cash position, and
the Company was forced to renegotiate its working capital facilities. These
renegotiations were successfully completed during the year, although it had the
effect of increasing interest expense. Average outstanding debt increased as the
Company sought to offset the loss of revenue with borrowed funds. The
stabilization of the operations mentioned in the Chairman's letter have allowed
the Company to improve its overall cash position and the collection of its
receivables. The Company has improved its days sales outstanding (receivable
turn) from a high of 44 days down to 38 days at year end 1997.
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OUTLOOK FOR 1998
While it is impossible to accurately forecast the future, management
believes that many of the more critical problems facing the Company in 1997 have
been resolved. The Company is now in the process of implementing a long term
strategic plan, working to improve its customer relationships and improving
relationships with its independent distributor channel. Proceeds from the sale
of payroll operations, as well as the sale of SSGB, will serve to reduce
outstanding debt levels, and the Company believes that its debt to equity ratios
will be substantially improved during 1998. Additionally, amortization expense
of approximately $17.3 million will not be present in 1998 as the final amount
of intangible costs related to the Safeguard customer list was written off in
1997.
Lastly, the Company continues to review its capital expenditures budget
for the upcoming year. The budget for capital expenditures in 1998 is much lower
than previously incurred in 1997. Future capital expenditures will be allocated
between maintenance and discretionary to properly utilize internally generated
capital to allow for future growth and profitability.
While the Company has many challenges, from within the industry as well
as internally, management remains committed to improving relations with our
distribution channel, as well as improving the quality and performance of our
products and services. To achieve the level of customer satisfaction that will
aid Safeguard in the future, every one of Safeguard officer's and employees is
dedicated to provide that extra effort to make the customer our most important
relationship. Thank you for your support and contribution!
/s/Michael D. Magill
Michael D. Magill
Senior Vice President and
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, 1997 and 1996, and the related
consolidated statements of operations, stockholders' deficiency, and cash flows
for each of the three years in the period ended December 31, 1997. 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 at December 31, 1997 and 1996, and the results of their operations
and their cash flows for each of the three years in the period ended December
31, 1997 in conformity with generally accepted accounting principles.
Deloitte & Touche LLP
February 24, 1998, except for Note B
as to which the date is March 31, 1998
Deloitte Touche
Tohmatsu
International
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SAN JACINTO HOLDINGS INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
($000 omitted)
December 31,
----------------------
1997 1996
---- ----
ASSETS
Current assets:
Cash and cash equivalents $ 385 $ 482
Receivables less allowances 22,340 27,912
Inventories 7,424 8,594
Assets held for disposition 500 763
Other current assets 1,113 2,480
--------- ---------
Total current assets 31,762 40,231
Property, plant and equipment 14,756 20,617
Excess of purchase price over net assets acquired 41,773 43,225
Customer list -- 17,273
Other assets 1,921 2,372
--------- ---------
Total assets $ 90,212 $ 123,718
========= =========
LIABILITIES AND STOCKHOLDERS' DEFICIENCY
Current liabilities:
Current debt obligations $ 9,563 $ 8,708
Accounts payable 15,740 14,476
Accrued expenses 8,872 16,572
--------- ---------
Total current liabilities 34,175 39,756
Long-term debt 105,507 110,017
Other Liabilities 8,091 7,631
Commitments and contingencies
Stockholders' 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 1,052,384 shares 11 11
Additional paid-in capital 94,143 94,143
Deficit (150,780) (126,880)
Foreign currency translation adjustment (935) (960)
--------- ---------
Total stockholders' deficiency (57,561) (33,686)
--------- ---------
Total liabilities and stockholders' deficiency $ 90,212 $ 123,718
========= =========
See notes to consolidated financial statements.
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SAN JACINTO HOLDINGS INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
($000 omitted)
Year Ended December 31,
1997 1996 1995
---- ---- ----
Net sales $ 193,251 $ 194,618 $ 191,215
Costs of sales 88,636 84,671 82,179
--------- --------- ---------
Gross profit 104,615 109,947 109,036
Selling expense 77,576 80,431 76,023
General and administrative expense 19,964 16,246 17,829
Special charges -- 5,100 5,700
Gain on sale of subsidiary (2,545) -- --
Other income - distributor receivables (1,801) (2,100) (2,465)
Amortization expense 19,255 19,082 19,290
Interest expense 14,836 14,102 9,597
--------- --------- ---------
Loss from continuing operations before income taxes
and extraordinary item (22,670) (22,914) (16,938)
Income tax provision 174 312 174
--------- --------- ---------
Loss from continuing operations before extraordinary item (22,844) (23,226) (17,112)
Discontinued operations:
Loss from discontinued operations 1,056 1,464 1,442
--------- --------- ---------
Loss before extraordinary item (23,900) (24,690) (18,554)
Extraordinary item:
Gain on early extinguishment of debt -- 2,401 --
--------- --------- ---------
Net loss $ (23,900) $ (22,289) $ (18,554)
========= ========= =========
See notes to consolidated financial statements.
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SAN JACINTO HOLDINGS INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIENCY
THREE YEAR PERIOD FROM JANUARY 1, 1995
TO DECEMBER 31, 1997
($000 omitted)
Foreign
Additional Currency
Preferred Stock Common Shares Paid In Translation
Shares Amount Shares Amount Capital Deficit Adjustment
------ ------ ------ ------ ------- ------- ----------
Balance -
January 1, 1995 -- $ -- 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
exchange offer 52,424 1
Net loss (22,289)
Unrealized gain on
foreign currency
translation -- 332
----- ----- --------- --- ------- --------- -------
Balance -
December 31, 1996 -- -- 1,052,384 11 94,143 (126,880) (960)
Net loss (23,900)
Unrealized gain on
foreign currency
translation -- 25
----- ----- --------- --- ------- --------- -------
Balance -
December 31, 1997 -- -- 1,052,384 $11 $94,143 $(150,780) $ (935)
===== ===== ========= === ======= ========= =======
See notes to consolidated financial statements.
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SAN JACINTO HOLDINGS INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
($000 omitted)
Year ended December 31,
1997 1996 1995
---- ---- ----
Cash flows from operating activities:
Net loss $(23,900) $(22,289) $(18,554)
Adjustments to reconcile net loss to
net cash (used in) provided by operating activities:B19
Extraordinary item -- (2,401) --
Amortization 19,255 19,082 19,290
Depreciation 5,765 4,849 4,419
Gain on sale of subsidiary (2,545) -- --
Unrealized exchange gain 25 332 132
Net gain (loss) on sale of assets 67 (727) --
Provision for loss on sale of real estate -- -- 1,700
(Increase) decrease in operating assets:
Receivables 5,572 (840) 248
Inventories 1,170 145 (597)
Assets held for disposition 263 135 78
Other assets 111 1,462 (759)
Increase (decrease) in operating liabilities:
Accounts payable 1,264 4,735 3,923
Accrued expenses and other liabilities (7,240) 2,408 4,226
Deferred interest -- -- 2,072
-------- -------- --------
Net cash (used in) provided by operating activities (193) 6,891 16,178
Cash flows from investing activities:
Net proceeds from sale of subsidiary 8,831 -- --
Purchase of machinery and equipment (3,800) (6,726) (5,510)
Proceeds from sale of assets 787 2,727 --
Adjustment due to currency fluctuations
and foreign purchase price adjustments (16) (477) (18)
-------- -------- --------
Net cash provided by (used in) investing activities 5,802 (4,476) (5,528)
-------- -------- --------
Cash flows from financing activities:
Repayment of long-term debt and
capital lease obligations (9,421) (22,978) (15,082)
Borrowings from revolving loans 7,061 19,724 1,600
(Repayment of) net proceeds from foreign obligations (3,346) 49 3,298
Financing costs -- (1,530) (380)
-------- -------- --------
Net cash used in financing activities (5,706) (4,735) (10,564)
-------- -------- --------
Net (decrease) increase in cash and cash equivalents (97) (2,320) 86
Cash and cash equivalents at beginning of year 482 2,802 2,716
-------- -------- --------
Cash and cash equivalents at end of year $ 385 $ 482 $ 2,802
======== ======== ========
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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 $25, $24, and $1,644, were
issued in 1997, 1996 and 1995, respectively. The PIK Debentures are in
payment of accrued interest on the Company's 8% Subordinated
Debentures, as described in note J.
Capital lease obligations of $2,051, $2,137, and $1,408 were incurred
during 1997, 1996 and 1995, respectively, to acquire certain machinery
and equipment.
Supplemental disclosure of cash flow information:
Cash paid during the year for:
1997 1996 1995
---- ---- ----
Interest $14,759 $14,267 $ 7,177
Income taxes 174 334 266
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, 1997, 1996 AND 1995
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 $809,000
in 1997 and $796,000 in 1996.
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 $18,110,000 in 1997 and
$16,658,000 in 1996. This asset is amortized by the straight-line
method over forty years. Customer list is fully amortized in 1997. The
accumulated amortization is $190,000,000 in 1997 and $172,727,000 in
1996. The customer list was 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.
RECLASSIFICATION - Certain reclassifications have been made to the 1996
and 1995 financial statements to conform to the classifications used in
1997.
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SAN JACINTO HOLDINGS INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(Continued)
B. SUBSEQUENT EVENT:
On March 31, 1998, effective as of April 1,1998, the Company sold its
payroll processing operations to Advantage Business Services, Inc..
Safeguard received proceeds, net of expenses and payments to third
parties, of $8,500,000 and will report a gain of from $7,000,000 to
$8,000,000 pending a determination of costs associated with the
transaction. The proceeds from the sale will be used to repay a portion
of the Revolving Loan and a portion of the Term Loan, and to fund
operations.
C. GAIN ON SALE OF A SUBSIDIARY AND DISCONTINUED OPERATIONS:
On December 2, 1997 the Company sold its investment in Safeguard
Systems Europe Limited ("SSGB"), a wholly-owned subsidiary of
Safeguard. The proceeds from the sale were $8.8 million, net of costs
associated with the sale, and resulted in a gain on the sale of $2.5
million. The operating results of SSGB, as more fully described in Note
R, are included in the statement of operations through the date of
sale. The proceeds from the sale were used to repay the outstanding
overadvance under the Revolving Loan, and to fund operations.
In the fourth quarter of 1997, the Company decided to divest of its
payroll and data processing operations. In December, 1997, the Company
was actively pursuing the sale of its payroll processing operations
(See Note B) and entered into an agreement of sale to sell its data
processing operations. The net assets of the data processing operations
were sold at approximately net book value effective January 1998.
The net assets relating to the payroll and data processing operations
held for sale have been segregated on the consolidated balance sheet
from their historic classification to separately identify them as
assets held for disposition. The net sales from discontinued operations
were $11,850,000 in 1997, $12,133,000 in 1996 and $10,519,000 in 1995.
The sales and related expenses of the operations were excluded from the
determination of the Company's loss from continuing operations for the
periods presented.
D. FINANCIAL RESTRUCTURING:
In 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, the Company and
Safeguard also refinanced existing bank debt. The refinancing plan
included payment in full of the existing 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.
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SAN JACINTO HOLDINGS INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(Continued)
E. 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 was consolidated with its East coast
facilities in 1997. The cost associated with the consolidation include
severance, recruiting and relocation costs. The Company reached an
agreement to settle its California litigation. The financial terms of
the settlement were satisfied by the Company in 1997.
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 cost
to complete this centralization was $5,700,000 which included a
$1,700,000 provision for a loss on the sale of certain real estate
owned by the Company.
F. INVENTORIES:
December 31,
1997 1996
---- ----
($000 omitted)
Raw materials $4,514 $5,327
Work-in-process 307 352
Finished goods 2,603 2,915
------ ------
Total Inventories $7,424 $8,594
====== ======
G. PROPERTY, PLANT AND EQUIPMENT:
December 31,
1997 1996
---- ----
($000 omitted)
Land $ 90 $ 761
Building and improvements 5,588 9,441
Machinery and equipment 42,362 43,468
-------- --------
48,040 53,670
Less accumulated depreciation and amortization (33,284) (33,053)
-------- --------
Total Property, Plant and Equipment $ 14,756 $ 20,617
======== ========
16
19
SAN JACINTO HOLDINGS INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(Continued)
H. 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 $1,801,000 in 1997,
$2,100,000 in 1996 and $2,465,000 in 1995.
Indebtedness of present distributors to selling distributors totaling
$468,000 at December 31, 1997, is guaranteed by Safeguard. In addition,
Safeguard has guaranteed $52,000 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.
I. ACCRUED EXPENSES:
December 31,
1997 1996
---- ----
($000 omitted)
Litigation and facility closure costs $ 574 $ 6,077
Distributor commissions 4,399 4,529
Sales and other taxes 1,077 1,802
Salaries and wages 713 1,309
Interest 665 588
Other 1,444 2,267
------- -------
Total Accrued Expenses $ 8,872 $16,572
======= =======
17
20
SAN JACINTO HOLDINGS INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(Continued)
J. DEBT:
The Company's debt outstanding at December 31, 1997 and 1996 is as
follows:
December 31,
1997 1996
---- ----
($000 omitted)
Revolving Loan - Collaterialized $ 18,086 $ 17,525
Revolving Loan 6,500 --
Term Loan 5,492 6,500
Amended Exchange Loan 17,227 22,633
12% Senior Subordinated Notes 65,878 65,878
8% Senior Subordinated Notes 2 3
8% Subordinated Debentures 262 321
Capital Lease Obligations 1,623 2,519
Foreign Obligations -- 3,346
--------- ---------
115,070 118,725
Less current debt obligation (9,563) (8,708)
--------- ---------
Total Long-term Debt $ 105,507 $ 110,017
========= =========
Safeguard entered into a Loan and Security Agreement in 1996 which
includes a Revolving Loan and a Term Loan. The Revolving Loan allows
for borrowing against eligible accounts receivable and inventories up
to a maximum of $23,500,000. At December 31, 1997, an additional
$2,000,000 was available under the terms of the Revolving Loan.
Outstanding borrowing bears interest at the prime lending rate plus
1.25% for a five year term, with automatic renewal for successive one
year periods. The effective interest rate for such borrowings at
December 31, 1997 was 11.3%. The 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.
Safeguard entered into a $4,000,000 Revolving Loan with its bank in
1996. On July 29, 1997, the loan was amended to allow for borrowings up
to $6,500,000. The borrowing capacity will be reduced by $100,000 per
month beginning January 1, 1998 until it is reduced to $4,000,000. 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 in full on January 25, 2001.
The amended Exchange Loan bears interest at 12.2% per annum and is
payable in monthly installments over a five year period with payment
due in full on November 1, 2000. All issued and outstanding stock of
Safeguard is pledged as collateral under the amended Exchange Loan
Agreement.
18
21
SAN JACINTO HOLDINGS INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
J. DEBT (Continued):
In January 1996 the Company issued 12% Senior Subordinated Notes (the
"New Notes") due December 31, 2002, in conjunction with the refinancing
(See Note D). The interest on the Notes is payable semi-annually on
June 30 and December 31 commencing June 30, 1997. 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, 1997. The Debentures are subordinate to
senior indebtedness (which includes the existing Notes and new Notes).
Safeguard's subsidiary in the United Kingdom ("SSGB") had a pound
sterling1,200,000 short-term line of credit and a 30 year mortgage for
a new manufacturing facility constructed in 1996. The short-term line
of credit and mortgage remain the liability of SSGB, a wholly owned
subsidiary of Safeguard which was sold in December 1997.
The aggregate maturities of long-term debt, exclusive of capital lease
obligations, during the next five years are: 1998 - $8,229,000, - 1999
- $8,229,000; 2000 - $7,135,000; 2001 - $23,977,000; and 2002 -
$65,878,000.
K. 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.
The estimated fair value of the 8% Senior Subordinated Notes and the 8%
Subordinated Debentures approximate their carrying values.
Since the Company is privately-held, there is no active public market
for its 12% Senior Subordinate Notes. Therefore, market information is
not available to the Company to determine estimates of its fair value.
19
22
SAN JACINTO HOLDINGS INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(Continued)
L. 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, 1997, has a net carrying value of $5,184,000 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, 1997 are:
Capital Operating
Leases Leases
------- ---------
($000 omitted)
1998 $1,459 $ 3,751
1999 285 2,419
2000 4 1,769
2001 -- 1,423
2002 -- 1,418
Thereafter -- 2,376
------ -------
$1,748 $13,156
=======
Minimum lease payments:
Amount representing interest (125)
------
Present value of net minimum lease payments $1,623
======
Total rental expense for all operating leases (including leases with
initial or remaining terms of one year or less) is $6,393,000 in 1997,
$4,924,000 in 1996 and $4,036,000 in 1995.
M. 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: 1998 -
$75,000, 1999 - $75,000, 2000 - $75,000, 2001- $50,200, 2001 - $50,200
and 2002 - $50,200.
20
23
SAN JACINTO HOLDINGS INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(Continued)
N. INCOME TAXES:
As prescribed by Statement of Financial Accounting Standards No. 109,
"Accounting for Income Taxes" 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)
1997 1996 1995
---- ---- ----
Domestic $(23,379) $(23,897) $(17,210)
Foreign 709 983 272
-------- -------- --------
Loss before income taxes $(22,670) $(22,914) $(16,938)
======== ======== ========
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 1997, 1996, and 1995.
Items that gave rise to a deferred tax asset (liability) are as
follows:
December 31,
1997 1996
---- ----
($000 omitted)
Net operating loss carryforwards $ 77,371 $ 68,564
Property, plant and equipment -- 2,908
Deferred compensation 1,924 1,730
Capital loss carryforwards -- 1,669
Other 966 773
-------- --------
Total 80,261 75,644
Less: valuation allowance (80,261) (75,644)
-------- --------
Net deferred tax asset (liability) $ -- $ --
======== ========
At December 31, 1997, the Company has, for federal income tax purposes,
net operating loss carryforwards of $210,410,000 which expire between
the years 2001 and 2012. 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.
21
24
SAN JACINTO HOLDINGS INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(Continued)
O. EMPLOYEE BENEFIT PLANS:
Safeguard has a contributory savings plan for employees meeting certain
requirements. The plan allows eligible employees to contribute from 2%
to 15% (effective January 1, 1997) of their compensation, including
overtime, bonuses and shift differential. Safeguard contributes an
amount equal to 100% of the first 3% and 50% of the next 2% (effective
January 1, 1997) 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 $1,154,000 in 1997, $654,000 in 1996, and $639,000
in 1995.
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. The profit-sharing plan contributions were suspended in 1997 and
1996.
P. STOCK OPTION PLAN:
In July 1996, the Company adopted a 1996 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 1996 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, 1997,
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, 1997. The number of shares (or units as described in Equity
Compensation Plan - see Note Q) 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. Since the Company is privately-held
there is no public market for the common stock. Therefore, market
information is not available to the Company to determine estimates of
the fair value of its common stock under the disclosure provision of
SFAS No. 123.
The summary of the option activity is as follows:
Vested Non-Vested Total
------ ---------- -----
Units converted 10,000 85,000 95,000
Units issued - 66,000 66,000
------ ------ ------
Units outstanding, December 31, 1996 10,000 151,000 161,000
Units issued - 45,000 45,000
Units canceled (1,000) (81,000) (82,000)
Units vested 39,000 (39,000) -
------ ------- -------
Units outstanding, December 31, 1997 48,000 76,000 124,000
====== ====== =======
As of December 31, 1997, 9,000 fully vested shares are at an exercise
price of $10.00 per unit; 39,000 vested shares and 76,000 non-vested
shares are at a $5.25 per unit exercise price.
22
25
SAN JACINTO HOLDINGS INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(Continued)
Q. EQUITY COMPENSATION PLAN:
The Equity Compensation Plan, adopted effective January 1, 1993 and
amended March 1, 1995, 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,
1995) 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. Outstanding units totaling 1,574 were
converted to stock options on October 29, 1997 (See Note P).
The summary of the units activity is as follows:
Vested Non-Vested Total
------ ---------- -----
Units outstanding, January 1, 1995 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 (1,078) (496) (1,574)
------- ----- -------
Units outstanding, December 31, 1996 39 -- 39
Units issued -- -- --
Units canceled (7) -- (7)
Units converted -- -- --
------- ----- -------
Units outstanding, December 31, 1997 32 -- 32
======= ===== =======
23
26
SAN JACINTO HOLDINGS INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(Continued)
R. GEOGRAPHIC SEGMENTS:
The Company's foreign operations are in Canada, the United Kingdom and
Belgium. Operations by geographic area are as follows:
1997 1996 1995
($000 omitted)
Net Sales:
United States $ 171,125 $ 171,961 $ 170,095
Foreign 22,126 22,657 21,120
--------- --------- ---------
Total $ 193,251 $ 194,618 $ 191,215
========= ========= =========
Income (Loss) From Continuing Operations:
United States $ (23,379) $ (23,899) $ (17,210)
Foreign 535 673 98
--------- --------- ---------
Total $ (22,844) $ (23,226) $ (17,112)
========= ========= =========
Total Assets:
United States $ 86,685 $ 106,085 $ 126,373
Foreign 3,527 17,633 16,486
--------- --------- ---------
Total $ 90,212 $ 123,718 $ 142,859
========= ========= =========
The Company's foreign operations is the United Kingdom and Belgium held
by SSGB was sold to an unaffiliated company on December 2, 1997. Net
sales of SSGB are $18,256,000 in 1997, $18,248,000 in 1996 and
$16,675,000 in 1995. The net income from SSGB's operations are $693,000
in 1997, $604,000 in 1996 and $476,000 in 1995. These operating results
are included in the Company's statement of operations.
S. 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.
24
27
SAN JACINTO HOLDINGS INC. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
RESULTS OF OVERVIEW
The following commentary presents management's discussion and analysis of the
Company's financial condition and results of operations. Certain of the
statements included below, including those regarding future financial
performance or results, that are not historical facts, are or contain
"forward-looking" information as that term is defined in the Securities Act of
1933, as amended. the words "expect", "believe", "anticipate", "project",
"estimate", and similar expressions are intended to identify forward-looking
statements. The Company cautions readers that any such statements are not
guarantees of future performance or event and such statements involve risks,
uncertainties and assumptions, including but not limited to industry conditions,
general economic conditions, interest rates, competition ability of the company
to successfully mange its growth, and other factors discussed below and in the
Company's quarterly reports. Should one or more of these risks or uncertainties
materialize or should the underlying assumptions prove incorrect, those actual
results and outcomes may differ materially from those indicated in the
forward-looking statements. This review should be read in conjunction with the
information provided in the financial statements, accompanying notes and
selected financial data appearing in the quarterly reports for the quarters
ended March 31, 1997, June 30, 1997 and September 30, 1997.
Year Ended December 31,
1997 1996 1995
---- ---- ----
Net sales 100.0% 100.0% 100.0%
Cost of sales 45.9 43.5 43.0
Gross profit 54.1 56.5 57.0
Selling expense 40.1 41.3 39.8
General and administrative expense 10.3 8.3 9.3
Special charges -- 2.6 3.0
Gain on sale of subsidiary (1.3) -- --
Other income - distributor receivables (1.0) (1.1) (1.3)
Amortization expense 10.0 9.8 10.1
Interest expense 7.7 7.2 5.0
------ ------ ------
Loss from continuing operations before income taxes
and extraordinary item (11.7) (11.8) (8.9)
Income tax provision 0.1 0.2 0.1
Loss from continuing operations before extraordinary item (11.8) (11.9) (8.9)
Loss from discontinued operations 0.5 0.8 0.8
------ ------ ------
Loss before extraordinary item (12.4) (12.7) (9.7)
Extraordinary item - gain on early extinguishment of debt -- 1.2 --
------ ------ ------
Net loss (12.4)% (11.5)% (9.7)%
======= ====== ======
25
28
SAN JACINTO HOLDINGS INC. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(continued)
COMPARISON OF THE YEAR ENDED DECEMBER 31, 1997 TO THE YEAR ENDED DECEMBER 31,
1996
NET SALES FROM CONTINUING OPERATIONS. Net sales were $193.3 million in 1997
compared to $194.6 million in 1996, representing a decrease of 0.7%. This sales
decline reflected a 8.1% decline in manual forms sales, partially offset by an
3.4% growth in computer forms. The decline in manual forms sales in 1997 was
offset in part by a 3.2% average price increase. The increase in computer forms
is in the laser forms component of the product line which continues to grow at a
double digit rates (29.4% in 1997 and 32.9% in 1996) as customers move from
standard pin fed forms to laser forms. The growth in the computer forms product
line includes a 3.0% average price increase.
The Company's sales growth in 1997 has been influenced by several factors. The
Company's computer hardware and software system conversion, initiated in the
first quarter of 1997, delayed implementation of certain marketing programs
intended to positively effect sales, and resulted in production delays and
product quality concerns. In addition, a significant amount of communications
with the Company's distributor network occurred during the second quarter of
1997 regarding proposed changes to the distribution channel: analysis indicates
that the distributors' sales performance was adversely effected by these
announcements. The distribution channel disruption was addressed promptly and
during the second half of 1997 communication between the Company and its
distribution channel were significantly improved. During the third quarter of
1997, as a result of the UPS strike, the Company and its distribution network
was forced to focus its attention on customer delivery concerns instead of
soliciting and manufacturing customer orders. Safeguard ships approximately 80%
of its product via UPS.
GROSS PROFIT FROM CONTINUING OPERATIONS. Gross profit margin was 54.1% of net
sales in 1997 compared to 56.5% in 1996. Gross profit is before selling and
administrative expenses, including commission expense. The decline in margin is
attributable to the change in the Company's product mix from manual forms to
computer forms and sourced products as indicated in the table below.
Years Ended December 31,
1997 1996
---- ----
Manual forms 63.6% 66.9%
Computer forms 50.8 50.3
Sourced products 38.8 41.1
---- ----
Total 54.1% 56.5%
==== ====
Computer forms and sourced products, high growth product lines, carry greater
material, direct labor and overhead costs (as a percentage of sales), resulting
in a lower gross profit margin than for manual forms. Overhead costs have also
increased in 1997 as a result of additional equipment costs in support of
technological advances in the computer systems.
SELLING EXPENSE. Selling expense are $77.6 million in 1997 compared to $80.4
million in 1996, representing 40.1% and 41.3% of net sales in each year.
Commissions to independent distributors account for approximately 80% of the
total selling costs and, as a percent of net sales has remained constant. The
dollar decline in selling expenses is attributable to the postponement of
certain marketing programs, partially offset by increased computer equipment
costs.
GENERAL AND ADMINISTRATIVE. General and administrative expenses were $20.0
million in 1997 compared to $16.2 million in 1996, representing 10.3% and 8.3%
of net sales in each year. The increase in costs is attributable to greater
administrative costs associated with the system conversion and the impact of the
UPS strike, partially off-set by legal and benefit cost reductions. In addition,
1996 includes a $0.7 million gain on the sale of a manufacturing facility in the
United Kingdom.
26
29
SAN JACINTO HOLDINGS INC. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(continued)
GAIN ON SALE OF SUBSIDIARY. On December 2, 1997 the Company sold its investment
in Safeguard Systems Europe Limited ("SSGB"), a wholly owned subsidiary of
Safeguard. The proceeds of the sale were $8.8 million, net of costs associated
with the sale, and resulted in a gain on the sale of $2.5 million. The operating
results of SSGB, as more fully described in Note R, are included in the
statement of operations through the date of sale. On December 2, 1997 the
outstanding intercompany balance due to Safeguard by SSGB totaling $3.4 million
was repaid in full. The proceeds from the sale were used to repay the
outstanding overadvance under the Revolving Loan, and to fund operations.
OTHER INCOME - DISTRIBUTOR RECEIVABLES. Other income (cash received greater than
carrying value of distributor receivables) was $1.8 million in 1997 compared to
$2.1 million in 1996, representing 0.9% and 1.1% 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 $19.3 million in 1997 and $19.1
million in 1996. 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 $14.8 million in 1997 and $14.1 million
in 1996, including $14.8 million and $14.3 million, respectively, of cash
interest payment. The increase in interest expense in 1997 is attributable to a
rise in the Company's average outstanding borrowings.
INCOME TAX . The Company's provision for income tax is related to its operations
in the United Kingdom. No tax liability was generated in the United States as a
result of net losses from operations.
DISCONTINUED OPERATIONS. In the fourth quarter of 1997, the Company decided to
divest of its payroll and data processing operations. In December, 1997, the
Company was actively pursuing the sale of its payroll processing operations (See
Note to Consolidated financial Statements) and entered into an agreement of sale
to sell its data processing operations. The net sales from discontinued
operations were $11,850,000 in 1997, $12,133,000 in 1996 and $10,519,000 in
1995. The sales and related expenses of the operations were excluded from the
determination of the Company's loss from continuing operations for the periods
presented.
COMPARISON OF THE YEAR ENDED DECEMBER 31, 1996 TO THE YEAR ENDED DECEMBER 31,
1995
NET SALES FROM CONTINUING OPERATIONS. Net sales were $194.6 million in 1996
compared to $191.2 million in 1995, representing an increase of 1.8%. This sales
growth reflected an 10.9% growth in computer forms, partially offset by a 8.2%
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 1996 was offset in part by a
3.7% average price increase.
27
30
SAN JACINTO HOLDINGS INC. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(continued)
GROSS PROFIT FROM CONTINUING OPERATIONS. Gross profit margin was 56.5% of net
sales in 1996 compared to 57.0% in 1996. Gross profit is before selling and
administrative expenses, including commission expense. The decline in margin was
a result of the change in the Company's product mix from manual form sales to
computer forms and sourced products as indicated in the table below.
Years Ended December 31,
1996 1995
---- ----
Manual forms 66.9% 67.5%
Computer forms 50.3 48.3
Sourced products 41.1 40.3
---- ----
Total 56.5% 57.0%
==== ====
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. Additionally, in 1996 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 $80.4 million in 1996 compared to $76.0
million in 1995, representing 41.3% and 39.8% of net sales in each year.
Commissions to independent distributors account for approximately 80% of the
total selling costs and, as a percent of net sales has remained constant over
the last several years. The increasing selling expenses in 1996 is attributable
to increased commission costs associated with the sales growth noted above, in
addition to a planned increase in sales support costs associated with the
establishment of a new sales/marketing facility in Dallas, Texas .
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses were
$16.2 million in 1996 compared to $17.8 million in 1995, representing 8.3% and
9.3% 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. 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 had been defending since 1992. The
Company's Addison, Illinois manufacturing facility was consolidated with its
East coast facilities in the third quarter of 1997. The cost associated with the
consolidation included severance, recruiting and relocation costs. The Company
reached an agreement to settle its California litigation. The financial terms of
the settlement were satisfied by the Company in 1997.
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 costs was $5.7 million,
which includes a $1.7 million loss on the sale of certain real estate owned by
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 1.1% 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.
AMORTIZATION EXPENSES. Amortization expense was $19.1 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.
28
31
SAN JACINTO HOLDINGS INC. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(continued)
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
payment. The increase in interest expense was attributable to an increase in the
Company's outstanding borrowings in addition to a rise in the interest rate of
the Company's long term debt.
INCOME TAX. The Company's provision for income tax is related to its 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 is a use of funds of $0.2 million
in 1997. As of December 31, 1997, the Company had $0.4 million in cash and cash
equivalents, and $2.0 million in availability under revolving loans. At that
date, the Company has a working capital deficiency of $2.4 million and a ratio
of current assets to current liabilities of approximately 0.93:1.
Liquidity during 1997 has been adversely affected by the issues associated with
the conversion of the Company's computer systems to the AS/400 platform. The
Company suspended its normal credit collection procedures pending resolution of
systems issues associated with the order entry and customer invoicing system.
This suspension had an adverse impact on days sales outstanding("receivable
turn") which adversely impacted cash flow. The Company has reinstated its
collection procedures and has significantly reduced its receivable turn during
the fourth quarter of 1997. The Company anticipates it will return to its
historical receivable turn in the first half of 1998.
The Company's ongoing liquidity requirements arise primarily from capital
expenditures, working capital needs and debt service. The Company's capital
expenditures in 1997 are $5.5 million in the installation of sales force
automation system, equipment purchases and software development costs. A
significant portion of the capital investment in equipment and software in 1997
is for the completion of the installation of an integrated computerized order
entry system, and the upgrade of existing manufacturing production equipment.
These expenditures are funded through additional capital lease obligations and
cash flow from operations.
At the end of the second quarter, the Company notified its bondholders that the
interest payment due June 30, 1997 would be postponed pursuant to the 30 day
grace period allowed pursuant to the Indenture Agreement on the 12% Subordinated
Bonds. This notice was sent pending completion of proposed changes in existing
senior lenders' credit agreements with Safeguard to compensate for the
unexpected operating problems. The interest payment was made to all bondholders
of record during the grace period and no default occurred. During the grace
period the Company amended its credit facilities to provide for a $4.0 million
increase in short-term borrowing capacity with its financial institutions which
provided sufficient funds for the Company to make its interest payment to its
bondholders. The Collaterialized Revolving Loan was amended during the third
quarter to extend the $1.5 million overadvance, adjust covenants, and increase
the interest rate on the working capital facility from prime plus 1% to prime
plus 1.25%. The $1.5 million overadvance was repaid in December 1997 from the
proceeds of the sale of the Company's subsidiary in the United Kingdom. Future
interest payments of the Company are expected to be made out of improved
operating results and cash flow as well as any asset sales which might be made,
although the ability to accurately project futures sales volume, and events
outside of the Company's control could have an impact on future interest
payments.
As more fully described in the Notes to the Consolidated Financial Statements,
on March 31, 1998 the Company sold its payroll processing operations. The
proceeds of $8.5 million which is net of expenses and payments to third parties,
will be used to reduce the Revolving Loan to a borrowing capacity of $4.0
million and to repay an additional $1.3 million under the Term Loan. The
remaining proceeds will be used to reduce the outstanding borrowings under the
Collaterialized Revolving Loan and reduce outstanding trade payables. The
Company has met all of its debt obligations and is not currently in default of
any of its loan agreements. The Company continues to monitor its cash position
and believes that sufficient funding alternatives exist to meet its current
obligations as they come due.
29