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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
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(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934.
For the quarterly period ended March 31, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934.
For the transition period from to
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Commission File Number 333-39373
SOVEREIGN SPECIALTY CHEMICALS, INC.
(Exact Name of Registrant as Specified in Its Charter)
---------------------------
DELAWARE
36-4176637
(State or Other Jurisdiction of Incorporation or Organization)
(IRS Employer Identification No.)
225 W. Washington St. - Ste. 2200, Chicago, IL 60606
(Address of Principal Executive Offices)
(Zip Code)
Registrant's Telephone Number, Including Area Code: (312) 419-7100
INDICATE BY CHECK MARK WHETHER THE REGISTRANT: (1) HAS FILED ALL REPORTS
REQUIRED TO BE FILED BY SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF
1934 DURING THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE
REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH
FILING REQUIREMENTS FOR THE PAST 90 DAYS. YES [X] NO [ ]
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SOVEREIGN SPECIALTY CHEMICALS, INC.
FORM 10-Q
TABLE OF CONTENTS
<Table>
<Caption>
PAGE NUMBER
-----------
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements:
Consolidated Balance Sheets at March 31, 2002 (Unaudited)
and December 31, 2001..................................... 1
Consolidated Statements of Operations for the three months
ended March 31, 2002
and 2001 (Unaudited)...................................... 2
Consolidated Statements of Cash Flows for the three months
ended March 31, 2002 and 2001 (Unaudited)................. 3
Notes to Consolidated Financial Statements.................. 4
ITEM 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations....................... 10
ITEM 3. Quantitative and Qualitative Disclosures about
Market Risk............................................... 16
PART II. OTHER INFORMATION
ITEM 6. Exhibits and Reports on Form 8-K.................... 18
Signatures.................................................. 19
</Table>
SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<Table>
<Caption>
MARCH 31, DECEMBER 31,
2002 2001
--------- ------------
(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents................................. $ 3,652 $ 15,584
Accounts receivable, net.................................. 58,379 55,897
Inventories............................................... 38,741 37,832
Deferred income taxes..................................... 3,411 3,411
Other current assets...................................... 6,140 5,904
-------- --------
Total current assets........................................ 110,323 118,628
Property, plant, and equipment, net......................... 68,319 70,021
Goodwill, net............................................... 151,999 151,999
Deferred financing costs, net............................... 9,283 8,944
Other assets................................................ 561 698
-------- --------
Total assets................................................ $340,485 $350,290
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................... $ 31,697 $ 30,586
Accrued expenses.......................................... 15,515 18,986
Other current liabilities................................. 313 364
Current portion of long-term debt......................... 16,779 16,288
Current portion of capital lease obligations.............. 398 401
-------- --------
Total current liabilities................................... 64,702 66,625
Long-term debt, less current portion........................ 225,239 232,531
Capital lease obligations, less current portion............. 2,833 2,889
Deferred income taxes....................................... 2,810 2,810
Other long-term liabilities................................. 1,184 1,377
Stockholders' equity:
Common stock, $0.01 par value, 2,700,000 shares authorized,
1,441,239 issued and outstanding.......................... 15 15
Common stock, non-voting, $0.01 par value, 2,100,000 shares
authorized, 730,182 issued and outstanding................ 7 7
Additional paid-in capital.................................. 64,078 64,078
Accumulated deficit......................................... (19,067) (18,766)
Accumulated other comprehensive loss........................ (1,316) (1,276)
-------- --------
Total stockholders' equity.................................. 43,717 44,058
-------- --------
Total liabilities and stockholders' equity.................. $340,485 $350,290
======== ========
</Table>
See accompanying notes to consolidated financial statements.
1
SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS)
<Table>
<Caption>
THREE MONTHS ENDED
--------------------------------
MARCH 31, 2002 MARCH 31, 2001
-------------- --------------
(UNAUDITED) (UNAUDITED)
Net sales................................................... $86,748 $88,877
Cost of goods sold.......................................... 63,134 64,795
------- -------
Gross profit................................................ 23,614 24,082
Selling, general and administrative expenses................ 17,677 19,485
------- -------
Operating income............................................ 5,937 4,597
Interest expense, net....................................... 6,420 6,973
------- -------
Loss before income taxes.................................... (483) (2,376)
Income tax expense (benefit)................................ (182) 728
------- -------
Net loss.................................................... $ (301) $(3,104)
======= =======
</Table>
See accompanying notes to consolidated financial statements
2
SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
<Table>
<Caption>
THREE MONTHS ENDED
--------------------------------
MARCH 31, 2002 MARCH 31, 2001
-------------- --------------
(UNAUDITED) (UNAUDITED)
OPERATING ACTIVITIES
Net loss.................................................... $ (301) $ (3,104)
Adjustments to reconcile net loss to net cash provided by
(used in) operating activities:
Depreciation and amortization............................. 2,462 4,699
Amortization of deferred financing costs.................. 387 344
Amortization of bond discount............................. 32 32
Foreign exchange losses................................... 183 503
Changes in operating assets and liabilities:
Accounts receivable.................................... (2,584) (6,224)
Inventories............................................ (968) 603
Prepaid expenses and other assets...................... (99) 1,523
Accounts payable and other liabilities................. (2,752) 6,317
--------- --------
Net cash provided by (used in) operating activities......... (3,640) 4,693
INVESTING ACTIVITIES
Acquisition of businesses, net of acquired cash............. -- (3,444)
Sale of property, plant and equipment....................... 80 --
Purchase of property, plant and equipment................... (697) (1,824)
--------- --------
Net cash used in investing activities....................... (617) (5,268)
FINANCING ACTIVITIES
Payments on long-term debt.................................. (4,000) --
Payments for deferred financing costs....................... (726) (332)
Payments on capital lease obligations....................... (59) (60)
Proceeds from revolving credit facilities................... 203 6,107
Payments on revolving credit facilities..................... (3,000) (10,000)
--------- --------
Net cash used in financing activities....................... (7,582) (4,285)
Effect of exchange rate changes on cash..................... (93) 314
--------- --------
Net decrease in cash and cash equivalents................... (11,932) (4,546)
Cash and cash equivalents at beginning of period............ 15,584 8,008
--------- --------
Cash and cash equivalents at end of period.................. $ 3,652 $ 3,462
========= ========
</Table>
See accompanying notes to consolidated financial statements
3
SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2002
(Dollars in Thousands)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION AND PRINCIPLES OF CONSOLIDATION
The consolidated financial statements as of and for the periods ended March
31, 2002 and 2001, respectively, include the accounts of Sovereign Specialty
Chemicals, Inc. and its wholly-owned subsidiaries (the "Company"). All
significant intercompany balances and transactions have been eliminated.
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Actual results could differ from those
estimates.
INTERIM FINANCIAL INFORMATION
The unaudited interim consolidated financial statements of the Company, in
the opinion of management, reflect all necessary adjustments, consisting only of
normal recurring adjustments, for a fair presentation of results as of the dates
and for the interim periods covered by the financial statements. The results for
the interim periods are not necessarily indicative of the results of operations
to be expected for the entire year.
The unaudited interim consolidated financial statements have been prepared
in conformity with generally accepted accounting principles and reporting
practices. Certain information in footnote disclosures normally included in
financial statements prepared in accordance with generally accepted accounting
principles has been condensed or omitted pursuant to the rules and regulations
of the Securities and Exchange Commission; however, the Company believes the
disclosures are adequate to make the information not misleading. The unaudited
interim consolidated financial statements contained herein should be read in
conjunction with the audited financial statements and notes thereto included in
our 2001 Annual Report on Form 10-K.
RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform to current
year presentation.
NEW ACCOUNTING STANDARDS
In August 2001, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards ("SFAS") No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets, which supersedes both SFAS No. 121,
Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of and the accounting and reporting provisions of Accounting
Principles Board Opinion No. 30, Reporting the Results of Operations--Reporting
the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual
and Infrequently Occurring Events and Transactions ("Opinion 30"), for the
disposal of a segment of a business (as previously defined in that Opinion).
SFAS No. 144 retains the fundamental provisions in SFAS No. 121 for recognizing
and measuring impairment losses on long-lived assets held for use and long-lived
assets to be disposed of by sale, while also resolving significant
implementation issues associated with SFAS No. 121. For example, SFAS No. 144
provides guidance on how a long-lived asset that is used as part of a group
should be evaluated for impairment, establishes criteria for when a long-lived
asset is held for sale, and prescribes the accounting for a long-lived asset
that will be disposed of other than by sale. SFAS No. 144 retains the basic
provisions of Opinion 30 on how to present discontinued operations in the income
statement but broadens that presentation to include a component of an entity
(rather than a segment of a business). Unlike SFAS No. 121, SFAS No. 144 does
not provide guidance on impairment of goodwill. Rather, goodwill is evaluated
for impairment under SFAS No. 142, Goodwill and Other Intangible Assets. The
Company adopted SFAS No. 144 on January 1, 2002, and there was no impact to the
results of operations or its financial position upon adoption.
4
SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
MARCH 31, 2002
(Dollars in Thousands)
2. GOODWILL AND INTANGIBLE ASSETS
In June 2001, the Financial Accounting Standards Board issued SFAS No. 141,
Business Combinations, and SFAS No. 142, Goodwill and Other Intangible Assets.
On January 1, 2002, the Company adopted SFAS No. 141 and 142. SFAS No. 141
requires that the purchase method of accounting be used for all business
combinations initiated after June 30, 2001 and also includes guidance on the
initial recognition and measurement of goodwill and other intangible assets
acquired in a business combination. The initial adoption of SFAS No. 141 did not
affect the Company's results of operations or its financial position.
The adoption of SFAS No. 142 eliminates the amortization of goodwill
beginning January 1, 2002 and instead requires that goodwill be tested for
impairment. The adoption of SFAS No. 142 will result in a $10.0 million decrease
in amortization expense in 2002. The quarterly breakdown of decrease in
amortization expense will be $2.4 million, $2.5 million, $2.3 million and $2.8
million, respectively for the four quarters of 2002. We have not yet completed
the transitional intangible asset impairment test required under SFAS No. 142 or
determined whether or not an impairment loss will be recorded in connection with
our adoption of the statement. Any impairment loss resulting from our completion
of the transitional intangible asset impairment test would be recorded as the
cumulative effect of a change in accounting principle. As of March 31, 2002, the
Company's unamortized definite lived intangible assets of $0.2 million,
primarily consisting of non-compete agreements, will be amortized over the
remainder of 2002.
Amortization expense for intangible assets during the three months ended
March 31, 2002 was $0.3 million. Estimated amortization expense for the
remainder of 2002 will be $0.2 million.
Actual results of operations for the three months ended March 31, 2002 and
the pro forma results of operations for the three months ended March 31, 2001
had we applied the non-amortization provisions of SFAS No. 142 in the prior
period are as follows:
<Table>
<Caption>
THREE MONTHS ENDED
MARCH 31,
------------------
2002 2001
------ --------
(IN THOUSANDS)
Net loss, as reported....................................... $(301) $(3,104)
Elimination of goodwill amortization, net of tax effect of
$558...................................................... -- 1,854
----- -------
Pro forma net loss.......................................... $(301) $(1,250)
===== =======
</Table>
5
SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
MARCH 31, 2002
(Dollars in Thousands)
3. AMENDMENT TO THE CREDIT AGREEMENT
On March 1, 2002 the Company completed Amendment No. 3 to its Credit
Agreement (the Amendment) which, among other things, amended certain financial
covenants beginning with the quarter ended December 31, 2001 and for each of the
next four quarters through December 31, 2002. At March 31, 2003, the amended
financial covenants return to the levels set prior to the Amendment. The
Amendment includes a new covenant which requires the company to maintain
borrowing availability under the credit facility of at least $10.0 million at
all times prior to December 31, 2002 and of at least $12.5 million from December
31, 2002 through March 30, 2003. In addition, the Amendment prohibits any
significant acquisitions unless only capital stock is used as the purchase
consideration and, if the acquisition is completed before April 1, 2003, no
indebtedness is assumed or acquired. The Amendment increased the applicable
interest rate margins as set forth in the Credit Agreement by 50 to 100 basis
points.
4. INVENTORIES
Inventories are summarized as follows:
<Table>
<Caption>
MARCH 31, DECEMBER 31,
2002 2001
--------- ------------
Raw Materials...................................... $13,628 $13,508
Work in process.................................... 728 544
Finished Goods..................................... 24,385 23,780
------- -------
$38,741 $37,832
======= =======
</Table>
5. COMPREHENSIVE LOSS
For the three months ended March 31, 2002 and 2001, respectively, the
calculation of comprehensive loss is as follows:
<Table>
<Caption>
2002 2001
----- -------
Net loss as reported.................................... $(301) $(3,104)
Foreign currency translation adjustments................ (40) (620)
----- -------
Comprehensive loss...................................... $(341) $(3,724)
===== =======
</Table>
6. SEGMENT REPORTING
The Company has two reportable segments: the Commercial segment and the
Construction segment. The Commercial segment consists of the Industrial and
Packaging, Converting & Graphic Arts divisions. Applications sold by the
Industrial division consist primarily of high performance, specialty adhesives
and coatings for automotive, aerospace, manufactured housing and textile
applications. The Packaging, Converting & Graphic Arts division produces
flexible packaging adhesives and coatings for a number of applications. Through
the Construction segment, the Company manufactures and sells housing repair,
remodeling and construction sealants and adhesives used in exterior and interior
applications.
The Company evaluates performance and defines segment profit based upon
operating income. The reportable segments' accounting policies are the same as
those of the Company as a whole. Segment profit is calculated as a reportable
segment's operating income. Total segment profits exceed consolidated operating
profits to the extent of unallocated corporate expenses included in selling,
general and administrative expenses. Unallocated corporate expenses were $2.6
million and $2.0 million for the quarters ended March 31, 2002 and 2001,
respectively.
6
SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
MARCH 31, 2002
(Dollars in Thousands)
The reportable segments are each managed and measured separately primarily
due to the differing customers, products sold and distribution channels. The
reportable segments are as follows:
<Table>
<Caption>
COMMERCIAL CONSTRUCTION TOTALS
---------- ------------ -------
For the three months ended March 31, 2002:
Revenues from external customers.......................... $59,242 $27,506 $86,748
Goodwill amortization(1).................................. -- -- --
Segment profit............................................ 5,077 3,508 8,585
For the three months ended March 31, 2001:
Revenues from external customers.......................... $63,482 $25,395 $88,877
Goodwill amortization(1).................................. 1,296 670 1,966
Segment profit............................................ 4,464 2,156 6,620
</Table>
- -------------------------
(1) Per the provisions of SFAS No. 142, beginning January 1, 2002, goodwill
amortization expense (included in segment profit during 2001) is no longer
recorded.
A reconciliation of the reportable segments to consolidated operating
income is as follows:
<Table>
<Caption>
FOR THE THREE MONTHS
ENDED MARCH 31,
---------------------
2002 2001
--------- ---------
Profit:
Total profit for reportable segments........................ $ 8,585 $ 6,620
Unallocated corporate expense............................... (2,648) (2,023)
------- -------
Income from operations................................. $ 5,937 $ 4,597
======= =======
</Table>
7. OTHER FINANCIAL INFORMATION
The Company is a holding company with no independent assets or operations.
Full separate financial statements of the Guarantor Subsidiaries have not been
presented as the guarantors are wholly-owned subsidiaries of the Company.
Management does not believe that inclusion of such financial statements would
7
SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
MARCH 31, 2002
(Dollars in Thousands)
be material to investors. The unaudited financial statement data as of March 31,
2002 and 2001, respectively of the Guarantor Subsidiaries and the Non-Guarantor
Subsidiaries are below.
THE FOLLOWING SETS FORTH THE UNAUDITED FINANCIAL DATA AT MARCH 31, 2002 AND FOR
THE THREE MONTHS THEN ENDED.
<Table>
<Caption>
GUARANTOR NON-GUARANTOR
SUBSIDIARIES SUBSIDIARIES PARENT ELIMINATIONS TOTAL
------------ ------------- -------- ------------ --------
STATEMENT OF OPERATIONS DATA:
Net sales..................................... $ 75,950 $10,798 $ -- $ -- $ 86,748
Cost of goods sold............................ 54,952 8,182 -- -- 63,134
-------- ------- -------- --------- --------
Gross profit.................................. 20,998 2,616 -- -- 23,614
Selling, general and administrative expense... 12,502 2,527 2,648 -- 17,677
-------- ------- -------- --------- --------
Operating income (loss)....................... 8,496 89 (2,648) -- 5,937
Interest expense.............................. 5,856 216 348 -- 6,420
-------- ------- -------- --------- --------
Income (loss) before income taxes............. $ 2,640 $ (127) $ (2,996) $ -- $ (483)
======== ======= ======== ========= ========
BALANCE SHEET DATA:
Current assets................................ $ 88,239 $20,926 $ 19,413 $ (18,255) $110,323
Property plant and equipment, net............. 56,736 11,212 371 -- 68,319
Goodwill, net................................. 146,570 5,293 136 -- 151,999
Deferred financing costs, net................. 8,122 -- 1,161 -- 9,283
Other assets.................................. 377 184 269,449 (269,449) 561
-------- ------- -------- --------- --------
Total assets.................................. $300,044 $37,615 $290,530 $(287,704) $340,485
======== ======= ======== ========= ========
Current liabilities........................... $ 53,610 $12,703 $ 17,723 $ (19,334) $ 64,702
Long term liabilities......................... 212,740 19,058 211,394 (211,126) 232,066
Total stockholders' equity.................... 33,694 5,854 61,413 (57,244) 43,717
-------- ------- -------- --------- --------
Total liabilities and stockholders' equity.... $300,044 $37,615 $290,530 $(287,704) $340,485
======== ======= ======== ========= ========
STATEMENT OF CASH FLOWS DATA:
Operating activities:
Net income (loss)............................. $ 292 $ (203) $ (390) $ -- $ (301)
Depreciation and amortization................. 2,145 284 33 -- 2,462
Foreign exchange losses....................... -- 183 -- -- 183
Amortization of deferred financing costs...... 365 -- 22 -- 387
Amortization of bond discount................. 32 -- -- -- 32
Changes in operating assets and liabilities... (11,516) 789 7,811 (3,487) (6,403)
-------- ------- -------- --------- --------
Net cash provided by (used in) operating
activities.................................. (8,682) 1,053 7,476 (3,487) (3,640)
Investing activities:
Sale of property, plant & equipment........... -- 80 -- -- 80
Purchase of property, plant & equipment....... (640) (57) -- -- (697)
-------- ------- -------- --------- --------
Net cash provided by (used in) investing
activities.................................. (640) 23 -- -- (617)
Financing activities:
Payments on long term debt.................... -- (250) (3,750) -- (4,000)
Payments for deferred financing costs......... -- -- (726) -- (726)
Payments on capital leases.................... (59) -- -- -- (59)
Net proceeds from revolving credit
facilities.................................. (1) 204 (3,000) -- (2,797)
-------- ------- -------- --------- --------
Net cash used in financing activities......... (60) (46) (7,476) -- (7,582)
Effect of foreign currency changes on cash.... -- (93) -- -- (93)
-------- ------- -------- --------- --------
Net increase (decrease) in cash............... (9,382) 937 -- (3,487) (11,932)
Cash and cash equivalents, beginning of
period...................................... 10,955 1,142 -- 3,487 15,584
-------- ------- -------- --------- --------
Cash and cash equivalents, end of period...... $ 1,573 $ 2,079 $ -- $ -- $ 3,652
======== ======= ======== ========= ========
</Table>
8
SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
MARCH 31, 2002
(Dollars in Thousands)
THE FOLLOWING SETS FORTH THE UNAUDITED FINANCIAL DATA AT MARCH 31, 2001 AND FOR
THE THREE MONTHS THEN ENDED.
<Table>
<Caption>
GUARANTOR
SUBSIDIARIES
THE NON-GUARANTOR
COMPANY SUBSIDIARIES PARENT ELIMINATIONS TOTAL
------------ ------------- -------- ------------ --------
STATEMENT OF OPERATIONS DATA:
Net sales..................................... $ 78,639 $10,238 $ -- $ -- $ 88,877
Cost of goods sold............................ 57,376 7,419 -- -- 64,795
-------- ------- -------- --------- --------
Gross profit.................................. 21,263 2,819 -- -- 24,082
Selling, general and administrative expense... 14,937 2,969 1,579 -- 19,485
-------- ------- -------- --------- --------
Operating income (loss)....................... 6,326 (150) (1,579) -- 4,597
Interest expense.............................. 6,419 384 170 -- 6,973
-------- ------- -------- --------- --------
Loss before extraordinary items and income
taxes....................................... $ (93) $ (534) $ (1,749) $ -- $ (2,376)
======== ======= ======== ========= ========
BALANCE SHEET DATA:
Current assets................................ $124,291 $23,130 $ 36,167 $ (70,564) $113,024
Property plant and equipment, net............. 59,730 10,632 171 -- 70,533
Goodwill, net................................. 150,341 4,215 522 -- 155,078
Deferred financing costs, net................. 9,427 -- 464 -- 9,891
Other assets.................................. 9,743 864 268,342 (276,597) 2,352
-------- ------- -------- --------- --------
Total assets.................................. $353,532 $38,841 $305,666 $(347,161) $350,878
======== ======= ======== ========= ========
Liabilities and Stockholders' Equity:
Current liabilities........................... $ 80,382 $29,964 $ 44,363 $ (71,438) $ 83,271
Long-term liabilities......................... 230,155 -- 213,528 (223,613) 220,070
Total stockholders' equity.................... 42,995 8,877 47,775 (52,110) 47,537
-------- ------- -------- --------- --------
Total liabilities and stockholders' equity.... $353,532 $38,841 $305,666 $(347,161) $350,878
======== ======= ======== ========= ========
STATEMENT OF CASH FLOWS DATA:
Operating activities:
Net loss...................................... $ (768) $ (587) $ (1,749) $ -- $ (3,104)
Depreciation and amortization................. 4,291 375 33 -- 4,699
Foreign exchange losses....................... -- 503 -- -- 503
Amortization of bond discount................. 32 -- -- -- 32
Amortization of deferred financing costs...... 326 -- 18 -- 344
Changes in operating assets and liabilities... (1,491) 1,994 1,716 -- 2,219
-------- ------- -------- --------- --------
Net cash provided by operating activities..... 2,390 2,285 18 -- 4,693
Investing activities:
Acquisition of business....................... (3,444) -- -- -- (3,444)
Purchase of property, plant and equipment..... (1,541) (283) -- -- (1,824)
-------- ------- -------- --------- --------
Net cash used in investing activities......... (4,985) (283) -- -- (5,268)
Financing activities:
Deferred financing costs...................... -- -- (332) -- (332)
Payments on capital lease obligations......... (60) -- -- -- (60)
Net payments on revolving credit facilities... 3 (2,896) (1,000) -- (3,893)
-------- ------- -------- --------- --------
Net cash used in financing activities......... (57) (2,896) (1,332) -- (4,285)
Effect of foreign currency changes on cash.... (255) 569 -- -- 314
-------- ------- -------- --------- --------
Net decrease in cash and cash equivalents..... (2,907) (325) (1,314) -- (4,546)
Cash and cash equivalents, beginning of
period...................................... 4,700 2,281 1,564 (537) 8,008
-------- ------- -------- --------- --------
Cash and cash equivalents, end of period...... $ 1,793 $ 1,956 $ 250 $ (537) $ 3,462
======== ======= ======== ========= ========
</Table>
9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (DOLLARS IN THOUSANDS)
The following discussion and analysis is provided to increase the
understanding of, and should be read in conjunction with, the consolidated
financial statements and accompanying notes included herein.
GENERAL
We were formed to acquire, consolidate and operate adhesives, sealants and
coatings businesses in the highly fragmented adhesives, sealants and coatings
business segment of the specialty chemicals industry. We have grown through
acquisition and integration of businesses. We plan to continue our growth
through a combination of new product development, continued market penetration,
international expansion, and in the longer term, strategic acquisitions.
CRITICAL ACCOUNTING POLICIES
Reserve for Inventory Obsolescence. We provide allowances for estimated
obsolescence or unmarketable inventory equal to the difference between the cost
of the inventory and the estimated market value based upon assumptions about
market conditions, future demand and expected usage rates.
Allowance for Doubtful Accounts. We maintain allowances for doubtful
accounts for estimated losses resulting from the failure of our customers to
make required payments. We evaluate the adequacy of our allowance for doubtful
accounts and make judgments and estimates in determining the appropriate
allowance at each reporting period. If a customer's financial condition were to
deteriorate, additional allowances may be required.
COMPONENTS OF INCOME AND EXPENSE
Revenue Recognition. Revenue is recognized when products are shipped to
the customer and title transfers.
Cost of Goods Sold. Cost of goods sold represents the actual cost of
purchased raw materials, direct and indirect labor, warehousing and
manufacturing overhead costs, including depreciation, utilized directly in the
production of products for which revenue has been recognized.
Selling, General & Administrative Expenses. Selling, general &
administrative expenses generally are those costs not directly related to the
production process and include all selling, marketing, research and development
customer service expenses as well as expenses related to general management,
finance and accounting, information services, human resources, legal and
corporate overhead expense.
SEGMENT REPORTING
We have two reportable segments: the Commercial segment and the
Construction segment. The Commercial segment consists of the Industrial division
and Packaging, Converting & Graphic Arts division. Applications sold by the
Industrial division consist primarily of high performance, specialty adhesives
and coatings for automotive, aerospace. manufactured housing and textile
applications. The Packaging, Converting & Graphic Arts division produces
flexible packaging adhesives and coatings for a number of applications. Through
the Construction segment, we manufacture and sell housing repair, remodeling and
construction sealants and adhesives used in exterior and interior applications.
We evaluate the performance of each segment based on operating income.
Segment profit is calculated as a reportable segment's operating income. Total
segment profits exceed consolidated operating profits to the extent of
unallocated corporate expenses included in selling, general and administrative
expenses. Unallocated corporate expenses were $2.6 million and $2.0 million for
the quarters ended March 31, 2002 and 2001, respectively.
10
RESULTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 2002 COMPARED TO THREE MONTHS ENDED MARCH 31, 2001
Net Sales. Net sales were $86.7 million in the first three months of 2002,
a decrease of $2.1 million, or 2.4% from first quarter 2001 net sales of $88.9
million. The year-to-year decrease was primarily due to demand-related weakness
in certain end-markets. Construction segment sales were $27.5 million in the
March 2002 quarter, up 8.3% from last year reflecting a good housing market and
gains in the retail DIY channel. Commercial segment sales were $59.2 million,
down 6.8% from last year due to declines in a number of end-markets including
aerospace, furniture, and graphic arts, particularly high-end printing
applications. One growth area was adhesives for high-pressure laminates where
revenues were up over 10% due to added business with Formica.
Cost of Goods Sold. Cost of goods sold was $63.1 million for the three
months ended March 31, 2002, a decrease of $1.7 million, or 2.6% from first
quarter 2001 cost of sales of $64.8 million. Gross profit as a percentage of net
sales increased slightly in 2002 to 27.2% from 27.1% in 2001. While our overall
gross profit margin was basically flat with last year, we did experience lower
raw material costs and lower manufacturing expenses that were offset by the
effect of a less rich sales mix. A contributor to the adverse sales mix was
lower sales volume in aerospace where margins are higher. Manufacturing costs in
the Commercial segment were lower reflecting the benefit of plant closures. Our
fourth quarter 2001 gross margin percentage was 25.9%. The solid improvement
over the fourth quarter was primarily due to lower raw material costs as well as
better manufacturing efficiency.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses were $17.7 million for the first three months of 2002, a
decrease of $1.8 million, or 9.3% from first quarter 2002 expenses of $19.5
million. The reason for the decrease in selling, general and administrative
expenses year over year was due to the adoption of SFAS No. 142 and the
discontinuation of goodwill amortization expense. Amortization of goodwill for
the quarter ended March 31, 2001 was $2.4 million. Excluding the goodwill
amortization in first quarter 2001, selling, general and administrative expenses
would have been $17.1 million. As a percentage of net sales, excluding goodwill
amortization, selling, general and administrative expenses increased to 20.4%
for the first quarter 2002 from 19.2% in 2001. This increase was due primarily
to $0.4 million of one-time costs incurred in first quarter 2002 related to
hiring of a senior executive and the effect of inflation on payroll and other
expenses.
Interest Expense. Net interest expense was $6.4 million for the three
months ended March 31, 2002, a decrease of $0.6 million or 7.9% from $7.0
million in the first quarter 2001. The decrease in interest expense was due
primarily to a decrease in the weighted average interest rate on our variable
rate debt offset somewhat by slightly higher average debt year over year.
Income Taxes. Income tax benefit was $0.2 million for the three months
ended March 31, 2002. Income tax expense was $0.7 million in the first quarter
2001.
Net loss. Net losses for the quarters ended March 31, 2002 and 2001 were
$0.3 million and $3.1 million. The decrease in net loss from the prior year is
primarily related to the $2.4 million of goodwill amortization not recorded in
2002 as a result of the adoption of SFAS No. 142.
11
COMMERCIAL SEGMENT
The following table presents net sales and segment profit expressed in
millions of dollars and segment profit margin, which is segment profit expressed
as a percentage of net sales:
<Table>
<Caption>
FOR THE
QUARTERS ENDED
MARCH 31,
-------------- DOLLAR PERCENTAGE
2002 2001 CHANGE CHANGE
----- ----- ------ ----------
Net sales.................................... $59.2 $63.5 $(4.3) (6.8)%
===== =====
Segment profit............................... $ 5.2 $ 4.5 $ 0.7 15.6%
===== =====
Goodwill amortization........................ -- $ 1.3
===== =====
Segment profit after exclusion of goodwill
amortization............................... $ 5.2 $ 5.8 $(0.6) (10.3)%
===== =====
Segment profit margin after exclusion of
goodwill amortization...................... 8.8% 9.1% (3.3)%
===== =====
</Table>
Net segment sales were $59.2 million in the first quarter 2002,
representing a $4.3 million decrease from first quarter 2001. Net sales for the
Commercial segment decreased due to declines in a number of end-markets
including aerospace, furniture, and graphic arts, particularly high-end printing
applications. One growth area was adhesives for high-pressure laminates where
revenues were up over 10% due to added business with Formica. Segment profit was
$5.2 million in the first quarter 2002, representing a $0.6 million and 10.3%
decrease from the first quarter 2001 $5.8 million segment profit excluding
goodwill amortization. This decrease was primarily due to lower sales volume.
Additional gross profit from lower raw material costs was offset by less rich
sales mix.
CONSTRUCTION SEGMENT
The following table presents net sales and segment profit expressed in
millions of dollars and segment profit margin, which is segment profit expressed
as a percentage of net sales:
<Table>
<Caption>
FOR THE
QUARTERS ENDED
MARCH 31,
-------------- DOLLAR PERCENTAGE
2002 2001 CHANGE CHANGE
----- ----- ------ ----------
Net sales.................................... $27.5 $25.4 $2.1 8.3%
===== =====
Segment profit............................... $ 3.5 $ 2.1 $1.4 66.6%
===== =====
Goodwill amortization........................ -- $ 0.7
===== =====
Segment profit after exclusion of goodwill
amortization............................... $ 3.5 $ 2.8 $0.7 25.0%
===== =====
Segment profit margin after exclusion of
goodwill amortization...................... 12.7% 11.0% 15.4%
===== =====
</Table>
Net sales for the Construction segment were $27.5 million for the quarter
ended March 31, 2002, representing a $2.1 million or 8.3% increase from $25.4
million for the quarter ended March 31, 2001. The increase in sales in 2002 was
primarily due to resilience of its end markets and strength at major retail
accounts. Segment profit after exclusion of goodwill amortization increased by
$0.7 million and 15.4% as a percentage of net sales in the quarter ended March
31, 2002 primarily as a result of increased sales volume and management actions
to reduce material costs.
12
LIQUIDITY AND CAPITAL RESOURCES
Net cash used in operating activities for the three months ended March 31,
2002 was $3.6 million. Net loss adjusted for non-cash charges, such as
depreciation and amortization and amortization of deferred financing costs
accounted for approximately $2.7 million of positive cash flow. Accounts
receivable and inventory increases in the quarter decreased operating cash flow
by an aggregate of $3.6 million. The first quarter traditionally is one of
working capital build-up to support higher levels of sales. The increase in
receivables and inventory was $2.0 million less than in the first quarter of
2001, reflecting management's focus on working capital improvements. Accounts
payable and accrued expenses decreased by $2.7 million in the first quarter of
2002, due primarily to the timing of our $8.9 million semi-annual bond interest
payment made on March 15, 2002.
Net cash used in investing activities was $0.6 million and $5.3 million in
the three months ended March 31, 2002 and 2001, respectively. In the current
quarter we incurred $0.7 million in capital expenditures which was $1.1 million
less than in 2001. This decrease was due the construction of a manufacturing
facility in Brazil in 2001. In the prior year we incurred $3.4 million in
acquisition related costs relative to acquisitions completed in the last quarter
of 2000.
Net cash used in financing activities was $7.6 million and $4.3 million in
the three months ended March 31, 2002 and 2001, respectively. We repaid $3.8
million of principle under our Term A loan and $3.0 million under our revolving
credit facility during the first quarter of 2002. We incurred $0.7 million of
deferred financing costs associated with the amendment of our credit facility on
March 1, 2002.
Credit Facilities
As amended to date, our credit agreement provides for aggregate borrowings
of $125 million, including (1) a $50.0 million revolving credit facility, and
(2) a $75.0 million term loan facility. Borrowings under the revolving credit
facility are available on a revolving basis and may be used for general
corporate purposes, excluding, however, loans, advances and investments,
including acquisitions, by us other than specified exceptions. The revolving
credit facility will mature on December 30, 2005. Scheduled quarterly repayments
of amounts outstanding under the term loan facility began on September 30, 2001
and through December 31, 2003 amount to 50% of the amount outstanding under that
facility on September 30, 2001. The remaining 50% is scheduled to be repaid in
equal quarterly payments through December 30, 2005. At March 31, 2002 we had
$63.8 million outstanding under our Term Loan A facility, $26.6 million drawn
under our revolving credit facility. We also had $1.0 million drawn under a
local $1.1 million sub-facility for our Singapore-based sales office. We also
have $1.9 million in letters of credit outstanding. At March 31, 2002, we had
approximately $21.5 million of borrowing availability which, after giving effect
to the amendment discussed below, left us with $11.5 million of effective
availability.
On March 1, 2002, we and our lenders amended our credit agreement. The most
significant effects of the amendment are:
- amendment of our financial covenants to decrease the restrictiveness of
those covenants for the quarter ended December 31, 2001 and each of the
fiscal quarters in 2002,
- a new covenant by us to maintain borrowing availability under our
revolving credit facility (a) of at least $10.0 million at all times
prior to December 31, 2002 and (b) of at least $12.5 million from
December 31, 2002 through March 30, 2003 (the practical effect of this
covenant is to reduce our revolving credit availability by $10.0 million
and $12.5 million and to effectively increase the cost of our standby
commitment fee),
- a limitation on the use of advances under the revolving credit facility
to prohibit the use of advances for, among other things, acquisitions
and investments in non-guarantor, offshore entities, other than very
limited amounts,
- an increase of 50 to 100 basis points, depending on our leverage level,
in the applicable margin included in our interest rates,
13
- amendment of our investment covenant to prohibit any significant
acquisitions unless only capital stock is used as the purchase
consideration and, if the acquisition is completed before April 1, 2003,
no indebtedness is assumed or acquired (the practical effect of this
amendment is to prohibit any significant acquisition prior to April 1,
2003), and
- a decrease in our permitted levels of capital expenditures and
indebtedness outside the credit facilities.
Borrowings under the credit facilities bear interest at a rate per annum
equal, at our option, to either (1) the higher of (a) the current base rate as
offered by JPMorgan Chase or (b) 1/2 of 1% per annum above the federal funds
rate plus, in either case, an applicable margin or (2) a eurodollar rate plus an
applicable margin. The applicable margin is based on our ratios of total debt to
earnings before interest taxes, depreciation and amortization, or EBITDA, (which
is more specifically defined in our credit agreement) and senior debt to EBITDA
and varies for revolving credit facility borrowings and for loans under the term
loan facility, from 2.50% to 3.75% for eurodollar rate loans and from 1.50% to
2.75% for base rate loans. Our credit ratings do not affect the interest rates
for our borrowings under our credit facilities.
Our credit facilities obligate us to make mandatory prepayments in certain
circumstances with the proceeds of asset sales or issuance of capital stocks or
indebtedness and with certain excess cash flow. Our credit facilities include
covenants that restrict our and our subsidiaries' ability to incur additional
indebtedness, incur liens, dispose of assets, prepay or amend other
indebtedness, pay dividends or purchase our stock, and change the business
conducted by us or our subsidiaries. In addition, the credit agreement requires
us to comply with specified financial ratios and tests including maintenance of
specified total debt to EBITDA ratios, senior debt to EBITDA ratios, fixed
charge coverage ratios and cash interest expense coverage ratios (each of these
ratios and the terms used to calculate them are specifically defined in our
credit agreement). The table below sets out the ratios we must meet (i.e., debt
to EBITDA ratios may not be exceeded; coverage ratios must be met or exceeded)
over the next four fiscal quarters.
<Table>
<Caption>
REQUIRED
ACTUAL AT --------------------------------------------------------
MAR. 31, MAR. 31, JUN. 30, SEP. 30, DEC. 31, MAR. 31,
2002 2002 2002 2002 2002 2003
--------- -------- -------- -------- -------- --------
Total Debt to EBITDA(1)........... 6.15:1 6.50:1 6.50:1 6.50:1 5.75:1 5.00:1
Senior Debt to EBITDA............. 2.41:1 2.55:1 2.55:1 2.55:1 2.10:1 2.50:1
Interest Coverage Ratio(2)........ 1.60:1 1.50:1 1.50:1 1.55:1 1.65:1 2.25:1
Fixed Charge Ratio(3)............. 0.92:1 0.75:1 0.75:1 0.80:1 0.85:1 1.15:1
</Table>
- -------------------------
(1) Under the credit agreement definition of EBITDA, management fees and certain
one-time costs are added back.
(2) A ratio of EBITDA to interest expense.
(3) A ratio of EBITDA to the sum of interest expense, principal payments on
indebtedness and capital expenditures.
Each of these covenants continues for the term of the credit agreement at
the latest level above, or a more restrictive level. A deterioration in our
current operating performance could result in our failure to satisfy our
financial covenants. In addition, unless our operating performance significantly
improves during 2002, we may not satisfy the financial covenants at March 31,
2003. A failure by us to satisfy the covenants under the credit agreement would
trigger the lenders' right to require immediate repayment of all or part of the
indebtedness; such acceleration, in turn, would also give rise to a right to
require immediate repayment by holders of our subordinated notes. In the event
of such acceleration, we can give no assurance that we will have sufficient
available funds to make such repayment. Our obligations under our credit
facilities are secured by substantially all of our assets and are guaranteed by
all of our domestic subsidiaries.
14
Senior Subordinated Notes
At March 31, 2002 the aggregate principal amount of our 11 7/8% senior
subordinated notes due 2010 was $149.2 million. The 11 7/8% senior subordinated
notes mature on March 15, 2010. Interest is payable semi-annually in arrears
each March 15 and September 15. On or after March 15, 2005, we may redeem these
notes, at our option, in whole or in part, at specified redemption prices plus
accrued and unpaid interest. The redemption price is 105.938% in 2005 and
decreases in equal annual increments to 100.000% in 2008 and thereafter. In
addition, at any time on or prior to March 15, 2003, we may redeem, in the
aggregate, up to 35% of the original aggregate principal amount of 11 7/8% notes
(calculated after giving effect to the issuance of additional notes, if any)
with the net cash proceeds of one or more public equity offerings by us, at a
redemption price in cash equal to 111.875% of the principal amount, plus accrued
and unpaid interest. In the event of a change in control, we would be required
to offer to repurchase the notes at a price equal to 101.0% of the principal
amount plus accrued and unpaid interest.
The notes are general obligations for us, subordinated in right of payment
to all existing and future senior debt and are guaranteed by our subsidiaries.
The indenture under which the 11 7/8% senior subordinated notes were issued
contains certain covenants that, among other things, limit our ability to incur
additional indebtedness, incur liens, dispose of assets, prepay or amend other
indebtedness, pay dividends or purchase our stock, and engage in transactions
with affiliates.
Liquidity and Capital Requirements
We have a management agreement with AEA Investors Inc. pursuant to which
AEA Investors Inc. provides us with advisory and consulting services. The
management agreement provides for an annual aggregate fee of $1.0 million plus
reasonable out-of-pocket costs and expenses.
Interest payments on the amounts drawn under the credit facilities, as well
as other indebtedness and obligations, represent significant obligations for us.
Our remaining liquidity demands relate to capital expenditures and working
capital needs. Our capital expenditures were approximately $8.0 million in 2001
and management currently anticipates capital expenditures will be approximately
$8.0 million in 2002 and approximately $9.5 million in 2003. While we engage in
ongoing evaluations of, and discussions with, third parties regarding possible
acquisitions, as of the date of this report, due to the terms of our credit
agreement we have no current expectations with respect to any acquisitions.
Exclusive of the impact of any future acquisitions, joint venture arrangements
or similar transactions, management does not expect capital expenditure
requirements to increase materially in the foreseeable future.
The following summarizes certain of our contractual obligations at December
31, 2001 and the effect of such obligations are expected to have on our
liquidity and cash flow in future periods. During the ordinary course of
business, we enter into contracts to purchase raw materials and components for
manufacture. In general, these commitments do not extend for more than a few
months.
<Table>
<Caption>
PAYMENTS DUE BY PERIOD
---------------------------------------------------
LESS THAN 1-3 4-5 AFTER
TOTAL 1 YEAR YEARS YEARS 5 YEARS
------- --------- ------ ------ -------
Long-term debt(3)................ 248,819 16,288 35,077 48,310 149,144
Operating leases................. 12,393 1,745 2,900 2,087 5,661
Capital leases................... 4,825 801 1,414 1,474 1,136
Total.......................... 266,037 18,834 39,391 51,871 155,941
</Table>
- -------------------------
(3) Represent principal amounts, but not interest.
Our primary sources of liquidity are cash flows from operations and
borrowings under our credit facilities. Based on current and anticipated
financial performance, we expect cash flow from operations and borrowings under
the credit facilities will be adequate to meet anticipated requirements for
capital expenditures, working capital and scheduled interest payments, including
interest payments on the amounts outstanding under the notes, the credit
facilities and other indebtedness through March 31, 2003. As discussed above,
our operating
15
performance will need to improve significantly in order for us to comply with
our financial covenants under our credit facilities at March 31, 2003. As a
result, our ability to satisfy capital requirements will be dependent upon our
future financial performance. Additionally our ability to repay or refinance our
debt obligations will also be subject to economic conditions and to financial,
business and other factors, many of which are beyond our control.
INFLATION
The costs of certain raw materials increased during the first half of 2001,
but stabilized by mid year. To offset these increases we raised our prices
selectively. We believe that our price increases were sufficient to recover new
raw material cost increases, but without margin. During the second half of 2001
some raw material costs decreased, however, a portion of this relief was used to
meet competitive pressures and maintain market share. There can be no assurance,
however, that our business will not continue to be affected by inflation in the
future.
FORWARD-LOOKING STATEMENTS
Some of the information presented in, or connection with, this report
include "forward-looking statements" based on our current expectations and
projections about future events and involve potential risks and uncertainties.
Our future results could differ materially from those discussed in this report.
Some of the factors that could cause or contribute to such differences include:
Changes in economic and market conditions that impact the demand for our
products and services;
Risks inherent in international operations, including possible economic,
political or monetary instability;
Uncertainties relating to our ability to consummate our business
strategy, including realizing synergies and cost savings from the
integration of acquired businesses.
The impact of new technologies and the potential effect of delays in the
development or deployment of such technologies; and,
Changes in raw material costs and our ability to adjust selling prices.
You should not place undue reliance on these forward-looking statements,
which are applicable only as of May 14, 2002. All written and oral
forward-looking statements attributable to us are expressly qualified in their
entirety by the foregoing factors and those identified in Exhibit 99.1
incorporated by reference into this report. We undertake no obligation to revise
or update these forward-looking statements to reflect events or circumstances
that arise after May 14, 2002 or to reflect the occurrence of unanticipated
events. New risks emerge from time to time and it is not possible for us to
predict all such risks, nor can we assess the impact of all such risks on our
business or the extent to which any risks, or combination of risks, may cause
actual results to differ materially from those contained in any forward-looking
statement.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The principal market risks, which are potential losses in fair values, cash
flows or earnings due to adverse changes in market rates and prices, to which we
are exposed, as a result of our holdings of financial instrument and commodity
positions, are:
- interest rates on debt;
- foreign exchange rates; and
- commodity prices, which affect the cost of raw materials.
Our financial instruments include short-term debt and long-term debt. Trade
accounts payable and trade accounts receivable are not considered financial
instruments for purposes of this item because their carrying amount approximate
fair value. We do not maintain a trading portfolio and do not utilize derivative
financial
16
instruments to manage our market risks. In the future, we may enter into foreign
exchange currency hedging agreements in connection with our international
operations.
MARKET RISK MANAGEMENT
We have measured our market risk related to our financial instruments based
on changes in interest rates and foreign currency rates utilizing a sensitivity
analysis. The sensitivity analysis measures the potential loss in fair values,
cash flows and earnings based on a hypothetical change (increase and decrease)
in interest rates and a decline in the U.K. pound/dollar exchange rate. We used
market rates as of March 31, 2002 on our financial instruments to perform the
sensitivity analysis. We believe that these potential changes in market rates
are reasonably possible in the near-term (one year or less). We have conducted
an analysis of the impact of a 100 basis point change in interest rates and a
10% decline in the U.K. pound/dollar exchange rate, discussed below.
INTEREST RATE EXPOSURE
Our primary interest rate exposure relates to our short-term debt and
long-term debt. We utilize a combination of variable rate debt, primarily under
our credit agreement, and fixed rate debt, primarily under our subordinated
notes. Our credit facilities require that, at least 45% of our funded
indebtedness be fixed-rate or subject to interest rate hedging agreements to
reduce the risk associated with variable-rate debt. At March 31, 2002
approximately 62% of our funded indebtedness was fixed-rate. The variable rate
debt is primarily exposed to changes in interest expense from changes in the
U.S. prime rate, the federal funds effective rate and the eurodollar borrowing
rate, while the fixed rate debt is primarily exposed to changes in fair value
from changes in medium term interest rates. Based on our indebtedness at March
31, 2002, we estimate that an immediate 100 basis point rise in interest rates
would result in $0.9 million increase in interest expense for the period April
1, 2002 to March 31, 2003. For purposes of this estimate, we have assumed a
constant level of variable rate debt and a constant interest rate over the
period equal to those existing on March 31, 2002.
CURRENCY RATE EXPOSURE
Our primary foreign currency exchange rate exposure relates to the U.K.
pound which results in our exposure to changes in the dollar exchange rate. Our
exposure to changes in U.S. dollar exchange rates with currencies other than the
U.K. pound are not currently material. Changes in translation risk are reported
as adjustments to stockholders' equity. We estimate that the impact of a 10%
decline in the dollar/U.K. pound exchange rate from $1.43/L1.00 to $1.29/L1.00
at March 31, 2002 would result in a decrease in our earnings before taxes of
$1.3 million for the period from April 1, 2002 to March 31, 2003.
These sensitivity analyses are estimates and are based on certain
simplifying assumptions. These analysis should not be viewed as predictive of
our future financial performance. Additionally, we cannot give any assurance
that the actual impact in any particular year will not.
COMMODITIES
We are subject to market risk with respect to commodities because our
ability to recover increased raw materials costs through higher pricing may be
limited by the competitive environment in which we operate.
17
PART II -- OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
<Table>
99.1 -- Cautionary Statements for Purposes of "Safe Harbor"
Provisions of Securities Reform Act of 1995, incorporated
by reference to the Company's Form 10-K dated March 29,
2002.
99.2 -- List of Subsidiaries
</Table>
(b) Reports on Form 8-K
The Company filed a report on Form 8-K, dated May 10, 2002, under Item 5,
other business, to provide an update on operations.
18
SOVEREIGN SPECIALTY CHEMICALS, INC.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
SOVEREIGN SPECIALTY CHEMICALS, INC.
/s/ ROBERT B. COVALT
--------------------------------------
Robert B. Covalt, Chief Executive
Officer
/s/ JOHN R. MELLETT
--------------------------------------
John R. Mellett, Chief Financial
Date: May 14, 2002 Officer
19