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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K/A
[X] AMENDMENT NO. 1 TO ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1997
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
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SOVEREIGN SPECIALTY CHEMICALS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 59-309-4679
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
225 WEST WASHINGTON STREET, CHICAGO, IL 60606
(Address of principal executive offices) (Zip Code)
(Registrant's telephone number, including area code): (312) 419-7100
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
NONE
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 ___ No X
All of the voting stock of the registrant is held by an affiliate of the
registrant.
On March 15, 1998, the registrant had 1,000 shares of common stock
outstanding.
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K (Section 229.405 of this chapter) is not contained herein,
and will not be contained, to the best of registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. [ ]
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the following documents are incorporated herein by reference
into the part of the Form 10-K indicated:
PART OF FORM 10-K INTO
DOCUMENT WHICH INCORPORATED
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None
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PART I
ITEM 1. BUSINESS
The Company was formed by Robert B. Covalt, First Chicago Equity
Corporation ("FCEC"), Waud Capital Partners and other investors to acquire and
consolidate specialty chemical businesses in the highly fragmented adhesives,
sealants and coatings industry. The Company has successfully grown its business
through its strategic acquisitions. In March 1996, the Company acquired SIA
Adhesives, Inc. ("SIA Adhesives"), a manufacturer of specialty adhesives used
primarily in the automotive, aerospace and general industrial markets, for $15.6
million. In August 1996, the Company acquired Pierce & Stevens Corp. ("Pierce &
Stevens"), a developer and manufacturer of specialty coatings and adhesives for
performance-oriented niche applications, for $44.8 million. Unless the context
otherwise requires, all references herein to the "Company" refer, prior to the
consummation of the Transactions (as defined below) to Sovereign Specialty
Chemicals, L.P., its consolidated subsidiaries and its predecessor and, after
consummation of the Transactions, to Sovereign Specialty Chemicals, Inc., its
consolidated subsidiaries and its predecessor, and all references to the "Parent
Partnership" refer to Sovereign Specialty Chemicals, L.P., the sole stockholder
of the Sovereign Specialty Chemicals, Inc.
The Company is a leading developer, producer and distributor of a wide
variety of adhesives, sealants and coatings utilized in numerous industrial and
commercial applications. The Company's broad line of over 1,300 products is sold
to more than 6,000 customers. The Company's products are frequently designed in
cooperation with its customers to meet unique specifications, resulting in a
significant number of primary supplier relationships. Many of the Company's
products provide critical performance attributes to its customers' products but
represent only a small portion of total costs. The Company focuses on select
value-added niche markets in which it has strong market positions and advantages
in product development, manufacturing and distribution. The Company markets its
products for use by customers for the following applications: Housing Repair,
Remodeling and Construction; Industrial; Overprint Coatings; and Flexible
Packaging.
The Company's principal executive offices are located at 25 West Washington
Street, Suite 2200, Chicago, IL 60606 and its telephone number is (312)
419-7100.
DEVELOPMENTS
Pursuant to an agreement dated May 22, 1997, the Company acquired on August
5, 1997 (the "Acquisition") the U.S. adhesives, sealants and coatings division
(the "Division") of Laporte PLC ("Laporte") for a cash purchase price of $133.3
million. The companies acquired from Laporte comprise OSI Sealants, Inc. ("OSI
Sealants"), Mercer Products Company, Inc. ("Mercer") and Tanner Chemicals, Inc.
("Tanner"). OSI Sealants, Mercer and Tanner manufacture, market and distribute
adhesives and sealants primarily utilized in housing repair, remodeling and
construction and industrial markets. The Acquisition has added significant depth
to the Company's product offerings, including the well-known OSI, Pro-Series,
and Polyseamseal brands. The Acquisition has also significantly enhanced the
company's distribution network, particularly in the professional builder and
retail home center channels, and has provided access to new customers and
markets for its existing product line.
The Acquisition was financed in part by the sale by the Company of
$125,000,000 principal amount of its 9 1/2% Senior Subordinated Notes due 2007,
Series A (the "Notes") to Chase Securities, Inc. and Donaldson, Lufkin &
Jenrette Securities Corporation (the "Initial Offering"). The Notes are fully
and unconditionally guaranteed by the following subsidiaries of the Company (the
"Guarantors"): Pierce & Stevens, SIA Adhesives, OSI Sealants, Mercer and Tanner.
Concurrently with the consummation of the Initial Offering, (i) the Company
acquired the Division for a cash purchase price of $133.3 million, (ii) FCEC,
management and other investors made, through the Parent Partnership, an equity
contribution of $33.8 million in cash (the "Equity Contribution"), (iii) the
Company and the Guarantors borrowed $30.0 million pursuant to a new senior
secured credit facility (the "Senior Credit Facility") and (iv) the Company
refinanced $41.4 million of indebtedness (the "Refinancing").
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The Initial Offering, the Acquisition, the Equity Contribution, the
Refinancing and the initial borrowings under the Senior Credit Facility are
referred to herein as the "Transactions."
COMPETITIVE STRENGTHS
The Company believes it benefits from the following competitive strengths,
which have enabled it to expand its penetration of existing customers and
markets, establish new customer relationships, enter new markets and develop
additional products and applications.
Leadership Positions in Selected Markets. The Company's customer-driven
product development, reputation for quality and high levels of customer service
have allowed it to achieve strong market positions and brand name recognition in
its markets. Management believes that over 50% of the Company's pro forma net
sales in 1997 were in niche markets in which the Company has either the number
one or two position. The Company's brand and trade names are particularly well
recognized in its target markets, and include Pierce & Stevens, OSI, Pro-Series,
Polyseamseal, Miracure, Plastilock, Latiseal, Hybond, Proxseal, Magic Seal and
Glaze'N Seal.
Strong Customer Relationships. The Company's leadership position within the
markets it serves, reputation for high levels of quality and customer service,
and proven product development skills have allowed it to secure strong
relationships across its customer base. The Company's products are sold to and
utilized by some of the world's largest companies, including The Boeing Company,
Airbus Industrie, General Motors Corporation, Chrysler Corporation and Baxter
International, Inc. Many of the Company's Industrial, Overprint Coatings and
Flexible Packaging products have been certified through intensive,
customer-specific technical approval processes which greatly enhance the
Company's position with such customers. The Company's relationships with
retailers and professional distributors of its Housing Repair, Remodeling and
Construction products are strengthened by the Company's broad product line,
strong brands and reputation for quality.
Technological Expertise. The Company is a technological leader in the
manufacture and development of specialty adhesives, sealants and coatings within
the markets it serves. The Company's technological expertise has allowed it to
introduce a broad variety of new products over the past three years. The Company
possesses numerous customized and proprietary formulations with unique
performance characteristics designed to address specific customer needs.
Examples of the Company's proprietary formulations include ultraviolet cured
coatings for graphic arts and adhesives used in aerospace, construction and
medical packaging. The Company continually leverages its technological expertise
to develop new products and additional applications for existing product
formulations. In addition, the Company has enhanced its technological expertise
both through cooperative research and development efforts and joint
technological alliances with suppliers and customers such as E. I. du Pont de
Nemours and Company, The Boeing Company, The Dow Chemical Company, Hoechst AG,
General Motors Corporation, Baxter International, Inc., Phillip Morris
Corporation and BASF Corporation.
Broad Product Offerings and Diverse Customer Base. The Company manufactures
over 1,300 products sold through multiple distribution channels to over 6,000
customers for a wide variety of applications. This diversity of customers,
products and distribution channels provides the Company with a broad base from
which to grow sales and expand customer relationships, and minimizes exposure to
any particular customer, economic cycle or geographic region.
Strong Management Team. The Company has assembled a strong and experienced
management team at both the corporate and operating levels. The Company's senior
and operating managers, led by Robert B. Covalt, have extensive experience in
the specialty chemicals industry. Upon closing of the Transactions, the top
managers will own, or have incentive awards to acquire approximately 19% of the
Parent Partnership's equity. In addition, the Parent Partnership has reserved 4%
of its equity on a fully diluted basis for future incentive awards.
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BUSINESS STRATEGY
Continued Focus on Niche Products in Attractive Markets. The Company will
continue to develop product offerings for value-added end-use applications in
higher growth markets, including those for: (i) structural adhesives; (ii)
fire-retardant adhesives and coatings; (iii) food and medical packaging
adhesives and coatings; and (iv) coatings which facilitate recycling and other
environmentally-friendly adhesives, sealants and coatings. Management believes
the Company's market leadership positions, technological expertise, and strong
customer relationships provide it with advantages in the development of new
products and the penetration of new markets.
Pursue Strategic Acquisitions. The Company has successfully grown through
acquisitions and intends to pursue additional strategic acquisitions that will
allow it to further improve its market positions in targeted markets. Management
believes that the high degree of fragmentation in the adhesives, sealants and
coatings business segment will continue to provide suitable acquisition
candidates. Potential acquisition candidates will be evaluated based upon the
ability of the Company to: (i) expand its product line; (ii) enhance its product
development capabilities; (iii) market products through new or expanded
distribution channels; and (iv) increase its international presence.
Increase International Presence. The Company believes it has significant
opportunities in international markets to increase sales to existing
multinational customers, enter developing markets and establish new customer
relationships. In October 1996, the Company appointed a Vice President --
International with over 30 years of international sales and marketing experience
in the adhesives, sealants and coatings industry. The Company intends to expand
its global sales, particularly in Southeast Asia and Latin America, by: (i)
increasing sales and marketing activities in targeted regions; (ii) entering
into strategic alliances; and (iii) pursuing targeted acquisitions. The Company
has recently established a sales office in Singapore focused on flexible
packaging adhesives and has increased its sales and marketing activities in
Latin America through its existing operations in Mexico.
Achieve Significant Operating Efficiencies. The Company believes that it
can achieve operating efficiencies resulting in enhanced revenue opportunities,
cost savings and improved cash flow through: (i) cross-selling its expanded
product line across the broader distribution and customer network which it will
develop from the Acquisition; (ii) consolidating raw material purchases to
increase purchasing economies of scale; (iii) reducing duplicative selling,
general and administrative expenses; (iv) consolidating various compensation,
benefit and insurance programs; (v) consolidating certain manufacturing and
distribution operations; and (vi) lowering working capital levels by optimizing
SKU counts and consolidating inventory management.
INDUSTRY
The Company operates in one business segment; the production, manufacture
and distribution of adhesives, sealants and coatings. Total sales of this
business segment in the United States were approximately $26.4 billion in 1996.
Adhesives, sealants and coatings are used in a wide range of products with
applications in numerous industries, including: industrial, consumer,
construction, automotive, aerospace and packaging. Typical industrial
applications include corrosion resistant industrial coatings, general assembly
adhesives, fire-retardant textile coatings, coatings for electronic components
and numerous other diverse applications. Consumer applications include various
consumer-applied adhesives such as white glues, caulks and sealants,
architectural coatings and miscellaneous do-it-yourself sealing applications for
bathtub and kitchen fixtures. Automotive market applications include the use of
primers and top coats, body sealants, structural adhesives and interior and
exterior trim adhesives. Typical construction applications include
contractor-applied architectural coatings, joint sealants and flooring and
roofing adhesives. Packaging industry applications include carton, corrugated
box and flexible consumer packaging adhesives, seam sealers and container
coatings. Aerospace applications include commercial, military and general
aviation coatings, composite bonding adhesives and structural epoxies.
The U.S. adhesives, sealants and coatings industry is highly fragmented
with over 500 competitors, the significant majority of which the Company
believes are small, regional competitors. While smaller companies have
successfully competed in niche markets, the industry is expected to consolidate
as competitors seek to
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enhance operating efficiencies in new product development, sales and marketing,
distribution, production and administrative overhead. Larger specialty
competitors also benefit through a greater diversification of end-use markets,
customers, technologies and geography, reducing the impact of industry or
regional cyclicality.
The U.S. adhesives, sealants and coatings industry grew from approximately
$13.8 billion in 1986 to approximately $26.4 billion in 1996, representing a
compound annual growth rate of 6.7%. Continued future growth is expected to
result from the following factors:
New Markets and More Stringent Demands of End Users. Adhesives and sealants
are increasingly being used in new applications, particularly in the
transportation and construction sectors, as end users desire simpler design and
manufacture, lower costs, improved bonding, lower weight, and reduced vibration
and corrosion. For example, in the bonding of automotive window glass to steel
body panels, high-performance adhesives provide structural reinforcement to the
adjacent steel panels, thus providing additional integrity to the car body. In
highway construction, new, long-lasting sealants are replacing traditional
bitumen, a traditional sealant used between adjacent slabs of concrete and other
materials that exhibit poor longevity.
New Materials. The growing use of nonferrous parts (e.g., aluminum and
plastics) in car bodies, appliances, buildings and other fabricated goods
requires the use of adhesives that are specially formulated to bond dissimilar
materials. On these substrates, traditional mechanical fasteners are frequently
not suitable.
Additional industry growth is expected to occur as a result of the
increased use of adhesives, sealants and coatings in international markets.
Total worldwide sales for adhesives, sealants and coatings were approximately
$75.2 billion in 1996. In 1996, the United States accounted for approximately
35% of worldwide sales, while Europe accounted for approximately 40% of
worldwide sales and Japan accounted for approximately 12% of worldwide sales.
Sales to the remainder of the world accounted for approximately 13% of total
industry sales. Developing markets are currently under-penetrated with respect
to the use of adhesives, sealants and coatings. Strong growth is expected in
these markets, particularly in the Far East, Eastern Europe and Latin America.
PRODUCTS AND MARKETS
The table below sets forth the Company's selected product applications to
customers in the following industries:
INDUSTRY SELECTED PRODUCT APPLICATIONS
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Housing Repair, Remodeling and
Construction............................ Aluminum and vinyl siding sealants
Window and door sealants
Tub and tile sealants
Drywall and subflooring adhesives
Industrial................................ Power staple and nail gun cartridge adhesives
Fire-retardant textile adhesives and coatings
Automotive structural and trim adhesives
Aerospace structural adhesives
Commercial insulation adhesives
Overprint Coatings........................ High gloss scratch and abrasion resistant coatings used
on paperback book covers, decorative packaging, annual
reports, catalog covers and playing and trading cards
Flexible Packaging........................ Blister packaging adhesives and coatings
Food and product packaging adhesives and coatings
Food packaging laminating adhesives
Housing Repair, Remodeling and Construction. The Company's Housing Repair,
Remodeling and Construction product offerings are primarily sealants and
adhesives used in exterior and interior applications. The Company's products in
this segment are marketed to defined niches in the do-it-yourself retail and
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professional markets. Distribution channels include professional distributors,
traditional hardware stores and retail home center customers such as Lowe's
Corp., Builder's Square, Inc. and Home Depot, Inc. The Company offers a broad
range of well-established branded products including OSI and Polyseamseal for
retail do-it-yourself markets and Pro-Series for professional markets.
Industrial. The Company's Industrial product offerings consist primarily of
specialty adhesives and coatings for the automotive, aerospace, manufactured
housing and textile markets. Such products include: adhesives for power staple
and nail gun cartridges, adhesives for carpet backing manufacturers,
fire-retardant coatings for carpet and other textiles, automotive trim
adhesives, commercial structural adhesives and insulation adhesives. In
addition, the Company manufactures and markets Dualite, a lightweight inert
filler that can both reduce the weight and enhance the strength of products to
which it is added. The Company's Industrial customers include The Boeing
Company, Airbus Industrie, General Motors Corporation, Chrysler Corporation,
Senco Corporation, Stanley Works and Zenith Corporation.
Overprint Coatings. The Company produces a variety of high quality, high
gloss scratch and abrasion resistant coatings used on paperback book covers,
decorative packaging, annual reports, catalog covers, playing and trading cards
and other miscellaneous items. The Company is the leading manufacturer of
coatings for paperback book covers. Overprint Coatings customers include
printers, custom coaters and magazine manufacturers.
Flexible Packaging. The Company produces Flexible Packaging adhesives
including: (i) heat-activated lidding adhesives used to apply flexible paper or
foil lids to plastic tubs in the food industry, such as individually packaged
condiments, creamers and cream cheese tubs; (ii) foil or paper blister packaging
for products such as pharmaceuticals, batteries, toys, and tool accessories;
(iii) film-to-film adhesives used to bond different types of plastic film, such
as metalized and moisture barrier films used in snack food bags; and (iv)
medical packaging adhesives.
Other. The Company also produces vinyl and rubber products such as wall
base, stair treads and nosings, and boat docking bumpers.
SALES AND MARKETING
Industrial, Flexible Packaging and Overprint Coatings. The Company operates
an extensive sales and marketing network for its Industrial, Flexible Packaging
and Overprint Coatings customers. This network consists of a direct sales force
of over 50 professionals, as well as independent agents and distributors. The
sales force works closely with customers to satisfy existing product needs and
to identify new applications and product improvement opportunities. The
Company's sales efforts are complemented by its product development and
technical support staff, who work together with the sales force to develop new
products based on customer needs. The Company augments its direct sales and
marketing coverage through a network of over 30 distributors and independent
agents who specialize in particular markets. This market specialization allows
the Company's products to gain access to a broader range of distribution
channels and end users and further strengthens the Company's brand names.
The Company's sales and marketing efforts and customer relationships are
enhanced by the numerous customer-specific technical approvals the Company has
secured. These approvals typically involve significant customer time and effort
and result in a strong competitive position for qualified products. Once
qualified, products are often referenced in customer specifications or qualified
product lists. These qualification processes also reinforce the partnership
between the Company and its customers and can lead to additional sales and
marketing opportunities.
Housing Repair, Remodeling and Construction. The Company sells products in
this segment through a network of distributors, as well as directly to large
national chains. This sales and marketing network allows the Company to reach a
variety of end users ranging from professional contractors to do-it-yourself
customers. The Company's brands are developed for specific end users:
Pro-Series, Magic Seal and Polyseamseal PRO for the professional contractor and
Polyseamseal, OSI, Bullet Bond, Nail Power and FI:X for retail distribution to
do-it-yourself end users. The Company differentiates itself through strong
technical service,
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specific product performance and color availability in the professional market
and consumer brand recognition, product performance, store service and point of
purchase packaging in the do-it-yourself market. The Company services its
customers in this segment through a network of six sales managers, ten regional
brand sales managers and 150 independent field sales representatives.
RAW MATERIALS
The Company uses a variety of specialty and commodity chemicals in its
manufacturing processes. These raw materials are generally available from
numerous independent suppliers. The Company typically purchases raw materials on
a spot basis. Certain of the Company's raw materials are derived from ethylene
and its derivatives. There have been historical periods of rapid and significant
movements in the price of ethylene both upward and downward. The Company has
historically been successful in passing on price increases to its customers
within 90 to 120 days, but there can be no assurance that it will continue to be
able to do so in the future.
TECHNOLOGY
The Company maintains a strong commitment to technology, focusing on
expanding applications for its existing products and developing new products and
processes, and employs over 100 chemists and chemical engineers. The Company's
research and development staff works together with the Company's sales force and
customers to identify specific customer needs and develop innovative, high
performance solutions which satisfy those needs. This method of product
development results in close ongoing working relationships between the Company
and its customers and allows the Company to better anticipate and service its
customers needs. The Company's research and development staff also seeks to
apply new products and applications resulting from this process to other end use
markets.
The Company's technological expertise has allowed it to develop proprietary
techniques and manufacturing expertise across a range of product applications,
including: (i) its patented proprietary process for manufacturing Dualite, a
filler which enables the customer to produce lighter and stronger products; (ii)
pre-formulated dispersions used as medical packaging adhesives, fiber setting
adhesives and food packaging coatings; (iii) advanced toughened epoxy technology
systems used as adhesives for metal-to-metal aircraft bonding; and (iv)
fire-resistant chemistry used in a number of industrial coatings and adhesives
for the textile, automotive and manufactured housing markets. The Company is
also engaged in technical alliances with both customers and suppliers to develop
new products, including alliances with E. I. du Pont de Nemours and Company, The
Boeing Company, The Dow Chemical Company, Hoechst AG, Phillip Morris
Corporation, Baxter International, Inc. and BASF Corporation, among others. The
Company's patents and custom formulations and qualifications, combined with its
strong technical service and partnership arrangements with many of its
customers, create substantial competitive advantages in many of its markets.
COMPETITION
The adhesives, sealants and coatings industry is highly competitive. The
industry is highly fragmented, with over 500 manufacturers ranging from small
regional companies to large multinational producers. No one company holds a
dominant position on a national basis and very few compete across all levels of
the Company's product line. The Company's competitors include CIBA-GEIGY
Corporation, National Starch and Chemical Company, Cytec Industries Inc., Morton
and DAP, Inc. Competition is generally regional and is based on product quality,
technical service for specialized customer requirements, breadth of product
line, brand name recognition and price.
EMPLOYEES
As of December 31, 1997, the Company had 675 employees, of whom 79 were
members of unions under contracts which expire between April 30, 1998 and
February 28, 1999. The Company believes that its relations with its employees
are good.
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ENVIRONMENTAL MATTERS
The Company is subject to extensive laws and regulations pertaining to the
discharge of materials into the environment, the handling and disposal of solid
and hazardous wastes, the remediation of contamination, and otherwise relating
to health, safety and protection of the environment ("Environmental Laws"). As
such, the Company's operations and the environmental condition of its real
property could give rise to liabilities under Environmental Laws, and there can
be no assurance that material costs will not be incurred in connection with such
liabilities. Environmental Laws are constantly evolving and it is impossible to
predict accurately the effect they may have upon the capital expenditures, cash
flow or competitive position of the Company in the future. Should Environmental
Laws become more stringent, the cost of compliance would increase. If the
Company cannot pass on future costs to its customers, such increases may have an
adverse effect on the Company's financial condition or results of operations.
In connection with its acquisitions, the Company has performed substantial
due diligence to assess the environmental liabilities associated with the
acquired businesses and the Division, and has negotiated contractual
indemnifications, which, supplemented by commercial "pollution cleanup cap and
pollution legal liability" insurance coverage designed for each acquisition, is
currently expected to adequately address a substantial portion of known and
foreseeable environmental liabilities. The Company does not currently believe
that environmental liabilities will have a material adverse effect on the
financial condition or results of operations of the Company. No assurance can be
given, however, that indemnitors or insurers will in all cases meet their
obligations or that the discovery of presently unidentified environmental
conditions, or other unanticipated events, will not give rise to expenditures or
liabilities that may have such an effect.
Following the Acquisition of the Division, the Company became responsible
to the State of South Carolina for completing the investigation and remediation
of certain subsurface contamination resulting from historic operations under
prior ownership at the Greenville, South Carolina facility, which activities are
currently projected to cost approximately $3.0 to $6.0 million. The Company is
indemnified by Laporte with respect to this matter (as well as certain other
known and unknown pre-closing environmental liabilities), subject to an overall
cap well in excess of the currently estimated cost of cleanup. Laporte has
agreed to conduct and finance the investigation and remediation of this matter.
Further, as part of the Acquisition purchase price, the Parent Partnership has
issued a $3.0 million junior subordinated note payable in five years to Laporte,
and such note may be reduced as a result of payments by the Company to cover
certain environmental liabilities associated with the Division. In addition, the
Company expects to receive the benefit of rent reductions negotiated by Laporte
with the owner and lessor of the facility worth approximately $1.5 million.
In connection with the 1996 acquisition of Pierce & Stevens, the Company's
environmental due diligence detected conditions of subsurface contamination
primarily associated with storage tank farms and at certain other areas of the
Pierce & Stevens facilities. The Company plans to address most areas of
contamination in connection with its plan to replace the tank farms in late 1997
and 1998. The Company currently estimates the total cost of remediation to be
$1.3 million, but this amount could be higher, depending upon the extent of
contamination. In connection with the acquisition, Sherwin-Williams Company
agreed to indemnify the Company with respect to this and other pre-closing
liabilities, subject to a $7.0 million overall cap, and, in addition to the
overall cap, has placed $2.0 million in escrow to secure payment for this and
certain other environmental matters.
As is the case with manufacturers in general, if a release of hazardous
materials occurs at real property owned or operated by the Company or its
predecessors or at any off-site disposal location utilized by the Company or its
predecessors, the Company may be held strictly, jointly and severally liable for
cleanup costs and natural resource damages under the federal Comprehensive
Environmental Response, Compensation, and Liability Act ("Superfund") and
similar Environmental Laws. Pierce & Stevens and the Division have been named
potentially responsible parties under Superfund and/or similar Environmental
Laws for cleanup of approximately fifteen multi-party waste disposal sites, the
liability for several of which have been resolved, subject to standard reopeners
found in Superfund settlements. Due to what the Company currently believes is
the relatively minor contribution of Pierce & Stevens' and the Division's waste
to such sites, the Company
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does not currently believe that its liability with respect to such sites will
have a material adverse effect on the financial condition or results of
operations of the Company.
The Company expects to incur capital expenditures for environmental
controls in the years ahead and currently estimates that such expenditures will
amount to $3.0 million in 1998. The majority of these expenditures will pertain
to removing and replacing aboveground and underground storage tank systems at
several facilities to comply with upcoming deadlines contained in Environmental
Laws. The Company expects that it will be entitled to indemnification for
approximately 90% of these expenditures.
BACKLOG
Total backlog orders at December 31, 1997 were approximately $4.6 million.
All 1997 backlog orders were expected to be filled within the current year.
Backlog orders at December 31, 1996 and 1995 were not significant.
ITEM 2. PROPERTIES
The production of adhesives, sealants and coatings is a multi-stage process
which involves extensive formulation, mixing and in some cases, chemical
synthesis. Following one or more of these processes, the product is packaged in
totes, drums, pails, cartridges or other delivery forms for sale based upon the
customer's requirements. The Company's principal manufacturing processes are
blending, polymerization, extrusion and film coating. Blending consists of
dissolving or dispersing various compounds in organic solvents or water. In
polymerization, vinyl, acrylic and urethane polymers are synthesized in closed
reactor systems. Extrusion consists of feeding formulated materials through an
extruder to compound pressure sensitive and hot melt products. Film coating
consists of transferring blended formulations onto release paper or polyethylene
liners to produce thin films of pressure sensitive, hot melt and epoxy products.
Many of the Company's manufacturing processes can be performed at more than one
facility.
The Company operates the manufacturing plants and facilities described in
the table below. Management believes that the Company's plants and facilities
are maintained in good condition and are adequate for its present and estimated
future needs.
Listed below are the principal manufacturing facilities operated by the
Company:
OWNED/ SQUARE
LOCATION LEASED(1) FOOTAGE APPLICATION SERVED
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Akron, Ohio........................ Owned 214,300 Industrial
Buffalo, New York.................. Owned 165,000 Industrial, Overprint Coatings, Flexible
Packaging
Mentor, Ohio....................... Owned 160,000 Home Repair, Remodeling and Construction
Greenville, South Carolina......... Leased(2) 104,500 Industrial
Eustis, Florida.................... Owned 96,500 Other
Carol Stream, Illinois............. Owned 81,800 Industrial, Overprint Coatings, Flexible
Packaging
LaGrange, Georgia.................. Owned 64,000 Home Repair, Remodeling and Construction
Kimberton, Pennsylvania............ Owned 55,900 Industrial, Overprint Coatings, Flexible
Packaging
Mexico City, Mexico................ Leased(3) 24,400 Industrial, Overprint Coatings, Flexible
Packaging
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(1) All of the Company's owned facilities are subject to mortgages pursuant to
the Senior Credit Facility.
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(2) Lease expires December 31, 2008.
(3) Lease expires December 31, 1999.
The Company's executive offices are located in Chicago, Illinois. The
Company also has sales offices in Fremont, California and Singapore.
ITEM 3. LEGAL PROCEEDINGS
The Company is a party to various litigation matters incidental to the
conduct of its business. The Company does not believe that the outcome of any of
the matters in which it is currently involved will have a material adverse
effect on its financial condition or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders in the fourth
quarter of 1997.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
No equity securities of the Company were sold in 1997. There is no public
trading market for the Company's equity securities.
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ITEM 6. SELECTED FINANCIAL DATA
SELECTED HISTORICAL FINANCIAL DATA
THE COMPANY
The selected information below presents the financial information of the
Company and its predecessor for the periods indicated. The data for the years
ended December 31, 1994 and 1995 and the three months ended March 31, 1996 are
derived from the audited financial statements of SIA Adhesives (the
"Predecessor"). The data for the period ended December 31, 1996 are derived from
the audited financial statements of the Parent Partnership. The data for the
year ended December 31, 1997 are derived from the audited financial statements
of the Parent Partnership and the Company. The data for the year ended December
31, 1993 are derived from the unaudited financial statements of the Predecessor.
The following information should only be read in conjunction with the audited
consolidated financial statements of the Company, and the notes thereto, and
"Management's Discussion and Analysis of Results of Operations and Financial
Condition," all included elsewhere herein.
PREDECESSOR THE COMPANY
--------------------------------------- ----------------------------
PERIOD PERIOD YEAR
ENDED ENDED ENDED
YEAR ENDED DECEMBER 31, MARCH 31, DECEMBER 31, DECEMBER 31,
--------------------------- --------- ------------ -------------
1993 1994 1995 1996 1996 1997
------- ------- ------- --------- ------------ -------------
(DOLLARS IN THOUSANDS)
STATEMENT OF OPERATIONS DATA:
Net sales........................................ $18,823 $20,100 $21,129 $ 5,410 $37,792 $134,771
Cost of goods sold............................... 12,817 13,498 13,734 3,580 26,637 92,889
------- ------- ------- ------- ------- --------
Gross profit..................................... 6,006 6,602 7,395 1,830 11,155 41,882
Selling, general and administrative expense...... 6,702 6,362 5,633 1,603 9,613 30,131
------- ------- ------- ------- ------- --------
Operating income (loss).......................... (696) 240 1,762 227 1,542 11,751
Interest expense................................. -- -- -- -- 1,666 9,080
Other............................................ -- -- -- -- -- 163
------- ------- ------- ------- ------- --------
Income (loss) before income taxes and
extraordinary item............................. (696) 240 1,762 227 (124) 2,508
Income taxes(1).................................. (278) 96 705 91 (99) 1,315
------- ------- ------- ------- ------- --------
Income (loss) before extraordinary item.......... (418) 144 1,057 136 (25) 1,193
Extraordinary item(2)............................ -- -- -- -- (281) (1,409)
------- ------- ------- ------- ------- --------
Net income (loss)................................ $ (418) $ 144 $ 1,057 $ 136 $ (306) $ (216)
======= ======= ======= ======= ======= ========
BALANCE SHEET DATA
(END OF PERIOD):
Working capital (deficit)........................ $(7,214) $(5,988) $ 1,786 $(5,019) $11,936 $ 30,111
Total assets..................................... 10,024 10,281 9,394 9,612 69,960 242,759
Total indebtedness............................... -- -- -- -- 41,652 159,377
Stockholder's equity............................. 696 144 7,013 136 17,444 52,053
OTHER FINANCIAL DATA:
Capital expenditures............................. $ 770 $ 655 $ 106 $ 131 $ 688 $ 1,834
See Notes to Selected Historical Financial Data
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NOTES TO SELECTED HISTORICAL FINANCIAL DATA
(1) Income of SIA Adhesives, a limited liability company, and the Parent
Partnership is taxed at the member or partner, as the case may be, level
and, as such, no income taxes are reflected prior to the Company's
reorganization on July 31, 1997. After the Transactions, the Company and SIA
Adhesives are subchapter C corporations and, as such, are subject to income
taxes. As such, income taxes have been reflected for the year ended December
31, 1997 for taxable earnings subsequent to the Transactions.
(2) Extraordinary item relates to the write-off of deferred financing costs
associated with the early extinguishment of debt.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
The Company was formed by Robert B. Covalt and other investors to acquire
and consolidate specialty chemical businesses in the highly fragmented
adhesives, sealants and coatings industry business segment. The Company began
operations in March 1996 with the acquisition of SIA, a manufacturer of
specialty adhesives used primarily in the automotive, aerospace and general
industrial markets. In August 1996, the Company acquired Pierce & Stevens, a
developer and manufacturer of specialty coatings and adhesives for performance-
oriented niche applications. In August 1997, the Company acquired in a single
transaction the net assets of Laporte Construction Chemicals North America,
Inc., Evode-Tanner Industries, Inc., and Mercer Products Company, Inc.
(Division). These businesses manufacture, market and distribute adhesives and
sealants primarily utilized in housing repair, remodeling and construction and
industrial markets.
The Operating results of the Company for 1996 include the results of the
Company for the period from March 31, 1996 (date of inception) to December 31,
1996 and the results of the Company's predecessor (the Adhesives Systems
Division of The BFGoodrich Company) for the period from January 1, 1996 to March
31, 1996. The results of acquired businesses have been included for all periods
subsequent to their respective dates of acquisition.
HISTORICAL RESULTS OF OPERATIONS
HISTORICAL 1997 COMPARED TO HISTORICAL 1996
Net Sales. Net sales for 1997 were $134.8 million, an increase of $91.6
million, or 212.0% over 1996. The increase is attributable primarily to the full
year impact of the acquisitions of SIA Adhesives and Pierce & Stevens in 1996
and the acquisition of the Division in 1997. Excluding the acquisitions, net
sales increased as a result of increased sales of aerospace adhesives resulting
from strong levels of commercial aircraft production. The increase in net sales
was partially offset by reduced sales of automotive pressure sensitive
adhesives.
Cost of Goods Sold. Cost of goods sold for 1997 was $92.9 million, an
increase of $62.7 million, or 207.4% over 1996. As a percentage of net sales,
cost of goods sold decreased from 69.9% in 1996 to 68.9% in 1997, thus resulting
in an improvement in gross profit margin from 30.1% in 1996 to 31.1% in 1997.
The improved margin in 1997 was a result of an improvement in product mix with
increased sales of construction adhesives (as a result of the acquisition of the
Division) and aerospace adhesives.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses were $30.1 million in 1997, an increase of $19.0
million, or 172.0% over 1996. Selling, general and administrative expenses
decreased to 22.3% of net sales for 1997 as compared to 25.6% for 1996. This was
a result of several factors, including (i) the acquisition of the Division in
August, 1997 which have generally lower selling expenses than SIA Adhesives and
Pierce & Stevens due to increased average customer size, and the use of large
distributors rather than a direct sales force in the construction adhesives and
sealants markets, (ii) lower corporate overhead charges as a percentage of
rapidly expanding net sales, (iii) elimination of certain non-recurring expenses
in connection with the formation of the Company and the development of
compensation and benefit programs and policies, and (iv) reduced insurance
premiums related to combining policies of the acquired businesses.
Interest Expense. Interest expense was $9.1 million in 1997, an increase of
$7.4 million, or 445.0% over 1996. This related directly to the increased debt
incurred as a result of the acquisitions of the Pierce & Stevens in August, 1996
and the Division in August, 1997.
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Minority Interest Expense. Minority interest expense was $.1 million in
1997, a decrease of $.1 million, or 50.0% from 1996. This was due to the
purchase in July 1997 of the outstanding minority interests in SEA Adhesives and
Pierce & Stevens through the issuance of additional equity in the Company.
Income Taxes. Prior to its restructuring in July 1997, the consolidated
entity was composed of various types of entities including a limited partnership
and a limited liability company. Income tax liabilities for such entities are
generally "passed through" to their owners. Subsequent to the restructuring, the
Company and its subsidiaries will file a consolidated tax return. The financial
statements for 1997 and 1996 include "pro forma" income taxes as if the
companies had been taxable entities for both periods.
Extraordinary Loss. The extraordinary loss, net income tax benefit, on the
extinguishment of debt was $1.4 million in 1997, an increase of $1.1 million, or
401.4% over 1996. These charges relate to the writeoff of deferred financing
costs and other fees related to the Transactions in August, 1997.
Net Income. As a result of the foregoing, the Company had a net loss of $.2
million in 1997 as compared to a net loss of $.3 million in 1996.
HISTORICAL 1996 COMPARED TO HISTORICAL 1995
Net Sales. Net sales for 1996 were $43.2 million, representing a $22.1
million, or 104.5%, increase over 1995. This increase was due to the acquisition
of Pierce & Stevens in August, 1996 which contributed $22.0 million in sales for
the period.
Cost of Goods Sold. Cost of goods sold for 1996 was $30.2 million,
representing a $16.5 million, or 120.0%, increase over 1995. This increase was
primarily due to the acquisition of Pierce & Stevens in August, 1996. As a
percentage of net sales, cost of goods sold increased to 69.9% in 1996 from
65.0% in 1995, primarily due to the addition of the generally lower gross margin
Pierce & Stevens products.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses in 1996 were $11.2 million, representing a $5.6 million,
or 99.1%, increase over 1995. This increase was primarily attributable to the
acquisition of Pierce & Stevens in August, 1996. As a percentage of net sales,
selling, general and administrative expenses decreased to 26.0% in 1996 from
26.7% in 1995 as a result of the lower level of selling, general and
administrative expenses as a percentage of net sales at Pierce & Stevens.
Net Income. Net loss for 1996 was $.2 million, compared to net income of
$.7 million in 1995, representing a $.9 million decrease from 1995. As a
percentage of net sales, net loss decreased to (.3)% in 1996 from 5.0% in 1995.
This decrease was the result of the factors discussed above as well as increased
interest expense of $1.7 million and an extraordinary loss of $.3 million due to
the refinancing resulting from the acquisition of Pierce & Stevens in August,
1996.
INFLATION
The Company does not believe that inflation has had a material impact on
net sales or income during any of the periods presented above. There can be no
assurance, however, that the Company's business will not be affected by
inflation in the future.
YEAR 2000 COMPLIANCE BY THE COMPANY AND OTHERS
Year 2000 compliance concerns the ability of certain computerized
information systems to properly recognize date-sensitive information, such as
invoices for the Company's services, as the year 2000 approaches. Systems that
do not recognize such information could generate erroneous data or cause systems
to fail; this problem may occur as early as calendar year 1999. The Company is
at risk both for its own Year 2000 compliance and for the Year 2000 compliance
of those with whom it does business, primarily third party payors. The Company
plans to replace or upgrade its non-compliant systems with Year 2000 compliant
software, and does not believe the cost of such will have a material impact on
the results of operations. Moreover, there can be no assurance that the third
party payors upon whom the Company relies will not experience system
difficulties as a result of the Year 2000 problem, which difficulties could
delay payment to the Company. Any such difficulties or delays could have a
material adverse effect on the Company.
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by financing activities totaled $135.1 million in 1997.
In 1997, the Parent Partnership contributed $33.8 million of capital, the
Company issued $125 million in Senior Subordinated notes, borrowed
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$30 million under its Senior Credit Facility, and refinanced existing senior and
subordinated credit facilities totaling $41.4 million, all in connection with
the acquisition of the Division.
Net cash provided by operating activities was $6.4 million for the year
ended December 31, 1997.
Investing activities required $135.2 million for 1997. The primary use of
funds from investing activities for the Company has been investments in
businesses acquired. Cash invested in businesses acquired used $133.3 million in
1997, relating to the acquisition of the Division (See Note 4 to the Financial
Statements -- Business Combinations). Capital spending for 1997 totaled $1.8
million and related to general facility maintenance.
Interest payments on the Notes and under the Senior Credit Facility and
amortization of the Term Loan represent significant obligations of the Company.
The Notes require semiannual interest payments, interest on loans under the
Senior Credit Facility will be due quarterly and the Term Loan will require
quarterly amortization payments of $1.2 million commencing on September 30,
1998. The Company's remaining liquidity demands relate to capital expenditures
and working capital needs. For the year ended December 31, 1997, the Company
spent $1.8 million on capital projects. The Company anticipates capital
expenditures totaling $7.0 million in 1998, $3.0 million of which relates to
environmental expenditures for which the Company is indemnified pursuant to
acquisition agreements. Exclusive of the impact of any future acquisitions, the
Company does not expect its capital expenditure requirements to increase
materially in the foreseeable future.
The Company's primary sources of liquidity are cash flows from operations
and borrowings under the Senior Credit Facility. The Revolving Credit Facility
provides the Company with $30.0 million of borrowings, subject to availability
under the borrowing base. At December 31, 1997, the Company had availability of
$29.1 million under the Revolving Credit Facility with $0.9 million of letters
of credit outstanding. The Company believes that, based on current and
anticipated financial performance, cash flow from operations and borrowings
under the Revolving Credit Facility will be adequate to meet anticipated
requirements for capital expenditures, working capital and scheduled principal
and interest payments (including interest payments on the Notes and amounts
outstanding under the Senior Credit Facility). However, the Company's capital
requirements may change, particularly if the Company should complete any
additional material acquisitions.
On April 21, 1998, the Company sold its Mercer subsidiary. The Company used
the net proceeds from the sale of Mercer to repay the $30 million Term Loan. The
repayment of the Term Loan triggered an additional $20 million revolving
commitment (Supplemental Revolver) which is subject to the terms set forth in
the Credit Agreement (See Note 18 to the Financial Statements -- Subsequent
Event).
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
This item is not applicable to the registrant pursuant to General
Instruction 1 to Item 305 of Regulation S-K. The registrant's market
capitalization is less than $2.5 billion.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated financial statements of the Company are submitted as a
separate section of this report. For a list of financial statements and
schedules filed as part of this report, see the "Index to Financial Statements"
beginning on page F-1.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
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PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth certain information with respect to: (i)
each member of the Company's Board of Directors (the "Board"); (ii) each
executive officer of the Company; and (iii) certain key employees of the
Company.
NAME AGE POSITION
---- --- --------
Robert B. Covalt............... 66 Chairman, President, Chief Executive Officer and Director
Lowell D. Johnson.............. 47 Vice President, Chief Financial Officer, Treasurer,
Secretary and Director
Martyn Howell-Jones............ 60 Vice President -- International
Richard W. Johnston............ 50 Vice President -- Technology
Stephen Zavodny................ 40 Director of Engineering
Paul Gavlinski................. 50 Vice President, Manufacturing
Karen K. Seeberg............... 45 Vice President, Human Resources
Louis M. Pace.................. 26 Director of Mergers & Acquisitions
Charles A. Aldag, Jr. ......... 65 Director
Carol E. Bramson............... 34 Director
Lawrence E. Fox................ 55 Director
Eric C. Larson................. 43 Director
Karl D. Loos................... 47 Director
Neal G. Reddeman............... 75 Director
Reeve B. Waud.................. 34 Director
The following table sets forth certain information concerning the
Guarantors' directors and officers. Officers of the Guarantors serve at the
discretion of the respective board of directors:
NAME AGE POSITION
---- --- --------
Robert B. Covalt............... 66 Chairman and Director of Pierce & Stevens, SIA Adhesives,
OSI Sealants, Mercer and Tanner
Lowell D. Johnson.............. 47 Vice President, Finance, Chief Financial Officer,
Treasurer and Secretary of Pierce & Stevens, OSI Sealants,
Tanner, Mercer and SIA Adhesives
Michael Prude.................. 46 President and Chief Executive Officer of Pierce & Stevens
Richard W. Johnston............ 50 Executive Vice President of Pierce & Stevens
Paul Gavlinski................. 50 Vice President -- Operations of Pierce & Stevens
Gerard A. Loftus............... 43 President and Chief Executive Officer of SIA Adhesives and
Tanner
Peter Longo.................... 38 President and Chief Executive Officer of OSI Sealants
Carol E. Bramson............... 34 Director of Pierce & Stevens, SIA Adhesives, OSI Sealants
and Tanner
Eric C. Larson................. 43 Director of Pierce & Stevens, SIA Adhesives, OSI Sealants
and Tanner
Reeve B. Waud.................. 34 Director of Pierce & Stevens, SIA Adhesives, OSI Sealants
and Tanner
Robert B. Covalt has served as Chairman, President and Chief Executive
Officer and as a director of the Company since its inception in 1995. Mr. Covalt
is a director of each of the Guarantors. From 1979 to 1990, Mr. Covalt served as
President of the Specialty Chemicals Group of Morton. During this period, Mr.
Covalt grew Morton's specialty chemicals group from $175.0 million to $1.3
billion in sales and he completed thirteen acquisitions ranging in size from
$3.0 million to $170.0 million. From 1990 to 1993, Mr. Covalt was Morton's
Corporation Executive Vice President. Prior to that time, Mr. Covalt served in
various capacities in Morton's Chemical Division which he joined in 1957. Mr.
Covalt serves on the board of directors of CFC International, Inc., a specialty
chemical coating manufacturer. Mr. Covalt has a B.S. in Chemical Engineering and
an honorary doctorate from Purdue University, and an M.B.A. from the University
of Chicago.
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Lowell D. Johnson has served as Vice President and Chief Financial Officer,
Treasurer, Secretary and director of the Company since January 1998. Mr. Johnson
also serves as Vice President, Finance, Chief Financial Officer, Treasurer and
Secretary of Pierce & Stevens, OSI Sealants, Tanner, Mercer and SIA Adhesives.
Mr. Johnson served as Vice President, Finance and Chief Financial Officer of the
Isaac Group from March 1994 to January 1998. From October 1988 to March 1994,
Mr. Johnson served as Vice President, Finance and Chief Financial Officer for
Kerr Manufacturing Company. From March 1983 to October 1988, Mr. Johnson was
Senior Vice President and Chief Financial Officer of KMS Industries, Inc. From
March 1972 to March 1983, Mr. Johnson served in various financial and audit
management capacities with Touche Ross & Company, Northwest Industries, Inc. and
the BOC Group. A C.P.A., Mr. Johnson holds B.B.A. and M.B.A. degrees from
Eastern Michigan University.
Martyn Howell-Jones has served as Vice President -- International of the
Company since October 1996. Mr. Howell-Jones is responsible for the Company's
international sales and marketing efforts. Prior to joining the Company, Mr.
Howell-Jones was engaged as a consultant to National Starch and Chemical Company
from June 1994 to September 1996 where he assisted in the development of
National Starch and Chemical Company's international adhesives business. From
1966 to 1992, Mr. Howell-Jones was employed by Morton in its European specialty
chemicals business. Mr. Howell-Jones holds a B.S. degree from London University.
Richard W. Johnston has served as Vice President -- Technology of the
Company since March 1997 and as Executive Vice President of Pierce & Stevens
since 1995. From 1992 to 1995, Mr. Johnston served as Vice President --
Technology of Pierce & Stevens. Prior to that time, Mr. Johnston served as Vice
President of Pierce & Stevens' Canadian operations from 1988 to 1992. Mr.
Johnston joined Pierce & Stevens in 1966 and has served in several technical
capacities with expertise in coatings and adhesives technology. Mr. Johnston
holds a B.S., M.S. and M.E.S. in Chemistry from the University of Waterloo,
Canada.
Stephen Zavodny has served as Director of Engineering for the Company since
February 1997. Mr. Zavodny is in charge of all capital projects and improvements
for the Company's manufacturing operations. From 1996 to January 1997, Mr.
Zavodny served as a project manager and product line manager for Raytheon. Prior
to that time, Mr. Zavodny served as Director of Engineering at Morton from 1991
to 1996. From 1981 to 1991, Mr. Zavodny served in various engineering capacities
with Morton. Mr. Zavodny holds a B.S. degree in Chemical Engineering from the
University of Illinois.
Louis M. Pace has served as the Company's Director of Mergers &
Acquisitions since January, 1998. From August 1996 to December 1997, he served
as the Company's Director of Corporate Development and Assistant Secretary. From
1995 to August 1996, Mr. Pace was an associate with FCEC. Prior to that time,
Mr. Pace was a member of First Chicago Corporation's First Scholar management
training program where he was engaged in various financial capacities including
emerging markets, interest rate derivatives and analysis of equity capital
investments. Mr. Pace holds a B.A. in Economics from Harvard University and an
M.B.A. from J.L. Kellogg Graduate School of Management at Northwestern
University.
Paul Gavlinski has served as Vice President, Manufacturing of the Company
since February, 1998 and Vice President, Operations of Pierce & Stevens since
September 1996. From 1995 to July 1996, Mr. Gavlinski served as President of
Catalyst Development, a management consulting firm. Prior to that time, Mr.
Gavlinski was Vice President -- Manufacturing of Emulsion Systems Inc., a
polymer manufacturing company. From 1969 to 1992, Mr. Gavlinski was employed by
Morton in various chemical manufacturing capacities. Mr. Gavlinski holds a B.S.
in Chemical Engineering from the University of Illinois.
Gerard A. Loftus has served as President of Tanner and SIA Adhesives since
February 1998 and President of SIA Adhesives since April 1996. From January 1995
to March 1996, Mr. Loftus served as General Manager of the Adhesive Systems
Division of The B.F. Goodrich Company, the predecessor of SIA Adhesives ("ASD").
In 1994, Mr. Loftus served as the division business manager of ASD with
responsibility for all sales, marketing and technical activities. From 1990 to
1994, Mr. Loftus was business manager of the aerospace products group of ASD.
Upon joining ASD in 1986, Mr. Loftus served in a variety of capacities including
materials manager and controller. Mr. Loftus, who is a C.P.A., holds a B.B.A. in
Accounting from Ohio University and a Masters of Accountancy from Cleveland
State University.
Peter Longo has been President and Chief Executive Officer of OSI Sealants
since 1991. From 1989 to 1991, Mr. Longo was Vice President of Operations of OSI
Sealants. Mr. Longo has been employed by OSI
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Sealants for more than 20 years and has served in a variety of capacities
including sales and marketing. Mr. Longo attended Lakeland Community College.
Michael Prude has been President of Pierce & Stevens since February 1998.
From 1993 to 1997, Mr. Prude was President and Chief Operating Officer of
Evode-Tanner Industries Division of Laporte plc, the predecessor of Tanner. From
1991 to 1993, Mr. Prude was President of Tamms Industries -- Division of Laporte
plc. Mr. Prude holds a B.S. degree in Chemical Engineering from the University
of Wales, United Kingdom. From 1990 to 1991, Mr. Prude served as Vice President
of Tamms Industries -- Division of Laporte plc. From 1987 to 1990, Mr. Prude
served as Works Manager of Interox. From 1987 to 1987, Mr. Prude served as
Operations Director of Chemical Specialties, Inc., a division of Laporte plc.
From 1977 to 1984, Mr. Prude was employed by Interox Chemicals, a company owned
jointly by Laport plc. and Solvay.
Karen K. Seeberg has been Vice President, Human Resources of the Company
since February, 1998. From January 1997 to February 1998, Ms. Seeberg was
Director, Human Resources for Pierce & Stevens. From September 1992 to January
1997, Ms. Seeberg was Human Resources Manager for the Information System
Division of Avery Dennison. From August 1982 to August 1992, Ms. Seeberg held
human resource management positions with Federated Department Stores, Iroquois
Industries, Inc. and British Petroleum. Ms. Seeberg holds a B.A. degree from
State University of New York.
Charles A. Aldag, Jr. has been a director of the Company since August 1996.
Mr. Aldag is retired but serves as a special advisor to the Chemical
Manufacturer's Association where he has been active in developing environmental,
health and safety management practices and systems. Prior to his retirement, Mr.
Aldag served from 1987 to 1991 as Vice Chairman of Sherex Chemical Co., a
subsidiary of Schering AG of Germany, which was a producer of oleochemical
products and specialty surfactants. Mr. Aldag joined Ashland Chemical, Sherex
Chemical's predecessor, in 1968 and served in various capacities including
President and Chief Executive Officer of Sherex Chemical from 1979 to 1987. Mr.
Aldag holds a B.S. in Chemistry from Purdue University and an M.B.A. from the
University of Indiana.
Carol E. Bramson has been a director of the Company since March 1996 and is
Chairman of its Compensation Committee. Ms. Bramson is a director of each of the
Guarantors. Ms. Bramson has been a partner of FCEC since 1995. From 1992 to
1995, Ms. Bramson was an associate with FCEC. From 1989 to 1992, Ms. Bramson was
employed by Household International Inc. in its leveraged finance group. Prior
to that time, Ms. Bramson was engaged as an associate with Essex Venture
Partners, a Chicago-based venture capital firm. Ms. Bramson also serves on the
board of directors of Seco Products Corporation. Ms. Bramson holds a B.S. in
Finance from DePaul University and an M.B.A. from the University of Chicago.
Lawrence E. Fox has been a director of the Company since June 1997. Mr. Fox
has been a senior vice-president of FCEC since 1979 and currently heads the
equity unit of the Capital Investments Department. Mr. Fox has previously been
responsible for FCEC's leveraged debt funding and mezzanine investments. Mr. Fox
is a director of Lafayette Pharmaceuticals Inc. and Alpha Technologies Group,
Inc. Mr. Fox received his undergraduate degree from the University of Wisconsin
and an M.B.A. from the University of Chicago.
Eric C. Larson has been a director of the Company since March 1996 and
serves as Chairman of its Audit Committee. Mr. Larson is a director of each of
the Guarantors. Mr. Larson has been a partner of FCEC since 1991. Since joining
FCEC in 1984, Mr. Larson has held a variety of principal investment and advisory
responsibilities in structuring middle market leveraged buyouts and
recapitalization transactions in a broad array of industries. Mr. Larson serves
on the board of directors of M-Wave, Inc., a manufacturer of specialty
components for the wireless communications industry as well as several private
companies. Mr. Larson holds a B.A. degree from Harvard University, a Masters in
Architecture from the University of Michigan and an M.B.A. from the University
of Chicago.
Karl D. Loos has been a director of the Company since August 1996. Mr. Loos
founded Garnett Consulting in 1996. From 1977 to 1996, Mr. Loos was employed at
Arthur D. Little & Co. in Boston, Massachusetts, most recently as Vice President
and Managing Director of Process Industries Consulting and Director of the
Strategic Planning practice. Mr. Loos received his undergraduate degree from
Dartmouth College and an M.B.A. from Harvard Business School.
Neal G. Reddeman has been a director of the Company since August 1996 and
has been engaged as a consultant to the Company. Mr. Reddeman who is retired,
has more than 40 years experience in the specialty
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packaging, coatings and adhesives industry. From 1965 to 1991, Mr. Reddeman was
employed in the specialty chemicals group of Morton, most recently as Executive
Vice President of Adhesives and Coatings. Prior to joining Morton, Mr. Reddeman
was Vice President of Manufacturing at General Packaging Inc. in Rochester, New
York and was manager of product development at Milprint Inc. in Milwaukee,
Wisconsin. Mr. Reddeman holds a B.S. in Chemical Engineering from the University
of Wisconsin.
Reeve B. Waud has been a director of the Company since March 1996. Mr. Waud
is a director of each of the Guarantors. Mr. Waud has served as a principal of
Waud Capital Partners, L.L.C., Waud Capital Partners -- I, L.P. and Waud Capital
Partners -- II, L.P., a Chicago-based group of equity investment firms, since
November 1993. From 1987 to 1993, Mr. Waud was an Associate with Golder, Thoma &
Cressey, a middle market venture capital group. Prior to that time, Mr. Waud was
an analyst with Salomon Brothers Inc in the corporate finance group. Mr. Waud
serves as Chairman of the board of directors of Christiana Industries, L.L.C.
and Whitehall Products, L.L.C. and serves on the board of directors of
Northwestern Memorial Management Corporation, Mr. Waud holds a B.A. from
Middlebury College and an M.B.A. from the J.L. Kellogg Graduate School of
Management at Northwestern University.
ITEM 11. EXECUTIVE COMPENSATION
Executive compensation is determined by the compensation committee of the
Company's Board of Directors (the "Compensation Committee"). The Compensation
Committee is composed of Mr. Aldaq, Ms. Bramson, Mr. Loos and Mr. Waud, Mr.
Aldaq, Mr. Loos and Mr. Reddeman each receive $1,000 per meeting as compensation
for their services as directors. None of the other directors receive
compensation for their services as directors. The following Summary Compensation
Table includes individual compensation information for the Chief Executive
Officer and each of the four other most highly compensated executive officers of
the Company in the years ended December 31, 1997 and 1996 for services rendered
in all capacities to the Company and its subsidiaries during the year ended
December 31, 1997 and 1996.
ANNUAL COMPENSATION
------------------------------------ ALL OTHER
FISCAL COMPENSATION
YEAR SALARY($) BONUS($) ($)(1)
------ --------- -------- ------------
Robert B. Covalt.................................. 1997 $250,000 $140,158 $17,512
Chairman, President and Chief Executive Officer 1996(2) 146,033 139,315 2,417
William T. Schram................................. 1997 140,000 26,994 6,081
Vice President, Chief Financial Officer and 1996(2) 88,533 44,877 2,750
Secretary
John H. Edholm.................................... 1997 153,333 -- 7,292
President of Pierce & Stevens 1996(3) 63,422 7,875 1,618
Gerard A. Loftus.................................. 1997 128,023 41,863 3,763
President of SIA Adhesives 1996(2) 81,450 5,000 1,438
Richard W. Johnston............................... 1997 146,667 24,961 7,156
Vice President -- Technology 1996(3) 63,904 7,875 1,632
- -------------------------
(1) Represents matching contributions under 401(k) plans. Robert B. Covalt's
1997 compensation includes $14,312 tax gross-up for shares of the General
Partner purchased in 1997.
(2) Represents compensation from April 1, 1996 to December 31, 1996
(3) Represents compensation from August 19, 1996 to December 31, 1996
MANAGEMENT INCENTIVE PLANS AND EMPLOYMENT AGREEMENTS
The Company's Board of Directors believes that equity- and
performance-based plans and programs should constitute a major portion of
management's compensation so as to provide significant incentives to achieve
corporate goals. The Company, in conjunction with the Parent Partnership, has
instituted four plans and programs for this purpose.
Stock Incentive Pool. The Parent Partnership adopted its Stock Incentive
Pool in April 1996 in order to provide incentives to employees and directors
(including nonemployee directors), the Company and its subsidiaries, by granting
them ownership awards in the form of Parent Partnership units and common stock
of its general partner. The Stock Incentive Pool awards are allocated by the
Compensation Committee of the
17
19
Board of Directors of the Company. An award granted from the Stock Incentive
Pool is subject to five year time and performance vesting. Accelerated vesting
may be granted in accordance with defined qualifying events. To date, Stock
Incentive Pool units and shares representing approximately 13.2% of the indirect
ownership of the Company's equity have been awarded by the Compensation
Committee of the Board to nine select officers, directors and employees of the
Company.
1997 Long-Term Incentive Plan. The Parent Partnership adopted its 1997
Long-Term Incentive Plan in May 1997 in order to provide long-term incentive
awards to all salaried employees (excluding executives who participate directly
in the Stock Incentive Pool). Participants are granted a "participation share"
in the incentive award pool which consists of a portion of equity reserved for
the program. At the time of a qualified transaction, determined and defined by
the Board of Directors, the value of the pool is allocated to participants based
upon their "participation share". Payment may be in the form of stock options,
stock, cash, or a combination of these elements, as determined by the Board of
Directors. "Participation shares" are not vested until earned and paid out. If a
participant leaves the Company before a qualified transaction has occurred,
their "participation share" is forfeited. If an individual joins the Company
during the plan cycle, they may be permitted to participate in the program, at
the discretion of the Chief Executive Officer and Board of Directors. The
Compensation Committee of the Board of Directors will administer the plan and
have the authority and responsibility to approve award levels and make any
changes in plan concept and design. As of May 31, 1997, the Long-Term Incentive
Plan was funded with an allocation of units and shares representing indirect
ownership of approximately 1.0% in the Company's equity.
1997 Management Incentive Plan. The Company adopted its 1997 Management
Incentive Plan in May 1997 in order to provide incentives to eleven selected
members of management and corporate staff judged to have the greatest impact on
the year's results. Each participant will be eligible for cash bonus awards
based on the Company's financial performance, measured in terms of 1997 revenues
and EBITDA, and on individual role-specific goals. Participants in this program
have been assigned a percentage of their base salary as their bonus target for
the 1997 fiscal year. Awards may be higher or lower than the target bonus as the
Company and/or individual performance is above or below the level expected to
achieve the target bonus. Total potential bonus as a percent of salary will be
in the range of 30%-120% of base salary dependent upon position. However, no
bonuses will be earned by the senior executives named in the Summary
Compensation Table unless a target cashflow threshold is attained and no bonus
will be awarded to any participating employee unless both the Company's revenues
and EBITDA reach a 90% attainment level.
1997 Incentive Bonus Program. The Company adopted its 1997 Incentive Bonus
Program in May 1997 in order to provide incentives to all salaried employees
(excluding any participant in the 1997 Management Bonus Program, sales incentive
eligible employees and union employees). Each participant will be eligible for
bonus awards based on the Company's financial performance, measured in terms of
revenues and EBITDA, and on individual role-specific goals. Participants in this
program have been assigned a percentage of their base salary as their bonus
target for 1997. Awards may be higher or lower than the target bonus as the
Company and/or individual performance is above or below the level expected to
achieve the target bonus. Total potential bonus will be in the range of 7.5% to
34% of base salary dependent upon position and salary band. Participants'
eligibility for the financial performance aspects of target bonus is contingent
upon the Company's realization of 90% of its target budget for the period. Upon
achievement of 90% of both target revenue and EBITDA, participants earn 50% of
the target bonus opportunity. For performance achievement between 90% and 100%
of target for revenue and EBITDA, the bonus awarded will increase from 50% to
100% of the target award level. For performance achievement above 100% of target
revenue and EBITDA, the bonus award will increase subject to a formula dependent
upon position and salary band.
In addition to the cash bonus program described above, the Company has
established a multi-tiered recognition program which provides cash and non-cash
recognition awards to employees. Service awards are in place to recognize
employees for loyalty and sustained contribution as demonstrated by length of
service. Contribution awards are provided to recognize a broad range of
employees for individual and team contributions of clear value to the
organization.
The Company also has employment agreements with Mr. Covalt, Mr. Johnson,
Mr. Prude, Mr. Loftus and Mr. Johnston, which provide for such executives to
serve in their current capacities. The agreement with Mr. Covalt currently
provides for a salary of at least $250,000. The remainder of these agreements
provide for
18
20
salaries of at least the following amounts: Mr. Johnson, $170,000; Mr. Prude,
$150,000; Mr. Loftus, $130,000; and Mr. Johnston, $145,000. The agreements with
Mr. Covalt and Mr. Loftus expire on March 31, 1999 and the agreement with Mr.
Johnston expires on August 19, 1999. The agreement with Mr. Johnson expires
January 5, 2001. The agreement with Mr. Prude expires February 16, 2001. All of
these agreements also contain noncompetition provisions which extend up to two
years after the end of such executives' employment with the Company.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The Company is a wholly-owned subsidiary of the Parent Partnership. The
following table sets forth certain information regarding the beneficial
ownership of the common stock of the general partner of the Parent Partnership,
by each person who beneficially owns more than five percent of such common stock
and by the directors and certain executive officers of the Company,
individually, and as a group.
NUMBER PERCENTAGE
OF SHARES OF SHARES
--------- ----------
FIVE PERCENT SECURITY HOLDERS
First Chicago Equity Corporation(1)......................... 598.6 34.5%
Three First National Plaza, Mail Suite 1210, Chicago,
Illinois 60670
Waud Capital Partners - I, L.P.(2).......................... 148.6 8.6%
560 Oakwood Avenue, Suite 203, Lake Forest, Illinois 60045
Waud Capital Partners - II, L.P.(2)......................... 137.2 7.9%
560 Oakwood Avenue, Suite 203, Lake Forest, Illinois 60645
Chase Venture Capital Associates, L.P. ..................... 161.5 9.3%
380 Madison Avenue, 12th Floor, New York, New York 10017
Bank of America Investments................................. 121.9 7.0%
231 South LaSalle Street, Chicago, Illinois 60697
Cross Creek Partners(3)..................................... 106.4 6.1%
Three First National Plaza, Mail Suite 1210, Chicago,
Illinois 60670
OFFICERS AND DIRECTORS
Robert B. Covalt............................................ 242.9 14.0%
Lowell D. Johnson........................................... 20.4 1.2%
Martyn Howell-Jones......................................... 8.8 *
Gerard A. Loftus............................................ 6.5 *
Richard W. Johnston......................................... 8.5 *
Charles A. Aldag............................................ 3.4 *
Carol E. Bramson(1)(3)...................................... 705.0 40.6%
Lawrence F. Fox(1)(3)....................................... 705.0 40.6%
Eric C. Larson(1)(3)........................................ 705.0 40.6%
Karl D. Loos................................................ 3.4 *
Neal G. Reddeman............................................ 3.4 *
Reeve B. Waud(2)............................................ 312.0 18.0%
*All executive officers and directors as a group............ 1,314.3 75.8%
- -------------------------
* Represents less than 1%.
(1) Carol E. Bramson, Lawrence E. Fox and Eric C. Larson are partners of First
Chicago Equity Corporation. Accordingly Ms. Bramson, Mr. Fox and Mr. Larson
may be deemed to be the beneficial owner of these securities to Ms. Bramson,
Mr. Fox and Mr. Larson disclaim beneficial ownership of these securities.
(2) Reeve B. Waud is affiliated with Waud Capital Partners -- I, L.P. and Waud
Capital Partners -- II, L.P. Accordingly Mr. Waud may be deemed to be the
beneficial owner of these securities. Mr. Waud disclaims beneficial
ownership of these securities.
19
21
(3) Carol E. Bramson, Lawrence E. Fox and Eric C. Larson are partners of Cross
Creek Partners. Accordingly, Ms. Bramson, Mr. Fox and Mr. Larson may be
deemed to be the beneficial owner of these securities. Ms. Bramson, Mr. Fox
and Mr. Larson disclaim beneficial ownership of these securities.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
In connection with the acquisition of SIA Adhesives in March 1996, Mr.
Loftus invested $110,000 to purchase membership interests of SIA Adhesives, and
in connection with the acquisition of Pierce & Stevens in August 1996, Mr.
Johnston invested $125,000, to purchase common stock of Pierce & Stevens.
In connection with the formation of Sovereign Specialty Chemicals, Inc. on
July 31, 1997 and the reorganization of the Company, the Parent Partnership
exchanged partnership units, with a fair value of approximately $1.5 million,
for ownership interests in SIA and P&S held by Mssrs. Loftus, Edholm, Johnston,
Zavodny, Gavlinski and Bashford.
The Chase Manhattan Bank is the administrative agent under the Senior
Credit Facility. Chase Securities Inc. acted as arranger for the Senior Credit
Facility. The Chase Manhattan Bank and Chase Securities Inc. are affiliates of
Chase Venture Capital Associates, L.P.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) The following documents are filed as a part of this report:
1. The financial statements listed in the "Index to Financial
Statements."
2. None.
3. The exhibits listed in the "Index to Exhibits."
(b) Reports on Form 8-K. None.
(c) Exhibits. The response to this portion of Item 14 is submitted as a
separate section of this report.
(d) Financial Statement Schedules.
20
22
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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 on May 12, 1998.
SOVEREIGN SPECIALTY CHEMICALS, INC.
By: /s/ ROBERT B. COVALT
------------------------------------
Robert B. Covalt
Chairman, Chief Executive Officer
and President
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities indicated on May 12, 1998.
SIGNATURE CAPACITY
--------- --------
* Chairman, Chief Executive Officer, President
- ----------------------------------------------------- and Director (Principal Executive Officer)
Robert B. Covalt
* Vice President, Chief Financial Officer,
- ----------------------------------------------------- Treasurer, Secretary and Director (Principal
Lowell D. Johnson Financial Officer and Principal Accounting
Officer)
* Director
- -----------------------------------------------------
Neil G. Reddeman
* Director
- -----------------------------------------------------
Charles A. Aldag
* Director
- -----------------------------------------------------
Carol E. Bramson
* Director
- -----------------------------------------------------
Lawrence E. Fox
* Director
- -----------------------------------------------------
Eric C. Larson
* Director
- -----------------------------------------------------
Karl D. Loos
* Director
- -----------------------------------------------------
Reeve B. Waud
- ---------------
* The undersigned, by signing his name hereto, does sign and execute this report pursuant to the Power
of Attorney executed by the above named officers and directors of the registrant and filed with the
Securities and Exchange Commission on behalf of such officers and directors.
/s/ ROBERT B. COVALT
- -----------------------------------------------------
Robert B. Covalt
Attorney-in-Fact
21
23
ANNUAL REPORT ON FORM 10-K
ITEMS 8 AND 14(A)
INDEX TO FINANCIAL STATEMENTS
F-1
24
Consolidated Financial Statements
Sovereign Specialty Chemicals, Inc.
and Subsidiaries
As of and for the periods ended
December 31, 1996 and 1997
with Report of Independent Auditors
F-2
25
SOVEREIGN SPECIALTY CHEMICALS, INC.
AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
AS OF AND FOR THE PERIODS ENDED
DECEMBER 31, 1996 AND 1997
CONTENTS
Report of Independent Auditors.............................. F-4
Consolidated Financial Statements
Consolidated Balance Sheets................................. F-5
Consolidated Statements of Operations....................... F-6
Consolidated Statements of Stockholder's Equity............. F-7
Consolidated Statements of Cash Flows....................... F-8
Notes to Consolidated Financial Statements.................. F-9
F-3
26
REPORT OF INDEPENDENT AUDITORS
The Board of Directors
Sovereign Specialty Chemicals, Inc.
We have audited the accompanying consolidated balance sheets of Sovereign
Specialty Chemicals, Inc. and Subsidiaries (the Company) as of December 31, 1996
and 1997, and the related consolidated statements of operations, stockholder's
equity, and cash flows for the period from March 31, 1996 (date of inception) to
December 31, 1996 and for the year ended December 31, 1997. Our audits also
included the financial statement schedule listed in the index at Item 14a. These
financial statements and schedule are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements and schedule 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, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Sovereign
Specialty Chemicals, Inc. and Subsidiaries at December 31, 1996 and 1997, and
the consolidated results of their operations and their consolidated cash flows
for the period from March 31, 1996 (date of inception) to December 31, 1996, and
for the year ended December 31, 1997, in conformity with generally accepted
accounting principles. Also, in our opinion, the related financial statement
schedule, when considered in relation to the financial statements taken as a
whole, presents fairly in all material respects the information set forth
therein.
ERNST & YOUNG LLP
Chicago, Illinois
March 27, 1998
(Except for Note 18, as to which
the date is April 21, 1998)
F-4
27
SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
DECEMBER
-------------------
1996 1997
---- ----
ASSETS
Current assets:
Cash and cash equivalents................................. $ 104 $ 6,413
Accounts receivable, less allowance of $325 and $655...... 10,997 26,824
Inventories............................................... 9,895 21,042
Deferred income taxes..................................... 688 944
Other current assets...................................... 1,972 4,539
------- --------
Total current assets........................................ 23,656 59,762
Property, plant, and equipment, net......................... 27,022 48,308
Goodwill, net............................................... 17,876 123,177
Deferred financing costs, net............................... 1,169 11,137
Other assets................................................ 237 375
------- --------
Total assets................................................ $69,960 $242,759
======= ========
LIABILITIES AND STOCKHOLDER'S EQUITY
Current liabilities:
Accounts payable.......................................... $ 4,959 $ 13,008
Accrued expenses.......................................... 4,629 14,023
Current portion of long-term debt......................... 2,000 2,400
Current portion of capital lease obligations.............. 132 120
------- --------
Total current liabilities................................... 11,720 29,551
Long-term debt, less current portion........................ 39,360 153,193
Capital lease obligations, less current portion............. 160 3,564
Deferred income taxes....................................... 72 209
Other long-term liabilities................................. 713 4,189
Minority interests.......................................... 491 --
Stockholder's equity:
Common stock, $.01 par value, 1,000 shares authorized,
issued and outstanding.................................... -- --
Additional paid-in capital.................................. 17,689 52,479
Accumulated deficit......................................... (306) (522)
Cumulative translation adjustment........................... 61 96
------- --------
Total stockholder's equity.................................. 17,444 52,053
------- --------
Total liabilities and stockholder's equity.................. $69,960 $242,759
======= ========
See accompanying notes to consolidated financial statements.
F-5
28
SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS)
PERIOD FROM
MARCH 31, 1996
(DATE OF INCEPTION) YEAR ENDED
TO DECEMBER 31, DECEMBER 31,
1996 1997
------------------- ------------
Net sales................................................... $37,792 $134,771
Cost of goods sold.......................................... 26,637 92,889
------- --------
Gross profit................................................ 11,155 41,882
Selling, general, and administrative expenses............... 9,458 30,081
Minority interest........................................... 155 50
------- --------
Operating income............................................ 1,542 11,751
Foreign exchange loss....................................... -- 163
Interest expense............................................ 1,666 9,080
------- --------
Income (loss) before income taxes and extraordinary
losses.................................................... (124) 2,508
Income taxes................................................ (99) 1,315
------- --------
Income (loss) before extraordinary losses................... (25) 1,193
Extraordinary losses (net of tax benefits).................. 281 1,409
------- --------
Net loss.................................................... $ (306) $ (216)
======= ========
Pro forma:
Net income (loss) before income taxes and extraordinary
losses, as stated......................................... $ (124) $ 2,508
Income taxes:
As stated................................................. (99) 1,315
Additional pro forma income taxes......................... 154 657
------- --------
55 1,972
------- --------
Net income (loss) before extraordinary losses............... (179) 536
Extraordinary losses........................................ 169 1,409
------- --------
Net loss.................................................... $ (348) $ (873)
======= ========
See accompanying notes to consolidated financial statements.
F-6
29
SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDER'S EQUITY
FOR THE PERIODS ENDED DECEMBER 31, 1996 AND 1997
(DOLLARS IN THOUSANDS)
ADDITIONAL CUMULATIVE
COMMON PAID-IN ACCUMULATED TRANSLATION
STOCK CAPITAL DEFICIT ADJUSTMENT TOTAL
------ ---------- ----------- ----------- -----
Balance at March 31, 1996 (date of
inception).............................. $-- $ 5,585 $ -- $-- $ 5,585
Capital contributions........................ -- 12,258 -- -- 12,258
Distributions................................ -- (154) -- -- (154)
Net loss..................................... -- -- (306) -- (306)
Translation adjustment....................... -- -- -- 61 61
--- ------- ----- --- -------
Balance at December 31, 1996................. -- 17,689 (306) 61 17,444
Capital contributions........................ -- 33,800 -- -- 33,800
Issuance of equity to purchase minority
interests.................................. -- 990 -- -- 990
Net loss..................................... -- -- (216) -- (216)
Translation adjustment....................... -- -- -- 35 35
--- ------- ----- --- -------
Balance at December 31, 1997................. $-- $52,479 $(522) $96 $52,053
=== ======= ===== === =======
See accompanying notes to consolidated financial statements.
F-7
30
SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
PERIOD FROM
MARCH 31, 1996
(DATE OF INCEPTION) YEAR ENDED
TO DECEMBER 31, DECEMBER 31,
1996 1997
------------------- ------------
OPERATING ACTIVITIES
Net loss.................................................. $ (306) $ (216)
Adjustments to reconcile net loss to net cash provided by
operating activities:
Depreciation and amortization.......................... 1,600 6,049
Deferred income taxes.................................. (133) 238
Minority interests..................................... 155 50
Amortization of deferred financing costs............... 47 651
Extraordinary losses................................... 281 1,409
Changes in operating assets and liabilities (net of
effect of acquired companies):
Accounts receivable.................................. 1,197 642
Inventories.......................................... 88 (114)
Prepaid expenses and other current assets............ (462) (1,889)
Accounts payable and accrued expenses................ 3,495 (434)
-------- ---------
Net cash provided by operating activities................... 5,962 6,386
INVESTING ACTIVITIES
Acquisition of businesses (net of acquired cash)............ (62,718) (133,338)
Purchase of property, plant, and equipment.................. (688) (1,834)
-------- ---------
Net cash used in investing activities....................... (63,406) (135,172)
FINANCING ACTIVITIES
Capital contributions....................................... 17,835 33,800
Proceeds from revolving credit facility..................... 3,228 593
Payments on revolving credit facility....................... (7,596) --
Proceeds from issuance of long-term debt.................... 54,226 155,000
Deferred financing costs.................................... (1,216) (12,672)
Payments on long-term debt.................................. (8,699) (41,360)
Payments on capital lease obligations....................... (53) (270)
Distributions............................................... (158) --
-------- ---------
Net cash provided by financing activities................... 57,567 135,091
Effect of exchange rate changes on cash..................... (19) 4
-------- ---------
Net increase in cash and cash equivalents................... 104 6,309
Cash and cash equivalents at beginning of period............ -- 104
-------- ---------
Cash and cash equivalents at end of period.................. $ 104 $ 6,413
======== =========
See accompanying notes to consolidated financial statements.
F-8
31
SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996 AND 1997
(DOLLARS IN THOUSANDS)
1. REORGANIZATION AND BASIS OF PRESENTATION
Effective July 31, 1997, Sovereign Specialty Chemicals, L.P. (the Parent
Partnership) reorganized its corporate structure. The Parent Partnership
purchased the outstanding minority interests in Sovereign Engineered Adhesives,
L.L.C. (SEA) and P&S Holdings, Inc. through the issuance of additional units in
the Parent Partnership in exchange for the membership interests in SEA and the
common stock in P&S not previously owned. The acquisition of minority interests
was accounted for as a purchase in accordance with Accounting Principles Board
Opinion No. 16, "Business Combinations," and goodwill in the amount of $990 was
recognized. Concurrently, SEA was merged with and into SIA Adhesives, Inc.
(SIA), a newly-formed C corporation, and SEA was dissolved. Also, P&S Holdings,
Inc. was merged into its wholly-owned subsidiary, Pierce & Stevens Corp. (P&S).
At the same time, Sovereign Specialty Chemicals, Inc. (Sovereign) was formed as
a wholly-owned subsidiary of the Parent Partnership. The initial capitalization
of Sovereign was comprised of a $33.8 million contribution from investors
through the Parent Partnership. In addition, the Parent Partnership contributed
its wholly-owned subsidiaries, SIA and P&S, to Sovereign. The contribution of
the subsidiaries was accounted for at historical book value (after accounting
for the purchase of the minority interests) in a manner similar to a
pooling-of-interests. Upon the consummation of the transactions, SIA, P&S, and
Acquired Companies (Note 4) became wholly-owned subsidiaries of Sovereign.
Unless otherwise noted, all references to the Company hereinafter refer to
Sovereign and its wholly-owned subsidiaries.
The financial statements as of December 31, 1996 and for the period from
March 31, 1996 (date of inception) through December 31, 1996 and as of and for
the year ended December 31, 1997 are presented on a basis "as if" the Company
existed prior to July 31, 1997 and included the operations of the subsidiaries
from their respective dates of acquisition.
2. NATURE OF BUSINESS
The Company operates in one business segment, as a developer, producer and
distributor of adhesives, sealants and coatings utilized in numerous industrial
and commercial applications. Commercial applications of the Company's products
include housing repair, remodeling and construction, industrial, overprint
coatings, and flexible packaging. Products are sold and distributed primarily
throughout the United States.
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiaries, SIA, P&S, newly-acquired companies (Note 4)
and Sovereign Specialty Chemicals, Pte. Ltd., a Singapore-based sales office.
All significant intercompany accounts and transactions have been eliminated.
INVENTORIES
Inventories are valued at the lower of cost or market. Cost is determined
using the first-in first-out (FIFO) method.
PROPERTY, PLANT, AND EQUIPMENT
Property, plant, and equipment are stated at cost, less accumulated
depreciation. Depreciation is provided using the straight-line method over the
respective estimated useful lives of the assets for financial reporting
purposes, as follows: three to ten years for machinery and equipment; seven
years for furniture and fixtures,
F-9
32
SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
and 39 years for buildings and improvements. Accelerated depreciation methods
are used for income tax purposes.
GOODWILL
Goodwill represents the excess of acquisition cost over the fair value of
net assets acquired and is being amortized using the straight-line method over
periods ranging from 15 to 25 years. Accumulated amortization of goodwill was
$590 and $3,660 as of December 31, 1996 and 1997, respectively. Management of
the Company assesses the recoverability of this intangible asset, through
undiscounted cash flows of the underlying acquired entity, to make a judgment
whether the amortization of goodwill over its remaining useful life can be
recovered. The amount of goodwill impairment, if any, is measured based on
projected discounted future operating cash flows using a discount rate
reflecting the Company's average cost of funds. There will be an impact on the
assessment of the recoverability of goodwill if estimated future operating cash
flows are not achieved.
DEFERRED FINANCING COSTS
The costs of obtaining financing are capitalized and are being amortized
using the straight-line method over the term of the related debt ranging from
seven to ten years. Accumulated amortization was $47 and $710 as of December 31,
1996 and 1997, respectively.
INCOME TAXES
Prior to its restructuring on July 31, 1997, the consolidated entity was
composed of various types of entities including a limited partnership and a
limited liability company. Income tax liabilities for such entities are
generally "passed through" to their owners. Subsequent to the restructuring, the
Company and its subsidiaries will file a consolidated federal tax return. The
financial statements of operations for the period ended December 31, 1996 and
for the year ended December 31, 1997, include "pro forma" income taxes as if the
companies had been subject to income taxes for all periods presented.
Deferred taxes have been recognized for the tax consequences of temporary
differences by applying the enacted statutory income tax rates applicable to
future years of differences between the financial statement carrying amounts and
the tax bases of the existing assets and liabilities. Deferred taxes have been
recognized due to differences in timing for financial reporting and tax
reporting of depreciation, net operating loss carryforwards, goodwill, inventory
reserves and capitalization, the allowance for doubtful accounts, and various
accruals.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid debt instruments with original
maturities of three months or less to be cash equivalents.
REVENUE RECOGNITION
Revenue is recognized when products are shipped to the customer.
RESEARCH AND DEVELOPMENT
Research and development costs are charged to expense as incurred. Research
and development expenses were $0.7 million and $3.0 million as of December 31,
1996 and 1997, respectively.
F-10
33
SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
TRANSLATION OF FOREIGN CURRENCIES
Except as noted below, the Company's foreign subsidiaries use the local
currency as their functional currency; accordingly, their financial statements
are translated using the current exchange rates as of the reporting dates for
the balance sheet and using a weighted-average exchange rate during the period
for statement of operations accounts. Adjustments resulting from such
translation are included in cumulative translation adjustment, a separate
component of stockholder's equity. Because Mexico is classified as a
hyperinflationary economy, P&S's Mexican subsidiary is required to use the U.S.
dollar as its functional currency. Accordingly, the financial statements of the
Mexican subsidiary have been remeasured from the peso to the U.S. dollar. Gains
and losses on such remeasurement have been included in the statement of
operations.
LONG-LIVED ASSETS
The Company evaluates its long-lived assets (including related goodwill) on
an ongoing basis. Identifiable intangibles are reviewed for impairment wherever
events or changes in circumstances indicate that the carrying amount of the
related asset may not be recoverable. Recoverability of assets to be held and
used is measured by a comparison of the carrying amount of the asset to future
undiscounted cash flows expected to be generated by the asset. If the asset is
determined to be impaired, the impairment recognized is measured by the amount
by which the carrying value of the asset exceeds its fair value.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying value of cash and cash equivalents, trade accounts receivable,
loans receivable, related party, accounts payable and accrued expenses, and
other current liabilities approximate to their fair value due to the short-term
nature of these instruments.
The carrying amounts reported in the Company's balance sheets for
variable-rate long-term debt, including current portion, approximate fair value,
as the underlying long-term debt instruments are comprised of notes that are
repriced on a short-term basis.
The Company estimates the fair value of fixed rate long-term debt
obligations including current portion, using the discounted cash flow method
with interest rates currently available for similar obligations. The carrying
amounts reported in the Company's balance sheets for these obligations
approximate fair value.
CONCENTRATION OF CREDIT RISK
Financial instruments that potentially subject the Company to significant
concentrations of credit risk consist principally of trade accounts receivable.
To minimize this risk, ongoing credit evaluations of customers' financial
condition are performed, although collateral is not required. In addition, the
Company maintains an allowance for potential credit losses.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts reported in the financial
statements and accompanying notes. Actual results could differ from those
estimates.
NEW ACCOUNTING STANDARDS
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive Income" (SFAS
130). In addition to net income,
F-11
34
SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
comprehensive income includes items recorded directly to stockholder's equity
such as the cumulative translation adjustment. The provisions of SFAS 130
establish new standards for reporting and displaying comprehensive income and
its components in a full set of financial statements. Application of the
provisions of SFAS 130 are required for fiscal years beginning after December
15, 1997. The Company is in the process of evaluating the specific reporting
requirements of SFAS 130; however, the adoption of SFAS 130 will have no impact
on the Company's consolidated results of operations, financial position, or cash
flows.
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131, "Disclosures About Segments of an
Enterprise and Related Information" (SFAS 131). The provisions of SFAS 131
establish standards for the way companies report information about operating
segments in annual financial statements and require that such companies report
selected information about operating segments in interim financial reports
issued to shareholders. The provisions of SFAS 131 require the disclosure of
segment information be based on a "management approach" whereby disclosures are
made of information that is available and evaluated regularly by the chief
decision makers of the Company in deciding how to allocate resources and assess
performance. Application of the provisions of SFAS 131 is required for fiscal
years beginning after December 15, 1997. Management believes that the operating
subsidiaries of the Company form a single business segment (the manufacture,
sale, and distribution of adhesives and sealant products) and manage the
companies as such. The Company has evaluated the disclosure requirements of SFAS
131 and believes that its adoption will not have a material impact on its future
disclosure requirements.
In February 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 132 (SFAS 132), "Employers' Disclosures
about Pensions and Other Postretirement Benefits." SFAS 132 revises the previous
disclosure requirements of pension and postretirement plans. The Statement does
not change the recognition or measurement of pension or postretirement benefit
plans. The Company has evaluated the disclosure requirements of SFAS 131 and
believes that its adoption will not have a material impact on its future
disclosure requirements.
RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform to the 1997
presentation.
4. BUSINESS COMBINATIONS
Effective March 31, 1996, the Company purchased, through SEA, the Adhesives
Systems Division of The BFGoodrich Company (BFG). The purchase was made in
accordance with the Asset Purchase Agreement between the Company, SEA and BFG.
The Company acquired certain assets and assumed certain commitments for $15,819,
including transaction related costs of $607 and net of acquired cash of $404.
The acquisition was accounted for as a purchase and, as such, the results of
operations subsequent to March 31, 1996, have been included in the consolidated
statement of operations of the Company. In connection with the acquisition, the
Company recognized goodwill in the amount of approximately $4.2 million which is
being amortized over a period of 15 years.
Effective August 19, 1996, the company purchased, through P&S Holdings,
Inc., 100% of the outstanding common stock of P&S. The cost of the acquisition
was $46,899 including transaction costs of approximately $1.2 million. The
acquisition was accounted for as a purchase and, as such, the results of
operations subsequent to August 19, 1996, have been included in the consolidated
statement of operations of the Company. In connection with the acquisition, the
Company recognized goodwill in the amount of approximately $14.0 million which
is being amortized over a period of 15 years.Effective August 5, 1997, the
Company purchased from Laporte plc (Laporte), the net assets of Laporte
Construction Chemicals North America, Inc.; Evode-Tanner Industries, Inc.; and
Mercer Products Company, Inc. (the Acquired Compa-
F-12
35
SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. BUSINESS COMBINATIONS (CONTINUED)
nies). The Acquired Companies were affiliated by common control as wholly-owned
subsidiaries of Laporte. The purchase price of the Acquired Companies was
approximately $133.3 million including expenses relating to the purchase of
approximately $1.5 million and net of acquired cash of $707. The purchase was
funded through the issuance of $125 million of subordinated notes payable, a $30
million term note, and a capital contribution of $33.8 million. Excess of
funding over the purchase price was used to retire long-term debt (Note 9).
Allocation of the purchase price to the fair values of significant assets and
liabilities as of the date of purchase was as follows:
Purchase price.............................................. $133,338
Assets acquired/liabilities assumed:
Accounts receivable....................................... 16,469
Inventories............................................... 11,033
Property, plant, and equipment............................ 22,431
Accounts payable.......................................... (11,717)
Accrued liabilities....................................... (9,954)
Capital lease obligations................................. (3,662)
Other, net................................................ 981
--------
25,581
--------
Goodwill.................................................... $107,757
========
The acquisitions were accounted for as purchases and, as such, the results
of the operations of the Acquired Companies subsequent to August 5, 1997 (date
of acquisition), have been included in the consolidated statement of operations
of the Company. Goodwill recognized in the acquisitions is being amortized over
a period of 25 years. The Acquired Companies are wholly-owned subsidiaries of
Sovereign and operate as OSI Sealants, Inc. (OSI), Tanner Chemicals, Inc.
(Tanner), and Mercer Products Company, Inc. (Mercer).
The unaudited pro forma consolidated statement of operations as if all of
the above acquisitions had occurred as of the beginning of the respective
periods, would have been as follows for the period from March 31, 1996 (date of
inception) to December 31, 1996, and year ended December 31, 1997:
1996 1997
---- ----
Net sales................................................ $157,010 $208,345
Cost of goods sold....................................... 109,144 142,615
-------- --------
Gross profit............................................. 47,866 65,730
Selling general and administrative expenses.............. 37,068 46,711
-------- --------
Operating income......................................... 10,798 19,019
Interest expense......................................... 16,070 16,478
Foreign exchange loss.................................... -- 163
Income taxes............................................. (1,166) 1,747
-------- --------
Income (loss) before extraordinary losses................ $ (4,106) $ 631
======== ========
F-13
36
SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. INVENTORIES
Inventories are summarized as follows:
DECEMBER 31
--------------------
1996 1997
---- ----
Raw materials............................................. $4,631 $10,908
Work in process........................................... 135 141
Finished goods............................................ 5,129 9,993
------ -------
$9,895 $21,042
====== =======
6. PROPERTY, PLANT, AND EQUIPMENT
Property, plant, and equipment are summarized as follows:
DECEMBER 31
---------------------
1996 1997
---- ----
Land..................................................... $ 2,930 $ 4,099
Building and improvements................................ 8,020 18,915
Machinery and equipment.................................. 16,820 27,271
Furniture and fixtures................................... 193 962
Construction-in-progress................................. -- 982
------- -------
27,963 52,229
Less: Accumulated depreciation........................... 941 3,921
------- -------
$27,022 $48,308
======= =======
7. OTHER CURRENT ASSETS
Other current assets are summarized as follows:
DECEMBER 31
-------------------
1996 1997
---- ----
Prepaid insurances......................................... $ 803 $1,337
Acquisition purchase price adjustment receivable........... -- 1,300
Other...................................................... 1,169 1,902
------ ------
$1,972 $4,539
====== ======
F-14
37
SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. ACCRUED EXPENSES
Accrued expenses are summarized as follows:
DECEMBER 31
----------------
1996 1997
---- ----
Interest.................................................... $ 393 $ 5,344
Compensations and benefits.................................. 3,309 4,435
Rebates and warranty........................................ 125 1,307
Insurance................................................... -- 526
Royalties................................................... 237 445
Professional fees........................................... 166 315
Property taxes.............................................. 138 268
Environmental liability..................................... -- 130
Other....................................................... 261 1,253
------ -------
$4,629 $14,023
====== =======
9. LONG-TERM DEBT
Long-term debt are summarized as follows:
DECEMBER 31
------------------
1996 1997
---- ----
Senior subordinated notes................................. $10,000 $125,000
Term loans................................................ 24,501 30,000
Revolving credit facilities............................... 6,859 593
------- --------
41,360 155,593
Less: Current maturities.................................. 2,000 2,400
------- --------
$39,360 $153,193
======= ========
In connection with its acquisition of SEA on March 31, 1996, the Company
entered into a credit agreement (the Initial Credit Agreement) which provided a
revolving credit facility and a long-term note expiring in 2002. Interest on the
revolving credit facility and the long-term note was variable and payable at
periods ranging up to three months. The rate approximated 8.0% on the debt
outstanding. On August 19, 1996, the Company repaid its outstanding debt
obligations under the Initial Credit Agreement and recognized an extraordinary
loss on the early extinguishment of debt in the amount of $281.
On August 19, 1996, concurrent with the acquisition of P&S, the Company
entered into new credit agreements (the Credit Agreements) which provided for a
revolving credit facility expiring in 2003, a long-term note due in quarterly
installments through 2003, and a senior subordinated note due in a single
payment on the earlier of March 31, 2004 or 90 days after the final payment on
the revolving credit facility and the long-term note. Interest on the Credit
Agreements were due quarterly and had a weighted-average interest rate of 9.3%
on obligations outstanding at December 31, 1996. On July 31, 1997, the Company
repaid its outstanding debt obligations under the Credit Agreements and
recognized an extraordinary loss on the early extinguishment of debt of $1,409,
net of tax benefit of $948.
Senior Subordinated Notes
On July 31, 1997, the Company completed a private placement issuance of
$125.0 million in principal amount of 9.5% Senior Subordinated Notes due 2007
(the Offering). The Offering was made to qualified
F-15
38
SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. LONG-TERM DEBT (CONTINUED)
institutional buyers pursuant to Rule 144A of the Securities and Exchange
Commission (SEC). Proceeds from the Offering were used, along with the $30.0
million term note and a $33.8 million capital contribution from the Parent
Partnership to fund acquisitions (Note 4), refinance existing debt of $41,360,
and pay fees and expenses related to the Offering and the purchase of Acquired
Companies. In connection with the refinancing of debt, the Company recognized an
extraordinary loss of $1,409, net of tax benefit of $948.
The Senior Subordinated Notes (the Notes) mature on August 1, 2007.
Interest is payable semi-annually in arrears each February 1 and August 1,
commencing February 1, 1998. On or after August 1, 2002, the Notes may be
redeemed at the option of the Company, in whole or in part, at specified
redemption prices plus accrued and unpaid interest:
YEAR REDEMPTION PRICE
---- ----------------
2002........................................................ 105.0%
2003........................................................ 103.0%
2004........................................................ 102.0%
2005 and thereafter......................................... 100.0%
In addition, at any time on or prior to August 1, 2000, the Company may,
subject to certain requirements, redeem up to $40.0 million aggregate principal
amount of the Notes with the net cash proceeds of one or more public equity
offerings, at a price equal to 110.0% of the principal amount to be redeemed
plus accrued interest and unpaid interest. In the event of a change in control,
the Company 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 of the Company, subordinated in right of
payment to all existing and future senior debt and are guaranteed by the
Company's wholly-owned subsidiaries -- SIA, P&S, OSI, Tanner, and Mercer (the
Guarantor Subsidiaries). The Company's wholly-owned foreign subsidiaries are not
guarantors of the Notes (the Non-Guarantor Subsidiaries). Each of the Guarantor
Subsidiaries' guarantees of the Notes are full, unconditional, and joint and
several. The Company may incur additional indebtedness, including borrowings
under its Facility (see below), subject to certain limitations. See Note 19 for
financial information as of December 31, 1997, of the Guarantor and the
Non-Guarantor Subsidiaries.
The indenture under which the Notes were issued contains certain covenants
that, among other things, limit the Company from incurring other indebtedness,
engaging in transactions with affiliates, incurring liens, making certain
restricted payments (including dividends), and making certain asset sales. All
such covenants were met at December 31, 1997.
Term Loan
On August 5, 1997, the Company entered into an agreement providing for a
$30.0 million term loan (Term Loan) to fund the acquisition of businesses (Note
4). The Term Loan matures on August 5, 2004, and bears the same rate of interest
as the Facility described below. The interest rate was approximately 8.25% at
December 31, 1997. Twenty-five quarterly installments under the note are due
commencing September 30, 1998. The covenants on the Term Loan are the same as
the Facility described below. All covenants were met at December 31, 1997.
Revolving Credit Facilities
On August 5, 1997, the Company entered into an agreement providing for a
$30.0 million revolving credit facility (the Facility) available to the Company
for working capital purposes. Advances under the Facility may be made up to an
aggregate of $30.0 million including letters of credit of up to $10.0 million.
The Facility matures on August 5, 2004. The funds available to be advanced may
not exceed 85.0% and 75.0% of the
F-16
39
SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. LONG-TERM DEBT (CONTINUED)
Company's eligible domestic accounts receivable and eligible foreign accounts
receivable, respectively and 50.0% of the Company's eligible inventories, as
defined in the Credit Agreement. Amounts advanced are secured by the Company's
existing and future subsidiaries other than any subsidiary designated as an
unrestricted subsidiary. At December 31, 1997, the Company had outstanding
letters of credit of $900, and an unused portion of the Facility of $29.1
million.
At the Company's election, amounts outstanding under the Facility and the
Term Loan will bear interest at either the London Interbank Offered Rate
(LIBOR), plus 1.5% to 2.5% or the Alternate Base Rate (ABR), plus a 0.25% to
1.25%. The variable spread to LIBOR or ABR is determined by the Company's
leverage ratio as detailed in the Amended and Restated Credit Agreement. The ABR
rate is defined in the Amended and Restated Credit Agreement as the highest of:
(i) the federal funds rate plus 0.5%, (ii) the prime rate for such day, or (iii)
the certificate of deposit rate plus 1.0%. Interest is due quarterly and the
interest rate was approximately 8.25% at December 31, 1997.
The Company is required to pay, on a quarterly basis, a commitment fee
equal to 0.5% per annum. The Company is also obligated to pay: (i) a per annum
letter of credit fee equal to the applicable margin for LIBOR loans on the
aggregate amount of outstanding letters of credit; (ii) bank fees for letters of
credit issued of 0.25% per annum; and (iii) agent, arrangement, and other
similar fees.
The Facility and the Term Loan contains several covenants that, among other
things, restrict the ability of the Company and its subsidiaries to dispose of
assets, incur additional indebtedness, prepay or amend other indebtedness, pay
dividends, or make other changes in the business conducted by the Company or its
subsidiaries. In addition, the Facility requires that the Company comply with
specified ratios and tests, including a minimum interest coverage ratio, a
maximum leverage ratio, and a minimum net worth test. All such covenants were
met at December 31, 1997.
The Company's Singapore-based sales office has a facility providing for
borrowings up to SG $1.0 million and secured by a SG $1.0 million letter of
credit. Interest is payable at prime plus 1.0%. As of December 31, 1997, $593
was outstanding on the facility.
Annual Maturities
Annual maturities of the Company's long-term debt are as follows at
December 31, 1997:
1998........................................................ $ 2,400
1999........................................................ 4,800
2000........................................................ 4,800
2001........................................................ 4,800
2002........................................................ 4,800
2003 and thereafter......................................... 133,993
--------
$155,593
========
F-17
40
SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. INCOME TAXES
The components of the provision for income taxes (inclusive of tax benefits
on extraordinary losses), are as follows for the period from March 31, 1996
(date of inception) to December 31, 1996, and year ended December 31, 1997:
1996 1997
---- ----
Current income taxes:
State..................................................... $ 11 $ 98
Foreign................................................... 23 31
----- ----
34 129
Deferred income taxes....................................... (133) 238
----- ----
$ (99) $367
===== ====
The reconciliation of income tax expense computed at the U.S. federal
statutory tax rates to income tax expense is as follows for the period from
March 31, 1996 (date of inception) to December 31, 1996, and year ended December
31, 1997:
1996 1997
---- ----
Income taxes at federal statutory rate...................... $(43) $ 47
Income not subject to income taxes.......................... (61) (558)
State taxes, net of federal benefit......................... 2 181
Foreign income taxes........................................ 23 31
Increase in valuation allowance............................. -- 400
Goodwill.................................................... -- 281
Other....................................................... (20) (15)
---- -----
Income taxes at the effective rate.......................... $(99) $ 367
==== =====
Income not subject to income taxes represents income from the Parent
Partnership and SEA which, prior to the reorganization (Note 1), was taxed at
the partner/member level. Pro forma income taxes, as if the Company and its
subsidiaries were subject to income taxes for all periods presented, are
presented in the statement of operations.
F-18
41
SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. INCOME TAXES (CONTINUED)
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities are as follows:
DECEMBER 31
----------------
1996 1997
---- ----
Deferred tax assets:
Allowance for doubtful accounts........................... $ 67 $ 130
Inventory obsolescence reserve............................ 88 343
Inventory capitalization.................................. -- 123
Accrued liabilities....................................... 336 421
Write-off of deferred financing costs..................... -- 400
Net operating loss carryforwards.......................... 413 1,779
----- -------
904 3,196
Less: Valuation allowance................................... -- 400
----- -------
Deferred tax assets......................................... 904 2,796
Deferred tax liabilities:
Accelerated depreciation.................................. (165) (1,827)
Amortization of goodwill.................................. -- (234)
Refundable investment tax credits......................... (123) --
----- -------
Deferred tax liabilities.................................... (288) (2,061)
----- -------
Net deferred tax asset...................................... $ 616 $ 735
===== =======
The Company has net operating loss carryforwards of approximately $4.5
million which may be used to reduce future federal and state income taxes, which
expire through 2112.
11. RETIREMENT PLANS
The Company sponsors a defined benefit pension plan covering certain
salaried employees of a subsidiary of the Company. Employees vest in the plan
over a five-year period, and the plan is frozen to new participants.
Participants in the plan were given credit for prior years of service. Net
periodic pension cost is as follows for the period ended December 31:
1996 1997
---- ----
Service costs............................................... $37 $81
Interest cost............................................... -- 3
Actual return on plan assets................................ -- (3)
--- ---
Net periodic pension cost................................... $37 $81
=== ===
F-19
42
SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. RETIREMENT PLANS (CONTINUED)
The funded status of the plan, based on actuarial computations at September
30, 1996 and 1997, is presented below. An assumed discount rate of 7.5% and a
4.5% rate of increase in future compensation levels was used in determining the
actuarial present value of the projected benefit obligation.
DECEMBER 31
-----------
1996 1997
---- ----
Actuarial present value of accumulated benefit obligation:
Vested benefits........................................... $13 $ 75
Nonvested benefits........................................ 15 10
--- ----
Accumulated benefit obligation.............................. $28 $ 85
=== ====
Projected benefit obligation for services rendered to
date...................................................... $37 $135
Plan assets at fair value................................... -- 47
--- ----
Projected benefit obligation in excess of plan assets....... 37 88
Unrecognized net loss from past experience different from
that assumed.............................................. -- 13
--- ----
Accrued pension liability................................... $37 $ 75
=== ====
The Company has a pension plan covering all union employees of a
subsidiary. The Company's funding policy has been to contribute annually at
least the minimum required by ERISA. The Plan provides monthly benefits under a
benefit formula.
Net periodic pension cost is as follows for the period ended December 31:
1996 1997
---- ----
Service cost................................................ $ 5 $ 23
Interest cost............................................... 29 114
Actual return on plan assets................................ (19) (313)
---- -----
Net periodic pension cost (income).......................... $ 15 $(176)
==== =====
The funded status of the plan, based on actuarial computations at September
30, 1996 and 1997 is presented below. Plan assets are stated at fair value and
composed of fixed rate securities and equity investments. The average assumed
discount rate is 7.5%, and the average expected long-term rate of return on plan
assets is 10.0%.
DECEMBER 31
---------------
1996 1997
---- ----
Actuarial present value of accumulated benefit obligation:
Vested benefits........................................... $1,567 $1,593
Nonvested benefits........................................ 8 24
------ ------
Accumulated benefit obligation.............................. $1,575 $1,617
====== ======
Projected benefit obligation for services rendered to
date...................................................... $1,575 $1,617
Plan assets at fair value................................... 1,493 1,695
------ ------
Plan assets in excess of (less than) projected benefit
obligations............................................... 82 (78)
Unrecognized gain from past experience different from that
assumed................................................... -- 153
------ ------
Accrued pension liability................................... $ 82 $ 75
====== ======
F-20
43
SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. RETIREMENT PLANS (CONTINUED)
The Company sponsored several defined contribution plans (IRS qualified
401(k) plans). Participation in the plans is available to all salaried and
hourly employees of the company. Participating employees contribute to the
401(k) plans based on a percentage of their compensation which are matched,
based on a percentage of employee contributions by the Company. The Company
recorded expense of $139 and $600 for the periods ended December 31, 1996 and
1997, respectively.
12. MANAGEMENT INCENTIVE PLANS
The Company has implemented, through the Parent Partnership, certain
management incentive plans.
Stock Incentive Pool
The Parent Partnership adopted its Stock Incentive Pool in April 1996 in
order to provide incentives to employees and directors (including nonemployee
directors), the Company and its subsidiaries, by granting them ownership awards
in the form of Parent Partnership units and common stock of its general partner.
The Stock Incentive Pool awards are allocated by the Compensation Committee of
the Board of Directors of the Company. An award granted from the Stock Incentive
Pool is subject to five year time and performance vesting. The awards allow the
participant to purchase units in the Parent Partnership and common stock in its
general partner. For the year ended December 31, 1997, 734 units of the Parent
Partnership and 74 shares of common stock in the general partner were purchased
by participants in the Plan. The Company recognized compensation expense for the
excess of the fair market value of the units and common stock over the purchase
price in the amount of approximately $22 for the year ended December 31, 1997.
1997 Long-Term Incentive Plan
The Parent Partnership adopted its 1997 Long-Term Incentive Plan in May
1997 in order to provide long-term incentive awards to salaried employees
(excluding executives who participate directly in the Stock Incentive Pool).
Participants are granted a "participation share" in the incentive award pool
which consists of a portion of equity reserved for the program. At the time of a
qualified transaction as determined and defined by the Board of Directors, the
value of the pool is allocated to participants based upon their "participation
share". Payment may be in the form of stock options, stock, cash, or a
combination of these elements, as determined by the Board of Directors.
"Participation shares" are not vested until earned and paid out. If a
participant leaves the Company before a qualified transaction has occurred,
their "participation share" is forfeited. Individuals joining the Company during
the plan cycle, may be permitted to participate in the program at the discretion
of the Chief Executive Officer and Board of Directors. The Compensation
Committee of the Board of Directors will administer the plan and have the
authority and responsibility to approve award levels and make any changes in
plan concept and design. At December 31, 1996 and 1997, no grants were awarded
under the plan.
13. CAPITAL LEASES
Property under capital leases included within property, plant, and
equipment are as follows:
DECEMBER 31
-------------------
1996 1997
---- ----
Buildings.................................................. $3,681 $1,912
Machinery and equipment.................................... 343 208
------ ------
4,024 2,120
Less: Accumulated depreciation............................. 1,719 215
------ ------
$2,305 $1,905
====== ======
F-21
44
SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
13. CAPITAL LEASES (CONTINUED)
Future minimum lease payments under capital leases at December 31, 1997,
together with the present value of the minimum lease payments are as follows:
1998........................................................ $ 611
1999........................................................ 634
2000........................................................ 621
2001........................................................ 621
2002........................................................ 676
Thereafter.................................................. 3,964
------
Total minimum payments...................................... 7,127
Less: Amounts representing interest......................... 3,443
------
Present value of minimum payments........................... 3,684
Less: Current portion....................................... 120
------
Total long-term portion..................................... $3,564
======
14. OPERATING LEASES
The Company has entered into operating leases for buildings and machinery
and equipment, which expire on various dates through 2004. Rent expense for all
operating leases approximated $39 and $351 for the periods ended December 31,
1996 and 1997, respectively. Future minimum lease payments under noncancelable
operating leases with terms in excess of one year are as follows:
1998........................................................ $ 816
1999........................................................ 751
2000........................................................ 476
2001........................................................ 317
2002........................................................ 82
2003 and thereafter......................................... 74
------
$2,516
======
15. ENVIRONMENTAL MATTERS
The Company is subject to various federal, state, local, and foreign
environmental laws and regulations pertaining to the discharge of materials into
the environment, the handling and disposal of solid and hazardous wastes, the
remediation of contamination, and otherwise relation to health, safety, and
protection of the environment. These laws and regulations provide for
substantial fines and criminal sanctions for violations and impose liability for
the costs of cleaning up, and for certain damages resulting from past spills,
disposals, or other releases of hazardous substances. In connection with the
acquisition of businesses, the Company has conducted substantial investigations
to assess potential environmental liabilities. The investigations, performed by
independent consultants of all facilities, found that certain facilities have
had or may have had releases of hazardous materials that may require
remediation. In addition, the facilities may be subject to potential liabilities
for contamination from off-site disposal of substances or wastes.
Certain subsidiaries have been named as potentially responsible parties
under the Comprehensive Environment Response, Compensation, and Liability Act
(CERCLA) and/or similar environmental laws for cleanup of multiparty waste
disposal sites. The Company is entitled to indemnification by previous owners of
certain acquired businesses, and the Company has negotiated contractual
indemnifications, which,
F-22
45
SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
15. ENVIRONMENTAL MATTERS (CONTINUED)
supplemented by commercial insurance coverage designed for each acquisition, is
currently expected to adequately address a substantial portion of known and
foreseeable environmental liabilities. At December 31, 1997, the Company had
established accrued liabilities relating to environmental matters of
approximately $3.0 million. The liabilities are included in the balance sheet as
"other long-term liabilities" and "other current liabilities". The Company does
not currently believe that potential additional expenses for environmental
liabilities will have a material adverse effect on the financial condition or
results of operations of the Company.
16. CONCENTRATIONS OF CREDIT RISK
No customer accounted for more than 10.0% of the Company's accounts
receivables nor sales for the years ended December 31, 1996 and 1997. The
Company estimates an allowance for doubtful accounts based on the
creditworthiness of its customers as well as general economic conditions.
Consequently, an adverse change in those factors could affect the Company's
estimate of its bad debt.
17. SUPPLEMENTAL CASH FLOW INFORMATION
The following table provides supplemental cash flow data in addition to the
information provided in the consolidated statements of cash flows for the period
from March 31, 1996 (date of inception) to December 31, 1996, and for the year
ended December 31, 1997:
1996 1997
---- ----
Cash paid for:
Interest................................................. $1,291 $3,536
Income taxes............................................. 20 302
18. SUBSEQUENT EVENT
Effective April 21, 1998, the Company consummated a stock purchase
agreement for the sale of Mercer to Burke Industries, Inc. Net proceeds from the
sale were approximately $35.9 million (sales price of $36.2 million less selling
expenses of $300).
F-23
46
SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
19. 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 be
material to investors. The financial statement data as of December 31, 1997 of
the Guarantor Subsidiaries and the Non-Guarantor Subsidiaries are below. The
financial statement data of the Guarantor Subsidiaries include SIA, P&S, OSI,
and Tanner under the caption "the Company." The financial data of Mercer, a
Guarantor Subsidiary, has been presented separately as Mercer was sold on April
21, 1998 (Note 18).
GUARANTOR SUBSIDIARIES
----------------------- NON-GUARANTOR
THE COMPANY MERCER SUBSIDIARIES TOTAL
------------ -------- ------------- --------
STATEMENT OF OPERATIONS DATA:
Net sales....................................... $119,951 $ 9,945 $4,875 $134,771
Cost of goods sold.............................. 82,608 6,921 3,360 92,889
-------- ------- ------ --------
Gross profit.................................... 37,343 3,024 1,515 41,882
Selling, general, and administrative expenses... 26,692 1,899 1,540 30,131
-------- ------- ------ --------
Operating income (loss)......................... 10,651 1,125 (25) 11,751
Foreign exchange loss........................... -- -- 163 163
Interest expense................................ 7,858 1,117 105 9,080
-------- ------- ------ --------
Income (loss) before income taxes and
extraordinary losses.......................... $ 2,793 $ 8 $ (293) $ 2,508
======== ======= ====== ========
BALANCE SHEET DATA:
Assets:
Current assets.................................. $ 50,235 $ 6,761 $2,766 $ 59,762
Property, plant and equipment, net.............. 42,772 4,952 584 48,308
Goodwill, net................................... 98,368 24,809 -- 123,177
Deferred financing costs, net................... 9,295 1,842 -- 11,137
Other assets.................................... 261 -- 114 375
-------- ------- ------ --------
Total assets.................................... $200,931 $38,364 $3,464 $242,759
======== ======= ====== ========
Liabilities and stockholder's equity:
Current liabilities............................. $ 24,996 $ 2,082 $2,473 $ 29,551
Long-term liabilities........................... 129,038 30,175 1,942 161,155
Total stockholder's equity...................... 46,897 6,107 (951) 52,053
-------- ------- ------ --------
Total liabilities and stockholder's equity...... $200,931 $38,364 $3,464 $242,759
======== ======= ====== ========
F-24
47
SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
GUARANTOR SUBSIDIARIES
----------------------- NON-GUARANTOR
THE COMPANY MERCER SUBSIDIARIES TOTAL
------------ -------- ------------- --------
STATEMENT OF CASH FLOWS DATA
OPERATING ACTIVITIES
Net income (loss)............................... $ 75 $ 2 $ (293) $ (216)
Adjustments to reconcile net income (loss) to
net cash provided by (used in) operating
activities
Depreciation and amortization................. 5,323 699 27 6,049
Deferred income taxes......................... 72 166 -- 238
Minority interests............................ 50 -- -- 50
Amortization of deferred financing costs...... 651 -- -- 651
Extraordinary losses.......................... 1,409 -- -- 1,409
Changes in operating assets and liabilities
(net of effect of acquired companies)...... (1,301) (391) (103) (1,795)
-------- ------- ------ --------
Net cash provided by (used in) operating
activities.................................... 6,279 476 (369) 6,386
INVESTING ACTIVITIES
Acquisition of businesses (net of acquired
cash)......................................... (133,338) -- -- (133,338)
Purchase of property, plant, and equipment...... (1,429) (37) (368) (1,834)
-------- ------- ------ --------
Net cash used in investing activities........... (134,767) (37) (368) (135,172)
FINANCING ACTIVITIES
Capital contributions........................... 33,800 -- -- 33,800
Proceeds from revolving credit facility......... -- -- 593 593
Payments on revolving credit facility........... -- -- -- --
Proceeds from issuance of long-term debt........ 155,000 -- -- 155,000
Deferred financing costs........................ (12,672) -- -- (12,672)
Payments on long-term debt...................... (41,360) -- -- (41,360)
Payments on capital lease obligations........... (270) -- -- (270)
Distributions................................... -- -- -- --
-------- ------- ------ --------
Net cash provided by financings activities...... 134,498 -- 593 135,091
Effect of exchange rate changes on cash......... -- -- 4 4
-------- ------- ------ --------
Net increase (decrease) in cash and cash
equivalents................................... 6,010 439 (140) 6,309
Cash and cash equivalents at beginning of
period........................................ (288) 62 330 104
Cash and cash equivalents at end of period...... $ 5,722 $ 501 $ 190 $ 6,413
======== ======= ====== ========
Supplemental cash flow information:
Cash paid for:
Interest................................... $ 2,890 $ 646 $ -- $ 3,536
Income taxes............................... 302 -- -- 302
F-25
48
REPORT OF INDEPENDENT AUDITORS
The Holder of Equity Interest
Adhesives Systems Division of The BFGoodrich Company
We have audited the accompanying statements of divisional operations and
division equity and cash flows of Adhesives Systems Division (a division of The
BFGoodrich Company) for the year ended December 31, 1995 and the three months
ended March 31, 1996. These financial statements are the responsibility of the
Division'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, the financial statements referred to above present fairly,
in all material respects, the results of its divisional operations and division
equity and its cash flows of Adhesives Systems Division (a division of The
BFGoodrich Company) for the year ended December 31, 1995 and the three months
ended March 31, 1996, in conformity with generally accepted accounting
principles.
ERNST & YOUNG LLP
Chicago, Illinois
June 19, 1997
F-26
49
ADHESIVES SYSTEMS DIVISION
(A Division of The BFGoodrich Company)
STATEMENTS OF DIVISIONAL OPERATIONS AND DIVISION EQUITY
YEAR ENDED DECEMBER 31, 1995
AND THE THREE MONTHS ENDED MARCH 31, 1996
(dollars in thousands)
THREE
YEAR MONTHS
ENDED ENDED
DECEMBER 31, MARCH 31,
1995 1996
------------ ---------
Net sales................................................... $21,129 $5,410
Cost of goods sold.......................................... 13,734 3,580
------- ------
Gross profit.............................................. 7,395 1,830
Selling, general, and administrative expenses............... 5,633 1,603
------- ------
Income before income taxes................................ 1,762 227
Income tax expense.......................................... 705 91
------- ------
Net income................................................ 1,057 136
Division equity -- Beginning of year........................ 5,956 7,013
------- ------
Division equity -- End of year.............................. $ 7,013 $7,149
======= ======
See accompanying notes.
F-27
50
ADHESIVES SYSTEMS DIVISION
(A Division of The BFGoodrich Company)
STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31, 1995
AND THE THREE MONTHS ENDED MARCH 31, 1996
(dollars in thousands)
THREE
YEAR MONTHS
ENDED ENDED
DECEMBER 31, MARCH 31,
1995 1996
------------ ---------
Operating activities:
Net income................................................ $ 1,057 $ 136
Adjustments to reconcile net income to net cash provided
by (used in) operating activities:
Depreciation........................................... 790 163
Amortization........................................... 111 28
Loss on sale/disposal of equipment..................... 117 --
Changes in operating assets and liabilities:
Accounts receivable.................................. (480) (265)
Inventories.......................................... 428 1
Prepaid expenses and other current assets............ 24 (26)
Other assets......................................... 3 12
Accounts payable and accrued expenses................ (27) (115)
Accrued liabilities.................................. (584) 13
------- -----
Net cash provided by (used in) operating activities......... 1,449 (53)
Investing activities:
Purchases of property, plant, and equipment............... (106) (131)
Proceeds from the sale of equipment....................... -- --
------- -----
Net cash used in investing activities....................... (106) (131)
Financing activities:
Net transfer (to) from The BFGoodrich Company............. (1,333) 184
------- -----
Net cash provided by (used in) investing activities......... (1,333) 184
------- -----
Change in cash.............................................. -- --
Cash at beginning of year................................... 1 1
------- -----
Cash at end of year......................................... $ 1 $ 1
======= =====
See accompanying notes.
F-28
51
ADHESIVES SYSTEMS DIVISION
(A Division of The BFGoodrich Company)
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1995 AND MARCH 31, 1996
(dollars in thousands)
1. DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION
Adhesives Systems Division (the Division) was a division of The BFGoodrich
Company (Parent Company or BFG) and was engaged primarily in the development and
production of liquid and film adhesives used in the automotive, aerospace, and
industrial markets sold primarily in the United States.
These financial statements present the results of operations of the
Division. Costs related to functions performed by BFG and certain other costs
which are attributable to the Division are allocated to the Division by BFG.
Refer to Note 4 for costs related to these functions performed by BFG.
The Division was part of a consolidated group and as such has significant
transactions with related entities. The terms of these transactions were
determined between related parties and may, therefore, differ from terms which
would have occurred between wholly unrelated parties and may also differ from
the costs which would have been incurred had the Division operated as a
completely autonomous entity.
The income and expenses shown on the Division's financial statements are
only part of those of a larger entity and are not subject to the constraints of
law and custom applicable entities.
2. ACCOUNTING POLICIES
Income Taxes
The Division is not a legal entity and, therefore, does not file income tax
returns. However, the Division's income was included in the federal and state
income tax returns of BFG. Federal and state income taxes for the year ended
December 31, 1995 and for the three months ended March 31, 1996 are recorded
based upon an estimated effective rate of 40% of financial reporting. Deferred
income taxes, based upon the net tax effects of temporary differences between
the carrying amounts of assets and liabilities for financial reporting purposes
and the amounts used for income tax purposes, are not reflected in the financial
statements due to, in the opinion of management, the amounts not being
significant. Management believes that the effective tax rate of 40%
appropriately approximates the current and deferred tax position of the Division
on a stand-alone basis.
Revenue Recognition
Sales are recorded when products are shipped.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management of the Division to make
estimates and assumptions that affect the reported amounts. Actual results could
differ from those estimates.
Research and Development
Research and development costs are charged to expense as incurred. Research
and development expense for the year ended December 31, 1995 and for the three
months ended March 31, 1996 was approximately $64 and $18, respectively.
3. CORPORATE ALLOCATION OF EXPENSES
Certain expenses related to employee benefits and administrative costs, tax
and legal services, among others, for the year ended December 31, 1995 and for
the three months ended March 31, 1996, were paid by
F-29
52
ADHESIVES SYSTEMS DIVISION
(A Division of The BFGoodrich Company)
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
BFG on behalf of the Division. These expenses were allocated to the Division by
BFG based on estimates of the Division's proportionate share of total common
expenses. The allocations were $958 and $461 for the year ended December 31,
1995 and for the three months ended March 31, 1996, respectively. Management
believes that the allocation methods used on common expenses were reasonable,
produce materially accurate results, and are indicative of the expenses that
would have been incurred had the Division been operated as a stand-alone
business.
4. RELATED PARTY TRANSACTIONS
The Division has entered into various intercompany transactions with BFG
and related affiliates. Net sales to these affiliates were approximately $381
and $53 for the year ended December 31, 1995 and for the three months ended
March 31, 1996, respectively.
5. EMPLOYEE BENEFITS
Medical Expenses
Medical coverage is provided by BFG to the Division's employees. Medical
expenses and claims experience of the Division and related affiliates are pooled
together and allocated to the Division based on estimates of the Division's
proportionate share of total medical expenses. For the year ended December 31,
1995 and for the three months ended March 31, 1996, medical expenses included in
selling, general, and administrative expenses, were approximately $608 and $104,
respectively.
Pension Plan
Substantially all salaried and hourly employees of the Division were
participants in BFG's defined benefit pension plan. BFG allocates pension costs
to the Division based on actuarial valuations. For the year ended December 31,
1995 and for the three months ended March 31, 1996, pension plan expenses
included in cost of goods sold and selling, general, and administrative expenses
were approximately $422 and $110, respectively.
Savings Plan
The Division participates in a BFG defined contribution savings plan which
covers most salaried and hourly employees of the Division. For the year ended
December 31, 1995 and for the three months ended March 31, 1996, Division
contributions under the plan included in cost of goods sold and selling general
and administrative expenses were approximately $183 and $45, respectively.
Other Postretirement Benefit Plans
The Division's employees participated in a BFG defined benefit
postretirement plan that provides certain health care and life insurance
benefits to eligible employees. The health care plan is contributory, with
retiree contributions adjusted periodically, and contains other cost sharing
features, such as deductibles and coinsurance. The life insurance plan is
generally noncontributory. For the year ended December 31, 1995 and for the
three months ended March 31, 1996, allocated net periodic postretirement benefit
expenses, included in corporate allocations in the statement of operation were
approximately $543 and $184, respectively.
6. OPERATING LEASES
The Division leases certain equipment and automobiles under noncancelable
equipment and automobile lease agreements. Rent expense was $38 and $11 for the
year ended December 31, 1995 and for the three
F-30
53
ADHESIVES SYSTEMS DIVISION
(A Division of The BFGoodrich Company)
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
months ended March 31, 1996. Future minimum annual lease payments under
operating leases with initial noncancelable terms extending beyond one year are
as follows:
1996........................................................ $ 39
1997........................................................ 30
1998........................................................ 27
1999........................................................ 14
2001........................................................ 1
----
$111
====
F-31
54
ANNUAL REPORT ON FORM 10-K
ITEMS 14(A) AND 14(C)
EXHIBIT INDEX
SEQUENTIALLY
EXHIBIT NUMBERED
NUMBER DESCRIPTION PAGE
- ------- ----------- ------------
3.1 Certificate of Incorporation of the Company
3.2 By-Laws of the Company
4.1 Indenture dated August 1, 1997 among the Company, the
Guarantors and the Bank of New York as trustee
4.2 Forms of 9 1/2% Senior Subordinated Notes due 2007, Series A
(included in Exhibit 4.1)
4.3 Form of Guarantee (included in Exhibit 4.1)
4.4 Registration Rights Agreement dated August 5, 1997 among the
Company, the Guarantors, Chase Securities, Inc. and
Donaldson, Lufkin & Jenrette Securities Corporation
4.5 Amended and Restated Credit Agreement, dated August 5, 1997
among the Company, the Guarantors and the Chase Manhattan
Bank, as administrative agent
10.1 Employment Agreement, dated March 31, 1996 among the Parent
Partnership, Sovereign Specialty Chemicals, Inc. and Robert
B. Covalt
10.2 Promissory Note, dated July 31, 1997, issued by Robert B.
Covalt to the Parent Partnership
10.3 Employment Agreement, dated March 31, 1996 among the Parent
Partnership, Sovereign Specialty Chemicals, Inc. and William
T. Schram
10.4 Promissory Note, dated July 31, 1997, issued by William T.
Schram to the Parent Partnership
10.5 Promissory Note, dated July 31, 1997, issued by William T.
Schram to the Parent Partnership
10.6 Employment Agreement, dated August 19, 1996 between John H.
Edholm and Pierce & Stevens
10.7 Employment Agreement, dated March 31, 1996 between SIA
Adhesives and Gerard A. Loftus
10.8 Employment Agreement, dated August 19, 1996 between Richard
W. Johnston and Pierce & Stevens
10.9 Consulting Agreement, dated October 1, 1996 between the
Parent Partnership and Neal G. Reddeman
10.10 Letter Agreements, dated September 8, 1997, February 17,
1997 and October 25, 1996 between the Parent Partnership and
Garnett Consulting
10.11 Assignment and Assumption Agreement dated July 31, 1997
among the Parent Partnership, Sovereign Chemicals
Corporation and the Company
10.12 1997 Management Incentive Plan
10.13 1997 Incentive Bonus Plan
10.14 Asset Purchase Agreement dated March 31, 1996 among The
BFGoodrich Company, Sovereign Engineered Adhesives, L.L.C.
and the Parent Partnership*
E-1
55
EXHIBIT INDEX
SEQUENTIALLY
EXHIBIT NUMBERED
NUMBER DESCRIPTION PAGE
- ------- ----------- ------------
10.15 Purchase Agreement, dated August 19, 1996 among The
Sherwin-Williams Company, Pierce & Stevens Canada, Inc., the
Parent Partnership and P&S Holdings, Inc.*
10.16 Stock Purchase Agreement dated May 22, 1997 between Laporte
Inc. and the Parent Partnership*
10.17 Closing Agreement dated August 5, 1997 between Laporte Inc.,
the Parent Partnership and the Company
10.18 Employment Agreement, dated January 5, 1998 among the Parent
Partnership, Sovereign Specialty Chemicals, Inc. and Lowell
D. Johnson
21.1 Subsidiaries of the Company
24 Power of Attorney
- -------------------------
* The Company agrees to furnish supplementally to the Commission a copy of any
omitted schedule to such agreement upon the request of the Commission in
accordance with Item 601(b)(2) of Regulation S-K.
E-2
56
SOVEREIGN SPECIALTY CHEMICALS, INC.
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
ADDITIONS
BALANCE AT -----------------------
BEGINNING CHARGED TO CHARGED TO
OF COSTS AND OTHER BALANCE AT END
PERIOD EXPENSES ACCOUNTS DEDUCTIONS OF PERIOD
---------- ---------- ---------- ---------- --------------
The Predecessor:
Year ended December 31, 1995
Reserve and allowances deducted from
asset accounts:
Allowance for uncollectible
accounts....................... $115 $ (6) $ -- $ 13(1) $ 96
Reserve for inventory
obsolescence................... 126 -- -- 59 67
Three months ended March 31, 1996:
Reserve and allowances deducted from
asset accounts:
Allowance for uncollectible
accounts....................... 96 34 -- 9(1) 121
Reserve for inventory
obsolescence................... 67 9 -- -- 76
The Company:
Nine months ended December 31, 1996:
Reserve and allowances deducted from
asset accounts:
Allowance for uncollectible
accounts....................... 94(2) 156 258(2) 184(1) 324
Reserve for inventory
obsolescence................... 74(2) 11 237(2) 29(1) 293
Year ended December 31, 1997
Reserve and allowances deducted from
asset accounts:
Allowance for uncollectible
accounts....................... 324 857 526(1) 655
Reserve for inventory
obsolescence................... 293 244 732 110(1) 1,159
- -------------------------
(1) Accounts written off, net of recoveries.
(2) Balances added through new acquisitions.
S-1