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Exhibit T3E-18
SAN JACINTO HOLDINGS INC. AND SUBSIDIARY
CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
TABLE OF CONTENTS
Page
----
Letter to Stockholders and Bondholders 1 - 4
Attachment to letter to Stockholders and Bondholders 5
Independent Auditors' Report 6
Consolidated Financial Statements and Related
Notes to the Consolidated Financial Statements 7 - 21
Management's Discussion and Analysis of Financial
Condition and Results of Operations 22 - 27
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March 31, 1999
TO ALL STOCKHOLDERS AND BONDHOLDERS:
Enclosed are the audited financial statements of San Jacinto Holdings,
Inc. and its operating subsidiary, (the "Company"), Safeguard Business Systems,
Inc. ("Safeguard") for the fiscal year ended December 31, 1998. Operating
earnings (EBITDA) totaled $12.9 million in 1998 compared to $11.4 million on a
comparable basis for 1997, excluding the income generated from U.K. operations
as well as the payroll and data services sales for both years. Long term debt
levels at year end December 31, 1998 were $7.4 million lower as compared to year
end 1997. Operating earnings have improved notwithstanding the absence of any
sales growth within Safeguard's distribution channel. It was for this reason
that the Company embarked on a program to expand its distribution channel
through a network expansion program. Also, due to the change in the dynamics
currently shaping the Office Forms and Products market, there was sufficient
evidence to indicate that such a program could be successful. For additional
information please review the Management's Discussion and Analysis following the
audited financial statements and footnotes.
OVERVIEW
During 1998 several critical elements to the Company's long-term
strategic direction were completed or implemented. At the end of the first
quarter of 1998 Safeguard's payroll operations were sold and the proceeds from
that sale were utilized to allow the Company to strengthen its capital position.
Additionally, the Company embarked upon a system wide focus on customer service
in an effort to strengthen its ties to the small business marketplace. This
focus has been continued into 1999 and will remain a critical element of
Safeguard's strategic direction for the future.
Additionally, during the second half of 1998, Safeguard embarked on a
growth strategy to expand its channel of distribution through the addition of
new distributors and new bases of business integrated into Safeguard
distributorships. The Company has expanded its infrastructure to accommodate
this new business, and has spent considerable time and effort communicating this
approach and the benefits to be derived for its channel.
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SALES
Net sales for 1998 were $168.4 million, down 3.8%, or $6.6 million from
the comparable period in 1997, excluding U.K. sales of $18.3 million. This sales
decline reflects the decline in One-Write and computer form sales of 10%,
although sales of laser products continue to grow by 24%. Additionally, sales
from sourced products were $26.6 million, up slightly from the $26.2 million
recorded in 1997. The Company has placed a greater emphasis with its
distribution channel on manufactured products, due to the impact that such sales
have on absorbing overhead built into the financial structure of the Company.
Clearly though, the distribution channel as it exists today is not providing the
growth in sales necessary to provide additional financial strength to the
Company. It is this problem which prompted the Company to redirect its focus to
adding new sales, either through distributor aided acquisitions of new business,
or through the addition of forms broker/dealers as new distributors.
RESULTS OF OPERATIONS
Annual sales were $168.4 million, or 12.9% below sales of $193.3
million for the annual period in 1997, which includes sales from the U.K.
subsidiary of $18.3 million for 1997. Since the sale of the U.K. subsidiary was
not considered as a discontinued operation, these sales amounts are shown in the
Company's audited financials for the previous year. Sales in One-Write continue
to decline at a 9.9% rate as well as short-run continuous forms, which are
declining at a 10.1% rate against 1997 amounts. Laser sales continue to increase
at a 24.1% rate over last years period, and at a pace greater than industry
averages. Sourced products have essentially remained flat from period to period.
During 1998, the Company reduced prices on its computer forms products to remain
competitive with the marketplace. The Company did announce a price increase on
its One-Write products at the end of 1998, and implemented an approximate 6%
increase beginning in 1999.
Selling expenses have declined from the comparable period in 1997 due
to the sale of the U.K. subsidiary. While a majority of these expense declines
have come from the sale of the U.K. subsidiary, additional reductions are coming
from improvements in cost controls and efficiencies.
Earnings before interest, taxes and amortization ("EBITA") has
increased 26.5%, from $6.4 million in 1997 to $8.1 million in 1998, primarily
due to the reduction in expenses and cost controls. EBITDA (EBITA plus
depreciation) has increased by 13.2%, from $11.4 million in 1997 to $12.9
million in 1998.
Amortization expense has declined by $17.4 million from the comparable
period in 1997 due to the complete amortization of the customer list at the end
of 1997. Interest expense was 10.2% lower than the amount in 1997 due to the
reduced levels of borrowing caused by the improvement in the Company's capital
position from the sale of payroll and the U.K. subsidiary. Thus the loss from
continuing operations declined by $15.7 million, from $22.8 million in 1997, to
$7.1 million for the year ended December 31, 1998. The extraordinary gain from
the sale of payroll, including the gain from discontinued operations, totaled $7
million for 1998, resulting in a net loss for 1998 of $170,000, compared to a
net loss of $23.9 million in 1997.
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During the third quarter the bank group allowed the Company to increase
its Term Loan facility to $8 million, and defer the amortization of principal on
the Term Note until September 1999. This amendment to our existing debt
agreements will provide the Company the capital necessary to focus on an
expansion of the current distribution channel. The Company also added a LIBOR
option to its Working Capital Line, which will have the effect of reducing
interest costs. At year-end 1998 the Company's long term debt stood at $115.1
million compared to $107.7 million at year end 1997.
FRANCHISE INITIATIVES
The Company continues its process to register as a franchise under the
applicable franchise laws of all states in which the Company operates. While the
Company does not expect such registration to change the existing relationship
with its current distribution channel, it will allow the Company more
flexibility in its dealings with new distributors as they join the Safeguard
organization under the new Network Expansion program currently underway.
CHANGE IN INDUSTRY
As the Company focused on its strategic direction for the future,
industry changes made it apparent that the distribution channel in the Office
Forms and Products industry had become a major factor in the ability to access
the marketplace. According to the International Business Forms Institute
("IBFI"), 1997 was the first year that more sales to customers were generated by
independent forms brokers/dealers than through direct marketing by
manufacturers. Clearly the distribution channel is becoming a stronger force in
the ability to reach the end customer as compared to the historical ability of
the manufacturing sector of the Office Products and Forms industry to control
the end user segment of the industry.
Furthermore, the 1997 IBFI study concluded that a majority of the
manufacturing sector was moving toward larger customers and largely abandoning
the small business market to a few niche players. It is this change in dynamics
that has caused Safeguard to refocus on a core competency which has existed
within the Company for forty years, namely the ability of its own distribution
channel to access small businesses. As such Safeguard believes that it possesses
an infrastructure and manufacturing capability, at the small business end of the
marketplace, that creates a unique niche within the industry and should allow
for additional growth in the one sector of the marketplace that has continued to
expand.
OPERATIONAL ADVANCEMENTS
Safeguard continues to make strides in improving its operational
infrastructure, both at the manufacturing and channel support level. Safeguard
has almost completed the implementation of a Bar Code Scanning capability as
well as consolidation of the front end of the order entry and photo-composition
phase of the manufacturing process. Additionally, the Company is improving its
proprietary order entry system for use by its distributors, and believes that
further improvements can be made by moving toward the current operating
platforms more commonly utilized in today's small business environment.
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Additionally, Safeguard is quickly moving to establish an Internet site
for its distributor channel that will ultimately provide for sales generation
and E-Commerce capabilities for the small business customer. E-Commerce will
allow repeat orders and referrals to be processed, and new orders to be assigned
to Safeguard distributors for their personal involvement with the new customer.
Safeguard believes that the Internet provides a unique opportunity to compliment
the personal involvement that Safeguard distributors currently provide to small
business customers.
MANAGEMENT CHANGES
Recently the role and duties of Chief Executive Officer of the Company
as well as President of the Company and its operating subsidiary have been
combined. A copy of the release has been attached to this report. Elvis Mason
will continue in the role of Chairman of the Board and Chairman of the Executive
Management Committee. Additionally, W. Mack Goforth has recently joined the
Company as Senior Vice President and Chief Financial Officer and will report to
Mike Magill.
CUSTOMER SERVICE INITIATIVES
The Company has established a Customer Service initiative that focuses
on improving many of the operational areas that interface with the distribution
channel and the customer base. A Customer Service Coalition, comprised of a
cross-section of departments within the Company as well as several of its
distributors, has recently produced a new customer service cultural change
throughout the Company. The Company believes that customer service must continue
to be part of the overall strategic focus of Safeguard and its distribution
channel. The establishment of a vision statement that states, "We Help Small
Business Succeed", requires the efforts of the Company and its distribution
channel to effect customer satisfaction, and more importantly customer loyalty.
The Company is committed to helping its independent distributors provide better
service, quality products, and exemplary service in its drive to improve
customer retention, as well as improve its future sales levels. The focus and
attention to customer service is absolutely necessary to remain competitive in
the marketplace and provide cost effective sales growth from the existing base
of customers.
The Company will continue to improve the quality, performance and
reliability of its operations through technology; achieve improved results in
sales and profitability through network expansion: identify and integrate new
products to manufacture: and maintain our commitment to our independent
distributor network where together, "We help small business succeed" in their
efforts to grow and prosper.
/s/ Elvis Mason /s/ Michael Magill
ELVIS L. MASON MICHAEL D. MAGILL
Chairman of the Board President & CEO
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DATE: March 15, 1999
TO: All Safeguard Distributors and Employees
FROM: Elvis L. Mason, Chairman of the Board
RE: Mike Magill Elected Chief Executive Officer
It is a genuine pleasure to announce that the Board of Directors of San Jacinto
Holdings and Safeguard Business Systems has elected Mike Magill Chief Executive
Officer effective March 15, 1999. His title will now be President & Chief
Executive Officer. I will continue to be active in the Company as Chairman of
the Board and Chairman of the Executive Management Committee. Mike will continue
to serve as Vice Chairman of the Executive Management Committee and Chairman of
the Operating Committee.
Mike joined Safeguard in July 1997 as Senior Vice President and Chief Financial
Officer. He was promoted to President and Chief Operating Officer in July 1998.
Prior to joining Safeguard, he served as Executive Vice President, Director and
Chief Financial Officer of KBK Capital Corporation, a publicly traded commercial
finance corporation specializing in asset-based lending and working capital for
middle market companies. Before joining KBK, Mike held senior executive
positions in two Texas banking organizations extending over a period of some 20
years. His experience included serving as Chief Financial Officer of a $22
billion publicly multi-bank holding company and senior responsibilities in
lending, investments and operations.
Mike earned a law degree at the University of Texas at Austin and an
undergraduate degree in Business Administration from the University of Texas at
Arlington. He has been a member of the Texas Bar Association since 1973 and a
Certified Public Accountant since 1974. His previous employment included working
with two public accounting firms, Ernst & Whinney and Peat, Marwick, Mitchell &
Co.
Since joining Safeguard, Mike has provided excellent leadership in all of his
responsibilities. He has certainly worked effectively with Safeguard's
management team, employees and with our independent distributors. I am certain
that he will do a superior job in his new position as Chief Executive Officer.
On a personal note, I remain fully committed to Safeguard, its employees and its
independent distributor network. I will do everything I can to support Mike and
Safeguard's entire organization. We now have a fully qualified and dedicated
management team for the future.
In commenting on his change in title, Mike stated that "I am delighted to have
this opportunity to work together with such a fine team of accomplished
professionals. Part of the Safeguard mystique in the marketplace is the personal
service offered to small business customers through its distributors as well as
the support given to Safeguard distributors to enhance their value as a small
business. I am proud to be a part of this commitment to excellence, and together
we will provide the highest standard of customer service in the small business
marketplace, Enough Said!"
Please join me in congratulating Mike on his election as Chief Executive
Officer.
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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, 1998 and 1997, and the related
consolidated statements of operations and comprehensive income, stockholders'
deficiency, and cash flows for each of the three years in the period ended
December 31, 1998. 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, 1998 and 1997, and the results of their operations
and their cash flows for each of the three years in the period ended December
31, 1998 and in conformity with generally accepted accounting principles.
February 23, 1999
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SAN JACINTO HOLDINGS INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
($000 omitted)
December 31,
----------------------
1998 1997
---- ----
ASSETS
Current assets:
Cash and cash equivalents $ 639 $ 385
Receivables less allowances 20,055 22,340
Inventories 6,985 7,424
Assets held for disposition - 500
Other current assets 861 1,113
--------- --------
Total current assets 28,540 31,762
Property, plant and equipment 12,179 14,756
Excess of purchase price over net assets acquired 40,332 41,773
Other assets 1,547 1,921
--------- --------
Total assets $ 82,598 $ 90,212
========= ========
LIABILITIES AND STOCKHOLDERS' DEFICIENCY
Current liabilities:
Current debt obligations $ 6,978 $ 9,563
Accounts payable 15,593 15,740
Accrued expenses 8,073 8,872
--------- --------
Total current liabilities 30,644 34,175
Long-term debt 100,703 105,507
Other liabilities 9,383 8,091
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 (150,950) (150,780)
Accumulated other comprehensive loss (1,336) (935)
--------- --------
Total stockholders' deficiency (58,132) (57,561)
--------- --------
Total liabilities and stockholders' deficiency $ 82,598 $ 90,212
========= ========
See notes to consolidated financial statements.
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SAN JACINTO HOLDINGS INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
($000 omitted)
Year Ended December 31,
---------------------------------------
1998 1997 1996
---- ---- ----
Net sales $168,404 $ 193,251 $ 194,618
Costs of sales 81,591 88,636 84,671
-------- --------- ---------
Gross profit 86,813 104,615 109,947
Selling expense 64,493 77,576 80,431
General and administrative expense 15,935 19,964 16,246
Special charges -- -- 5,100
Gain on sale of subsidiary -- (2,545) --
Other income - distributor receivables (1,717) (1,801) (2,100)
Amortization expense 1,899 19,255 19,082
Interest expense 13,323 14,836 14,102
-------- --------- ---------
Loss from continuing operations before income taxes
and extraordinary item (7,120) (22,670) (22,914)
Income tax provision -- 174 312
-------- --------- ---------
Loss from continuing operations before extraordinary item (7,120) (22,844) (23,226)
Discontinued operations:
Gain on sale of assets 6,438 -- --
Gain (loss) from discontinued operations 512 (1,056) (1,464)
-------- --------- ---------
6,950 (1,056) (1,464)
-------- --------- ---------
Loss before extraordinary item (170) (23,900) (24,690)
Extraordinary item:
Gain on early extinguishment of debt -- -- 2,401
-------- --------- ---------
Net loss (170) (23,900) (22,289)
Other comprehensive income (loss), net of tax:
Foreign currency translation adjustment (401) 234 332
Reclassification adjustment for realized currency exchange
losses due to gain on sale of subsidiary -- (209) --
-------- --------- ---------
Comprehensive loss $ (571) $ (23,875) $ (21,957)
======== ========= =========
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, 1996
TO DECEMBER 31, 1998
($000 omitted)
Accumulated
Additional other
Preferred stock Common stock paid in comprehensive
Shares Amount Shares Amount capital Deficit income (loss)
------ ------ ------ ------ ------- ------- -------------
Balance -
January 1, 1996 - $ - 999,960 $ 10 $ 94,143 $(104,591) $ (1,292)
Issuance of common stock
in conjunction with
the exchange offer 52,424 1
Net loss (22,289)
Accumulated other
comprehensive income 332
----- ----- ---------- ----- -------- --------- --------
Balance-
December 31, 1996 - - 1,052,384 11 94,143 (126,880) (960)
Net loss (23,900)
Reclassification
adjustment for realized
currency exchange losses
due to gain on sale of
subsidiary (209)
Accumulated other
comprehensive income - 234
----- ----- ---------- ----- -------- --------- --------
Balance -
December 31, 1997 - - 1,052,384 11 94,143 (150,780) (935)
Net loss (170)
Accumulated other
comprehensive loss - (401)
----- ----- ---------- ----- -------- --------- --------
Balance -
December 31, 1998 - $ - 1,052,384 $ 11 $ 94,143 $(150,950) $ (1,336)
===== ===== ========== ===== ======== ========= ========
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,
-----------------------
1998 1997 1996
---- ---- ----
Cash flows from operating activities:
Net loss $ (170) $(23,900) $(22,289)
Adjustments to reconcile net loss to
net cash provided by (used in) operating activities:
Extraordinary item -- -- (2,401)
Amortization 1,899 19,255 19,082
Depreciation 4,803 5,765 4,849
Net (gain) loss on sale of assets (6,438) 67 (727)
Gain on sale of subsidiary -- (2,545) --
Unrealized exchange gain (loss) (401) 25 332
(Increase) decrease in operating assets:
Receivables 2,285 5,572 (840)
Inventories 439 1,170 145
Assets held for disposition 500 263 135
Other assets -- 111 1,462
Increase (decrease) in operating liabilities:
Accounts payable (147) 1,264 4,735
Accrued expenses and other liabilities 504 (7,240) 2,408
------- ------- -------
Net cash provided by (used in) operating activities 3,274 (193) 6,891
Cash flows from investing activities:
Net proceeds from sale of subsidiary -- 8,831
Purchase of machinery and equipment (1,339) (3,800) (6,726)
Proceeds from sale of assets 6,695 787 2,727
Adjustment due to currency fluctuations
and foreign purchase price adjustments 100 (16) (477)
------- ------- -------
Net cash provided by (used in) investing activities 5,456 5,802 (4,476)
------- ------- -------
Cash flows from financing activities:
Repayment of long-term debt and capital lease obligations (9,975) (9,421) (22,978)
Net borrowings from (repayment of) revolving loans (3,209) 7,061 19,724
Borrowing from term loan 4,708 -- --
(Repayment of) net proceeds from foreign obligations -- (3,346) 49
Financing costs -- -- (1,530)
------- ------- -------
Net cash used in financing activities (8,476) (5,706) (4,735)
------- ------- -------
Net increase (decrease) in cash and cash equivalents 254 (97) (2,320)
Cash and cash equivalents at beginning of year 385 482 2,802
------- ------- -------
Cash and cash equivalents at end of year $ 639 $ 385 $ 482
======= ======= =======
See notes to consolidated financial statements.
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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 $11, $25, and $24, were
issued in 1998, 1997 and 1996, 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 $1,076, $2,051, and $2,137 were incurred
during 1998, 1997 and 1996, respectively, to acquire certain machinery
and equipment.
Supplemental disclosure of cash flow information:
Cash paid during the year for:
1998 1997 1996
--------------------------------
Interest $13,498 $14,759 $14,267
Income taxes - 174 334
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, 1998, 1997 AND 1996
A. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
-------------------------------------------
PRINCIPLES OF CONSOLIDATION - The consolidated financial statements
include the accounts of San Jacinto Holdings Inc. ("San Jacinto") 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 $795,000
in 1998 and $809,000 in 1997.
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. The provision for depreciation
is based on the estimated useful lives of the related assets computed
by the straight-line method.
INTANGIBLE ASSETS - Excess of purchase price over net assets acquired
is net of accumulated amortization of $19,550,000 in 1998 and
$18,110,000 in 1997. This asset is amortized by the straight-line
method over forty years. The customer list was fully amortized in 1997.
The accumulated amortization was $190,000,000 in 1997. 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 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. No assets were considered impaired as of December
31, 1998.
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, 1998, 1997 AND 1996
(Continued)
B. RECENT ACCOUNTING PRONOUNCEMENTS:
---------------------------------
Effective January 1, 1998, the Company adopted SFAS 130, "Reporting
Comprehensive Income." This statement established standards for
reporting and disclosure of comprehensive income and its components in
the financial statements. Accumulated other comprehensive income in the
consolidated balance sheets as of December 31, 1998 and 1997 consists
of foreign currency translation adjustment.
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 its
payroll and data processing operations. On March 31, 1998, effective as
of April 1,1998, the Company sold its payroll processing operations to
Advantage Business Services Holdings, Inc. Safeguard reported a gain of
$6,400,000 after expenses and payments to third parties. The proceeds
from the sale were used to repay a portion of the Revolving Loan and a
portion of the Term Loan, and to fund operations. The net assets of the
data processing operations were sold at approximately net book value,
effective January 1998. Consideration for this sale will be in the form
of royalty payments beginning in 1999.
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 $2,931,000 in 1998, $11,850,000 in 1997 and $12,133,000 in 1996.
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 (the "Existing 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 early extinguishment of debt and
resulted in an extraordinary gain of $2,401,000 after deducting related
expenses.
In conjunction with the Exchange Offer described above, the Company
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, 1998, 1997 AND 1996
(Continued)
E. SPECIAL CHARGES:
----------------
In December 1996 the Company recorded 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.
F. INVENTORIES:
------------
December 31,
1998 1997
-------------------------
($000 omitted)
Raw materials $4,380 $4,514
Work-in-process 258 307
Finished goods 2,347 2,603
------ ------
Total Inventories $6,985 $7,424
====== ======
G. PROPERTY, PLANT AND EQUIPMENT
-----------------------------
December 31,
1998 1997
--------------------------------
($000 omitted)
Land $ 90 $ 90
Building and improvements 5,490 5,588
Machinery and equipment 42,274 42,363
-------- --------
47,854 48,040
Less accumulated depreciation and amortization (35,675) (33,284)
-------- --------
Total Property, Plant and Equipment $ 12,179 $ 14,756
======== ========
14
16
SAN JACINTO HOLDINGS INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(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 $1,717,000 in 1998,
$1,801,000 in 1997 and $2,100,000 in 1996.
Indebtedness of present distributors to selling distributors totaling
$248,000 at December 31, 1997, is guaranteed by Safeguard. In addition,
Safeguard has guaranteed $20,000 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,
1998 1997
-----------------------
($000 omitted)
Discontinued operations and facility closure costs $ 566 $ 574
Distributor commissions 4,550 4,399
Sales and other taxes 1,720 1,077
Salaries and wages 614 713
Interest 479 665
Other 144 1,444
------ ------
Total Accrued Expenses $8,073 $8,872
====== ======
15
17
SAN JACINTO HOLDINGS INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(Continued)
J. DEBT:
-----
The Company's debt outstanding at December 31, 1998 and 1997 is as
follows:
December 31,
1998 1997
-------------------------
($000 omitted)
Revolving Loan - Collaterialized $ 17,377 $ 18,086
Revolving Loan 4,000 6,500
Term Loan 8,000 5,492
Amended Exchange Loan 11,487 17,227
12% Senior Subordinated Notes 65,878 65,878
8% Senior Subordinated Notes 1 2
8% Subordinated Debentures 194 262
Capital Lease Obligations 744 1,623
--------- ---------
107,681 115,070
Less current debt obligation (6,978) (9,563)
--------- ---------
Total Long-term Debt $ 100,703 $ 105,507
========= =========
Safeguard entered into a five year 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, 1998, an
additional $900,000 was available under the terms of the Revolving
Loan. Outstanding borrowings bear interest at the prime lending rate
plus 1.25% or LIBOR plus 3.25% per annum. The effective interest rate
for such borrowings at December 31, 1998 was 10.9%. On September 2,
1998, Safeguard amended it's Term Loan to increase the loan to $8.0
million and to defer the monthly principal repayments to September 1,
1999. The Term Loan is payable in monthly installment through December
1, 2001 and 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, as defined in
the agreement, 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 and the outstanding balance
returned to $4,000,000 in April 1998 when the funds provided from the
sales of the payroll services assets were used to repay the increase in
the loan balance. The outstanding borrowings bear 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.
16
18
SAN JACINTO HOLDINGS INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
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. 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 Subordinated Notes (the "Existing Notes") due
December 31, 2000 after the refinancing totaled $3,200. Interest on the
Existing Notes is payable in cash semiannually on June 5 and December
5. The Existing Notes are subordinate to the 12% Senior Subordinated
Notes, the revolving loans, the Term Loan, the Amended Exchange Loan
and capital lease 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 $1,000 at December 31, 1998. The Debentures are subordinate to
senior indebtedness (which includes the existing Notes and new Notes).
The aggregate maturities of long-term debt, exclusive of capital lease
obligations, are: 1999 - $6,317,000; 2000 - $7,365,000; 2001 -
$27,377,000; and 2002 - $65,878,000.
K. LEASES:
-------
Safeguard conducts a portion of its operations in leased facilities,
vehicles, machinery and equipment. Operating leases expire at various
dates through 2001. Leased property under capital leases at December
31, 1998, has a net carrying value of $3,896,000 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, 1998 are:
Capital Operating
Leases Leases
------ ------
($000 omitted)
1999 $ 621 $ 3,105
2000 149 2,199
2001 23 1,971
2002 - 1,979
2003 - 1,744
Thereafter - 786
----- --------
$ 793 $ 11,784
========
Minimum lease payments:
Amount representing interest (49)
-----
Present value of net minimum lease payments $ 744
=====
Total rental expense for all operating leases (including leases with
initial or remaining terms of one year or less) is $4,977,000 in 1998,
$6,393,,000 in 1997 and $4,924,000 in 1996.
17
19
SAN JACINTO HOLDINGS INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(Continued)
L. 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.
The domestic and foreign components of income (loss) from continuing
operations before income taxes are as follows:
($000 omitted)
1998 1997 1996
---- ---- ----
Domestic $(6,726) $(23,379) $(23,897)
Foreign (394) 709 983
------- -------- --------
Loss before income taxes $(7,120) $(22,670) $(22,914)
======= ======== ========
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 1998, 1997 and 1996.
Items that gave rise to a deferred tax asset (liability) are as
follows:
December 31,
1998 1997
--------------------------
($000 omitted)
Net operating loss carryforwards $ 78,455 $ 77,371
Deferred compensation 1,966 1,924
Other 2,084 966
-------- --------
Total 82,505 80,261
Less: valuation allowance (82,505) (80,261)
-------- --------
Net deferred tax asset (liability) $ - $ -
======== ========
At December 31, 1998, the Company has, for federal income tax purposes,
net operating loss carryforwards of $213,000,000 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.
18
20
SAN JACINTO HOLDINGS INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(Continued)
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 San Jacinto in December 1986.
Payments are due to the former officers in varying amounts through
2008. Aggregate payments due during the next five years are: 1999 -
$75,000, 2000 - $75,000, 2001- $50,200, 2001 - $50,200, 2002 - $50,200
and 2003 - $50,200 and $4,928,000 thereafter.
N. 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 totaled $896,000 in 1998, $1,154,000 in 1997 and $654,000
in 1996.
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. No
contributions were made in 1998, 1997 and 1996.
O. 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 participants vest 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, 1996 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 canceled (7) - (7)
------ ---- ------
Units outstanding, December 31, 1997 32 - 32
Units canceled (12) - (12)
------ ---- ------
Units outstanding, December 31, 1998 20 - 20
====== ==== ======
19
21
SAN JACINTO HOLDINGS INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(Continued)
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. The Board approved the conversion of the outstanding units
under the existing Equity Compensation Plan (see Note O) to stock
options under the 1996 Option Plan. Under the Plan, options granted to
participants vest over three years or upon a change in the Company's
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 O) 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 50,000 (50,000) -
------ ------ ------
Units outstanding, December 31, 1997 59,000 65,000 124,000
Units issued - 15,000 15,000
Units canceled (5,000) - (5,000)
Units vested 35,000 (35,000) -
------ ------ ------
Units outstanding December 31, 1998 89,000 45,000 134,000
====== ====== =======
As of December 31, 1998, 4,000 fully vested shares are at an exercise
price of $10.00 per unit; 85,000 vested shares and 45,000 non-vested
shares are at a $5.25 per unit exercise price.
20
22
SAN JACINTO HOLDINGS INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(Continued)
Q. GEOGRAPHIC SEGMENTS:
--------------------
The Company's foreign operations are in Canada, the United Kingdom and
Belgium. Operations by geographic area are as follows:
1998 1997 1996
------------------------------------
($000 omitted)
NET SALES:
United States $165,318 $171,125 $171,961
Foreign 3,086 22,126 22,657
-------- -------- --------
Total $168,404 $193,251 $194,618
======== ======== ========
INCOME (LOSS) FROM CONTINUING OPERATIONS:
United States $ (6,726) $(23,379) $(23,899)
Foreign (394) 535 673
-------- -------- --------
Total $ (7,120) $(22,844) $(23,226)
======== ======== ========
TOTAL ASSETS:
United States $ 79,905 $ 86,685 $106,085
Foreign $ 2,693 3,527 17,633
-------- -------- --------
Total $ 82,598 $ 90,212 $123,718
======== ======== ========
The Company's foreign operations in the United Kingdom and Belgium held
by SSGB were sold to an unaffiliated company on December 2, 1997. Net
sales of SSGB were $18,256,000 in 1997 and $18,248,000 in 1996. The net
income from SSGB's operations were $693,000 in 1997 and $604,000 in
1996. These operating results are included in the Company's statement
of operations.
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.
21
23
SAN JACINTO HOLDINGS INC. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
RESULTS OF OPERATIONS
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 and such statements involve risks,
uncertainties and assumptions, including but not limited to industry conditions,
general economic conditions, interest rates, ability of the company to
successfully mange its growth, and other factors discussed below and in the
Company's annual report. 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 in the
reports for the periods as of and ending December 31, 1998.
Year Ended December 31,
1998 1997 1996
------------------------------
Net sales 100.0% 100.0% 100.0%
Cost of sales 48.4 45.9 43.5
----- ----- -----
Gross profit 51.6 54.1 56.5
Selling expense 38.3 40.1 41.3
General and administrative expense 9.5 10.3 8.3
Special charges - - 2.6
Gain on sale of subsidiary - (1.3) -
Other income - distributor receivables (1.0) (0.9) (1.1)
Amortization expense 1.1 10.0 9.8
Interest expense 7.9 7.7 7.2
----- ----- -----
Loss from continuing operations before income taxes
and extraordinary item (4.2) (11.7) (11.8)
Income tax provision - 0.1 0.1
----- ----- -----
Loss from continuing operations before extraordinary item (4.2) (11.8) (11.9)
Discontinued operations:
Gain on sale of assets 3.8 - -
Loss from discontinued operations 0.3 (0.5) (0.8)
----- ----- -----
Loss before extraordinary item (0.1) (12.4) (12.7)
Extraordinary item - gain on early extinguishment of debt - - 1.2
----- ----- -----
Net loss (0.1)% (12.4)% (11.5)%
===== ===== =====
22
24
SAN JACINTO HOLDINGS INC. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(continued)
RESULTS OF OPERATIONS
San Jacinto Holdings Inc. through its wholly owned subsidiary, Safeguard
Business Systems, Inc. ("Safeguard"), provides business solutions and services
to small businesses through its independent distribution network in the United
States and Canada. Through this distribution channel, Safeguard markets pegboard
systems, continuous forms and checks, laser forms and checks, advertising
specialty goods, filing systems, envelopes and other business products designed
for small businesses with less than 50 people on staff. Safeguard is a privately
owned company with manufacturing plants in California, Pennsylvania and Georgia.
COMPARISON OF THE YEAR ENDED DECEMBER 31, 1998 TO THE YEAR ENDED DECEMBER 31,
1997
NET SALES. Net sales from continuing operations by operating segment are as
follows:
Years Ended December 31,
1998 1997
---- ----
Net sales:
North America $168,404 $174,995
Europe - 18,256
-------- --------
Total $168,404 $193,251
======== ========
Excluding sales from Europe, the 1998 sales results are $168.4 million in 1998
compared to $175.0 million in 1997, representing a decrease of $6.6 million (or
3.8%). The sales decline reflects a 10.0% decline in manual form and computer
form sales, partially offset by a 24.0% growth in laser form sales. The Company
is addressing the negative sales trends through extensive distributor network
expansion efforts. These efforts are focused on recruiting new distributors and
assisting existing distributors in purchasing customer bases from independent
dealers interested in selling their businesses. The Company also implemented in
the second half of 1998 a sales incentive program designed to encourage sales to
new customers of products directly manufactured by Safeguard. Favorable results
from this program began to be realized at the end of 1998. The 1998 sales
performance has been negatively impacted by the strengthening of the US dollar
in the Canadian marketplace. The change in the value of the Canadian dollar has
resulted in a $1.0 million reduction in 1998 sales.
GROSS PROFIT. Gross profit before selling and administrative expenses excludes
commission expense. Gross profit margin from continuing operations in North
America is as follows:
Years Ended December 31,
1998 1997
---- ----
Manual forms 61.1% 61.6%
Computer and laser forms 49.4 50.9
Sourced products 39.2 38.9
---- ----
Total 51.6% 52.7%
==== ====
The decline in profit margin is attributable to a shift in the company's product
mix from manual forms sales to laser forms and sourced products, as a percentage
of total sales. Computer and laser forms, and sourced products, carry greater
material, labor and overhead costs (as a percentage of sales) resulting in a
lower gross profit margin than for manual forms, as well as the competition in
the forms marketplace pressuring reduction in the retail prices. The shift in
product mix has been offset in part by manufacturing efficiencies as a result of
the implementation of an integrated order entry system and the consolidation of
certain manufacturing operations in 1997.
23
25
SAN JACINTO HOLDINGS INC. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(continued)
SELLING EXPENSE. Selling expenses were $64.5 million in 1998 compared to $77.6
million in 1997, representing 38.3% and 40.1% of net sales in each year. The
reduction in selling expenses in 1998 is attributable to the sale of the
Company's European operations and strategic cost reductions. The company's
operations in Europe, of which $7.7 million in expense is included in the 1997
results, was sold in December 1997. Commissions to independent distributors
account for approximately 85% of the total selling costs and, as a percent of
net sales has remained constant at approximately 34% of net sales.
GENERAL AND ADMINISTRATIVE. General and administrative expenses were $15.9
million in 1998 compared to $20.0 million in 1997, representing 9.5% and 10.3%
of net sales in each year. The reduction in costs is attributable to strategic
cost reductions and no expenses in 1998 from the Company's operations in Europe
which totaled $2.6 million in 1997. The 1997 administrative expenses included
greater administrative costs associated with the system conversion and the
impact of the UPS strike.
OTHER INCOME - DISTRIBUTOR RECEIVABLES. Other income (cash received greater than
the carrying value of distributor receivables) was $1.7 million in 1998 compared
to $1.8 million in 1997, representing 1.0% and 0.9% 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 by 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 is
expected to continue in amounts approximating $1.5 through the year 2000.
AMORTIZATION EXPENSE. Amortization expense was $1.9 million in 1998 and $19.3
million in 1997. The expense consists of the amortization of intangible assets
including the customer list, excess purchase price over net assets acquired and
deferred financing costs. The significant reduction in amortization expense in
1998 is a result of the full amortization of the customer list in December 1997.
The customer list amortization was $17.3 million in 1997.
INTEREST EXPENSE. Interest expense was $13.3 million in 1998 and $14.8 million
in 1997, including $13.5 million and $14.8 million, respectively, of cash
interest payment. The decrease in interest expense in 1998 is attributable to a
reduction in the Company's average outstanding borrowings and a slight (0.5%)
reduction in the company's borrowing rate under its collaterialized Revolving
Loan.
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.
GAIN ON SALE OF ASSETS AND DISCONTINUED OPERATIONS. In 1997, the Company decided
to divest of payroll and data processing operations. On March 31, 1998,
effective as of April 1, 1998, the Company sold its payroll processing
operations. Safeguard reported a gain of $6.4 million after expenses and
payments to third parties (See Note C to consolidated financial statements). The
net assets of the data processing operations were sold at approximately net book
value, effective January 1998. The net sales from discontinued operations were
$2.9 million in 1998 and $11.9 million in 1997. 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.
24
26
SAN JACINTO HOLDINGS INC. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(continued)
COMPARISON OF THE YEAR ENDED DECEMBER 31, 1997 TO THE YEAR ENDED DECEMBER 31,
1996
NET SALES. Net sales from continuing operations by operating segment are as
follows:
Years Ended December 31,
1997 1996
---- ----
Net sales:
North America $174,995 $176,370
Europe 18,256 18,248
-------- --------
Total $193,251 $194,618
======== ========
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 61.6% 65.7%
Computer and laser forms 50.9 50.6
Sourced products 38.9 40.7
---- ----
Total 52.7% 55.3%
==== ====
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.
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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, 1998, 1997 AND 1996
(continued)
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.
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.
26
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, 1998, 1997 AND 1996
(continued)
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary sources of liquidity are cash flows generated from
operations, cash on hand, availability of long-term capital lease alternatives
and borrowing capacity under the revolving loans. The Company's cash flow from
operating activities is $3.3 million in 1998. As of December 31, 1998, the
Company had $0.6 million in cash and cash equivalents, and $0.9 million in
availability under revolving loans. At that date, the Company had a working
capital deficiency of $2.1 million and a ratio of current assets to current
liabilities of approximately 0.93:1.
The Company's ongoing liquidity requirements arise primarily from capital
expenditures, working capital needs and debt service. The Company's capital
expenditures in 1998 were $2.4 million in software, hardware and equipment
purchases. These expenditures are funded through additional capital lease
obligations and cash flow from operations.
As more fully described in the Notes to the Consolidated Financial Statements,
on March 31, 1998 the Company sold its payroll processing operations. The net
proceeds of $8.0 million, net of $3.3 million in payments to third parties, was
used to reduce the Revolving Loan to $4.0 million and to repay an additional
$1.3 million under the Term Loan. The remaining proceeds were used to reduce the
outstanding borrowings under the Collaterialized Revolving Loan and reduce
outstanding trade payables.
On September 2, 1998, the Company amended its Revolving and Term Loan Agreement.
The amendment included an increase in the borrowings under the Term Loan by $4.6
million to $8.0 million, and a deferral of principal repayments on the Term Loan
until September 1, 1999. The funds provided are being used to fund the network
expansion endeavors and continuing operations. The Company has met all of its
debt obligations and is not 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.
27