SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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Form 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2003
Or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
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Sovereign Specialty Chemicals, Inc.
(Exact name of registrant as specified in its charter)
Delaware 36-4176637
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
225 West Washington Street, Suite 1450
Chicago, IL 60606
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (312) 223-7970
Registrant's website address : www.sovereignsc.com
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 [X] No [ ]
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. [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [ ] No [X]
The common stock of the registrant is not publicly traded. Therefore, the
aggregate market value of the common stock of the registrant is not readily
available. On February 26, 2004, the registrant had 1,441,189 shares of voting
common stock outstanding and 730,182 shares of non-voting common stock
outstanding. Approximately 75% of the voting common stock and of the non-voting
common stock of the registrant is held by an affiliate of the registrant.
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
TABLE OF CONTENTS
Page
Item 1. Business 1
Item 2. Properties 8
Item 3. Legal Proceedings 9
Item 4. Submission of Matters to a Vote of Security Holders 9
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters 9
Item 6. Selected Financial Data 10
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations 11
Item 7A. Quantitative and Qualitative Disclosures About Market
Risk 21
Item 8. Financial Statements and Supplemental Data 22
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure 22
Item Controls and Procedures
9A.
Item 10. Directors and Executive Officers of the Registrant 23
Item 11. Executive Compensation 25
Item 12. Security Ownership of Certain Beneficial Owners and
Management 31
Item 13. Certain Relationships and Related Transactions 32
Item 14. Principal Accounting Fees and Services 33
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form
8-K 34
Signatures 35
Supplemental Information to be Furnished With Reports Filed
Pursuant to Section 15(d) of the Act by Registrants Which
Have Not Registered Securities Pursuant to Section 12 of the
Act 36
FORWARD-LOOKING STATEMENTS
Some of the information presented in, or connection with, this report
include "forward-looking statements" based on our current expectations and
projections about future events and involve potential risks and uncertainties.
Our future results could differ materially from those discussed in this report.
You should not place undue reliance on these forward-looking statements,
which are applicable only as of February 27, 2004. All written and oral
forward-looking statements attributable to us are expressly qualified in their
entirety by the factors discussed under "Item 7. Management's Discussion and
Analysis of Financial Conditions and Results" and those identified in Exhibit
99.1 to this report. We undertake no obligation to revise or update our
forward-looking statements to reflect events or circumstances that arise after
February 27, 2004 or to reflect the occurrence of unanticipated events. New
risks emerge from time to time and it is not possible for us to predict all such
risks, nor can we assess the impact of all such risks on our business or the
extent to which any risks, or combination of risks, may cause actual results to
differ materially from those contained in any forward-looking statement.
PART I
Item 1. Business
We are a leading developer and supplier of high performance specialty
adhesives, sealants and coatings for use in three primary end markets: packaging
and converting; industrial and construction. We operate in the highly fragmented
adhesives, sealants and coatings segment of the specialty chemicals industry. We
focus on select value-added market niches in which we have established
leadership positions and competitive advantages in product development,
manufacturing and distribution. An growth oriented company, we are strategically
positioned to swiftly respond to customers' emerging needs and to fully leverage
the depth and breath of our operations, technologies, best practices and
expertise. We frequently design our products in cooperation with our customers
to meet unique specifications and to provide critical performance attributes to
their products, resulting in a significant number of long-lived primary supplier
relationships.
We are headquartered in Chicago, Illinois, and supported by operations
worldwide. Our executive office is located at 225 West Washington Street, Suite
1450, Chicago, Illinois, and our office number is 312-223-7970. We provide a
link to all of our SEC filings and press releases via our website address of
www. Sovereignsc.com. We are the largest privately owned adhesives manufacturer
in the United States and among the largest adhesives manufacturer in the world,
private or public. We were founded as a partnership in 1995, were incorporated
in 1997, and in 1999, 75% of our common stock was acquired by SSCI Investors
LLC. We have successfully expanded our business through the integration of ten
strategic acquisitions. Currently, our business is comprised of a Commercial
segment and a Construction segment. Our Commercial segment (approximately 63% of
2003 net sales) serves a range of industrial markets, including high-performance
specialty adhesives and coatings for transportation, furniture and product
assembly applications, flame retardant specialties and specialty polymers. Our
Commercial segment also manufactures coating and adhesive products for
packaging, paper converting and graphic arts applications. Our Construction
segment (approximately 37% of 2003 net sales) manufactures branded caulk,
sealants and adhesives which serve the following markets: distributors for
professional contractors, Original Equipment Manufacturers (OEM), Co-Op
distributors and do-it-yourself retailers. We plan to continue our growth
through a combination of strong customer focus and focus on key product areas,
new product development, leveraging technology throughout the organization,
continued market penetration, international expansion and efficiencies in
spending.
Developments
During 2003, we made significant strategic progress in key areas by
completing and initiating aggressive actions in a number of areas. We completed
the reorganization of our sales force and approach toward our key product
markets served by the Commercial segment. We consolidated research and
development and business unit management in our Commercial segment, to allow for
better focus on capturing business development opportunities. We have increased
productivity through continued manufacturing actions, including the completion
of lean manufacturing implementation at most of our facilities, continued
improved warehouse logistics and further product line rationalization where
necessary. Cost containment, especially in the area of outside professional
services, was and continues to be a significant management focus. We continue to
make significant progress on business processes standardization to reduce
internal and external complexity. We have also refocused the sales and research
and development effort and strategy within our Commercial segment to better
align resources toward growth markets.
We have continued our focus on working capital improvement both in dollars
and as a percent of net sales, debt reduction and improved liquidity to allow us
to continue improving our core business through productivity and internal growth
initiatives. During 2003, we reduced total debt by approximately $13.0 million
from year end 2002 (net debt by approximately $7.0 million. We reduced year end
working capital levels by approximately $9.0 million year over year and
maintained a lower average operating working capital throughout 2003 while
supporting increased sales volumes over the prior year.
In 2003, we completed the closure of our Cincinnati, Ohio and Kapellen,
Belgium facilities, two of our higher-cost manufacturing plants. The Cincinnati,
Ohio facility primarily produced water-borne industrial adhesives. Production
from this plant was transferred to Sovereign's plants in Greenville, South
Carolina, and Carol Stream and Plainfield, Illinois in 2003. Significant
portions of technical, sales support, customer service, and administrative
functions were transitioned to other locations during 2003. The Kapellen,
Belgium plant produced water-borne and hot-melt adhesives for the European
packaging and converting market. This production was shifted to the Newark,
United Kingdom plant during the first half of 2003. The Kapellen facility
continues to provide sales, technical and distribution support to continental
Europe.
We were impacted by the continued challenging industrial market conditions
for much of 2003, primarily in terms of demand for products we provide in the
Commercial segment and in raw material costs increases for much of the first
half of the year which impacted both segments. Our Commercial segment financial
performance fell short of management's expectations in large part due to the
end-market demand being down in many of the applications sold through our
Commercial segment through much of the year. After posting some modest gains in
2002 and early 2003, industrial production showed signs of some sustainable
improvement in the second half of 2003 which began to have a positive impact on
sales in the Commercial segment in late 2003. Construction segment sales
performance continued to be strong, aided by stable housing market and gains in
the retail do-it-yourself market.
1
We believe that our ongoing initiatives, together with the actions we have
taken in the last fifteen to eighteen months have positioned us to continue our
goal of top-line growth driven by the leveraging of technologies and utilizing
existing customer relationships to create customers for other products in the
our portfolio.
Competition and the Industry
We face a variety of competitors in each of the business segments in which
we operate, but we believe that no single company competes with us across all of
our existing product lines. The adhesives, sealants and coatings segment of the
specialty chemicals industry is a large, global segment which has historically
exhibited stable growth and remains highly competitive and fragmented and its
participants offer a broad array of product lines and categories, representing
many different products designed to meet specific customer requirements. Our
competitors include Ciba Specialty Chemicals, Cytec Industries Inc., GE Sealants
and Adhesives (a unit of General Electric Company), H.B. Fuller Company,
Imperial Chemical Industries Plc., Omnova, Rohm & Haas Co. and RPM Incorporated.
Competition is on a global, regional and local level and is based on product
quality, technical service for specialized customer requirements, breadth of
product line, brand name recognition and price. Some of our competitors are
larger, have greater financial resources and are less leveraged than we are. As
a result, these competitors may be better able to withstand a change in market
conditions within the specialty chemical industry and throughout the economy as
a whole. These competitors may also be able to maintain significantly greater
operating and financial flexibility than we can.
We believe we have the following competitive strengths:
Leadership Positions in Attractive Markets. We enjoy leadership positions in
growing markets as a result of our customer-driven product development,
reputation for quality, high levels of customer service and brand name
recognition. Our brand and trade names are particularly well recognized among
our customers, and include OSI(R), Pro-Series(R), PL(R), Polyseamseal(R),
Miracure(R), Plastilock(R), Latiseal(TM), Dualite(R), Hybond(R), Proxseal(TM),
Primaseal(TM), Primalam(TM), Avadyne(TM), Bondrite(TM), NailPower(TM) and
Proxmelt(TM). We believe our leadership positions, technological expertise and
strong customer relationships provide us with meaningful advantages in the
development of new products and the penetration of new markets.
Technological Expertise. We are a technology leader within many of the
markets we serve. Our current technology portfolio, comprising numerous
customized and proprietary formulations with unique performance characteristics,
provides us with a broad technological base to satisfy our customers'
requirements. We continually leverage our technological expertise to develop new
products and additional applications for existing product formulations. In
addition, we have enhanced our technological expertise both through cooperative
research and development efforts and joint technological alliances with
world-class suppliers, and customers.
Strong Customer Relationships. Our business teams work hand-in-hand with our
customers to develop innovative, high-performance solutions to satisfy current
and future needs. By directly involving customers in the product development
process, we strengthen our relationships with them and are better able to
develop products that will add value to their businesses. We sell our products
to some of the world's largest companies, including Airbus Industries, Baxter
International Inc., Bemis, Boeing, General Motors Corporation, The Home Depot,
Inc., International Paper Company, Johns Manville Corporation, Lowe's Companies,
Inc., Milliken and RR Donnelly & Sons Company. Many of our transportation
adhesives and coatings, and folding carton adhesives and coatings have been
certified through rigorous, customer-specific technical and regulatory approval
processes, which provides a disincentive to customers to switch to another
supplier because of the significant costs involved. Our relationships with
retailers and professional distributors of our housing repair, remodeling and
construction products are strengthened by our broad product line, strong brands
and reputation for quality.
Broad Product Offerings and Diverse Customer Base. We manufacture over 5,000
products that are sold through multiple distribution channels to over 5,000
customers for a wide variety of applications. In 2003, no single customer
accounted for over 4.5% of our sales, and our top 20 customers accounted for
less than 25% of our sales. This diversity of customers, products and
distribution channels provides us with a broad base from which to increase sales
and expand customer relationships, and limits our exposure to any particular
customer, end market or geographic region.
2
Business Strategy
Continued Focus on Attractive Growth Markets. We will continue to develop
product offerings for value-added, end-use applications with attractive growth
prospects, including
-- structural adhesives;
-- furniture distribution;
-- product assembly applications, including recreational vehicle panel
lamination (RV), roofing and pressure sensitive adhesives (PSA's);
-- food and medical packaging adhesives and coatings; and
-- environmentally friendly products.
Accelerate New Product Pipeline. We deploy our research and development
resources to align with the most promising growth opportunities. We assign
technical experts by chemistry and market to leverage our broad product
portfolio. We continue the efforts to shorten the time it takes to bring new
products to our customers.
Continued Focus on Cash Flow Improvements. We continue to target working
capital improvement where possible through improved accounts receivable
collection, optimization of inventory management, consolidation of warehouses
and rationalization of product lines.
Continue to Work Toward Significant Operating Efficiencies. We believe we
can continue to achieve operating efficiencies resulting in enhanced
performance, cost savings and improved cash flow through:
-- improving manufacturing and distribution operations, through maintenance
of lean manufacturing initiatives and recently announced facility
rationalizations;
-- lowering working capital levels by optimizing SKU counts, better
management of inventory and improving customer receivable collections;
and
-- improving freight logistics to lower our costs.
Increase International Presence. We believe we have significant
opportunities in international markets to increase sales to existing
multinational customers, enter developing markets and establish new customer
relationships. In addition, international sales are expected to benefit from the
increased use of adhesives, sealants and coatings in developing markets. We have
expanded our global sales, particularly in Europe and Latin America complemented
by our manufacturing operations in the United Kingdom (U.K.), Mexico and Brazil.
We closed the Belgium facility in 2003 in order to consolidate production and
reduce costs. In addition, we have sales and technical offices in the U.K.,
Brazil, Mexico Italy, Canada, Sweden, France, Switzerland and Singapore. The
principal office for our European operation is in the U.K.
Pursue Strategic Acquisitions. We have successfully grown through effective
integration of acquisitions and, although our near term strategy revolves around
optimizing our existing resources, our long-term strategy will be to continue to
pursue strategic acquisitions that will allow us to further increase sales in
targeted markets. Potential acquisition candidates will be evaluated based upon
our ability to expand existing product lines and customer relationships ,
enhance our product development capabilities, market products through new or
expanded distribution channels, increase utilization of available manufacturing
capacity , generate cost savings, augment our technology portfolio and/or open
new market opportunities.
3
Segment Reporting
We have two reportable segments: the Commercial segment and the Construction
segment.
Commercial Segment:
Our Commercial segment (approximately 63% of 2003 net sales) serves a range of
industrial markets, including high-performance specialty adhesives and coatings
for transportation, furniture and product assembly applications, flame retardant
specialties and specialty polymers. Our Commercial segment also manufactures
coating and adhesive products for packaging, paper converting and graphic arts
applications. Below are brief descriptions of the markets served by the
Commercial segment:
-- Flexible Packaging -We formulate a variety of products for flexible
packaging including: lidding adhesives for individually packaged food
products, blister packaging adhesives for tamper resistant packaging
of pharmaceuticals, batteries, toys and tool accessories, laminating
adhesives used to bond multiple film layers used in complex flexible
packages and adhesives used for the protective packaging of medical
instruments.
-- Furniture - Our products are primarily used in the high pressure
laminate and other rigid substrate bonding, woodworking assembly and
foam fabricating markets.
-- Industrial Specialties, Flame Retardant Technologies - We offer custom
formulated coatings and adhesives for textiles, insulation and
manufactured housing to meet specific application and end use
requirements with emphasis on flame retardant technologies.
-- Polymers - We offer commercial and custom formulated polymers for
formulating wood, vinyl, and concrete coatings as well as toll
producing specialty polymers.
-- Product Assembly - Our full range of technological and applications
expertise are used in many industrial areas such as RV/panel
lamination, roofing, footwear, window and door, pressure sensitive
adhesives and fasteners.
-- Transportation - In the automotive industry, our products are
primarily used in primers and top coats, body sealants, structural
adhesives and interior and exterior trim adhesives. In the aerospace
industry our products are primarily used in commercial, military and
general aviation coatings, composite bonding adhesives and structural
epoxies.
-- Paper Converting - We provide specialty adhesives and coatings for
printers and converters of folding cartons, specialty bags, foil
structures, corrugators, tubewinders, bottle labelers and
point-of-purchase display converters.
-- Graphic Arts - We provide formulated adhesives and coatings to four
market niches: trade service converting, commercial printing,
bookbinding and in-line finishing (including direct mail and tag &
label).
-- Microspheres - Produced by a patented process and marketed under the
name DUALITE(R), our hollow, polymeric microspheres offer many unique
properties. These microspheres, used as a "functional filler", have
the ability to simultaneously reduce cost, weight, and VOC's from
formulations and products and are primarily used in commercial
applications.
Construction Segment:
Our Construction segment (approximately 37% of 2003 net sales) manufactures
branded caulk, sealants and adhesives which serve the following markets:
distributors for professional contractors, OEM, Co-Op distributors and
do-it-yourself retailers. We manufacture and sell housing repair, remodeling and
construction sealants and adhesives used in exterior and interior applications.
We are a leader in aluminum and vinyl siding sealants as well as kitchen and
bath sealants, offering ease of use, durability and color match capabilities.
These products are marketed for do-it-yourself retail and professional
applications. We offer polyurethane consumer adhesives and sealants and sub
flooring and drywall adhesives. We offer a broad range of well-established
branded products including PL(R) and Polyseamseal(R) for retail do-it-yourself
applications and Pro-Series(R) and PL(R) for professional applications.
4
Sales and Marketing
We operate an extensive sales and marketing network for our customers. This
network consists of a direct sales force of over 80 professionals, as well as
independent agents and distributors. This network works closely with customers
to satisfy existing product needs and to identify new applications and product
improvement opportunities. Our sales efforts are complemented by our product
development and technical support staff, who work together with the sales force
to develop new products based on customer needs. We augment our direct sales and
marketing coverage through a network of distributors and independent agents who
specialize in particular areas. This specialization allows our applications to
gain access to a broader range of distribution channels and end users and
further strengthens our brand names.
Our sales and marketing efforts and customer relationships are further
enhanced by the numerous customer-specific technical approvals we have 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 us
and our customers and can lead to additional sales and marketing opportunities.
Technology
We maintain a strong commitment to technology with a focus on the
development of new products and processes. We work hand-in-hand with our
business teams and customers to develop innovative, high-performance solutions
to satisfy current and future needs. This methodology of involving the customer
throughout the product development process enhances the creation of products
that will add value to our customers' businesses.
We focus our technical resources to ensure deployment is aligned with sales
growth opportunities. Our technological resources are organized so as to support
extending core technologies into more markets and applications.
During the past several years, we have focused our research and development
efforts on the development of high performance, environmentally safe products.
This effort has led to a broad range of technologies and applications,
including:
-- high temperature resistant, reactive hot melt used in industrial
construction applications;
-- reactive epoxy liquid used as structural bonding adhesive in truck bed
assembly;
-- acrylated epoxy ultraviolet/electron-beam curable systems used as
coatings for multi-wall bags that allow bags to be stacked without
slipping while greatly enhancing their appearance;
-- pre-formulated dispersions that function as medical packaging
adhesives, fiber locking binders, and food packaging lidding adhesives
and
-- advanced toughened epoxy systems used to bond plastics, composites and
metals in both automotive and aerospace construction.
Our technical activities are further enhanced through alliances with key
industry suppliers and large multi-national customers. These include BASF AG,
Baxter International Inc., The Boeing Company, The Dow Chemical Company, E.I. du
Pont de Nemours and Company, General Motors, and Johns Manville Corporation,
among others.
We hold approximately 10 patents and trademarks, primarily in the U.S. Our
products include a wide variety of technology, some of which is protected, some
of which is not. No one patent or trademark or group of patents or trademarks is
material to our business. Our patents and qualified formulations, in combination
with our customer integrated approach to product and application design, should
enhance our ability to create a sustainable, competitive advantage in the next
several years. We have several brands and trademarks that are well recognized by
customers, including OSI(R), Pro-Series(R), PL(R), Polyseamseal(R), Miracure(R),
Plastilock(R), Latiseal(TM), Dualite(R), Hybond(R), Proxseal(TM), Primaseal(TM),
Primalam(TM), Avadyne(TM), Bondrite(TM), NailPower(TM) and Proxmelt(TM).
5
Employees
As of December 31, 2003, we had 895 employees, of whom 111 were members of
unions under contracts which expire between 2004 and 2006. Approximately 743 of
our employees are employed in the U.S. and approximately 152 are employed
internationally. We believe that our relations with our employees are good. As
of December 31, 2002, we had 930 employees.
Environmental Matters
We are subject to extensive laws and regulations pertaining to air
emissions, waste water discharges, the handling and disposal of solid and
hazardous wastes, the remediation of contamination, and otherwise relating to
health, safety and protection of the environment. Our operations and the
environmental condition of our real property could give rise to liabilities
under these laws, which could result in material costs.
In connection with our acquisitions, we have performed substantial due
diligence to assess the environmental liabilities associated with acquired
businesses and have negotiated contractual indemnifications, which, supplemented
by commercial environmental insurance coverage, is currently expected to
adequately address a substantial portion of known and foreseeable environmental
liabilities. We do not currently believe that environmental liabilities will
have a material adverse effect on our business, financial condition or results
of operations. We cannot be certain, 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 a material adverse
effect.
In connection with soil and groundwater contamination resulting from
historic operations under prior ownership of our Greenville, South Carolina
facility, in November 1994, the former owner of the business entered into a
consent agreement with the South Carolina Department of Health and Environmental
Control that requires the successors to complete investigation and remediation
of soil and groundwater contamination at the site. These activities are
currently projected to cost approximately $2.0 million, $1.6 million of which
had been spent by December 31, 2003. We are indemnified by the former owner with
respect to this matter, as well as certain other known and unknown pre-closing
environmental liabilities, subject to an overall limit well in excess of the
currently estimated cost of cleanup. The former owner has agreed to conduct and
finance the investigation and remediation of this matter.
Our facility located in Akron, Ohio is part of a larger industrial complex
formerly operated by The B.F. Goodrich Company, the prior owner of SIA
Adhesives, Inc. The B.F. Goodrich Company, as part of a voluntary cleanup
agreement with the Ohio Environmental Protection Agency, is conducting an
assessment of soil and groundwater contamination throughout the entire complex.
In connection with our 1996 acquisition of SIA Adhesives, Inc., The B.F.
Goodrich Company agreed to indemnify us with respect to this matter (as well as
other known and unknown pre-closing environmental liabilities).
In connection with the 1996 acquisition of Pierce & Stevens Corp., our
environmental due diligence detected conditions of subsurface contamination
primarily associated with storage tank farms and at various other areas of the
Pierce & Stevens Corp. facilities. Our current estimated total cost of
investigation and remediation is approximately $5.0 million. This amount could
be higher, depending upon the extent of required remediation. In connection with
the acquisition, The Sherwin-Williams Company agreed to indemnify us with
respect to this and other environmental and non-environmental pre-closing
liabilities, subject to a $9.0 million overall limit and has already paid us for
all our expenses related to these facilities, which has totaled greater than
$4.0 million to date. We have entered into a voluntary agreement with the New
York State Department of Environmental Conservation with regard to the Buffalo
facility remediation. The majority of this project was completed in 2003, at a
cost of approximately $0.6 million. Those costs, and future maintenance costs
are expected to be fully funded by Sherwin Williams.
As part of our Imperial Adhesives acquisition, we acquired facilities in
Cincinnati, Ohio and Nashville, Tennessee. The Nashville facility was sold in
December 2002. At our Cincinnati facility, some soil and groundwater
contamination exists. The contamination resulted from the past (pre 1995) use of
several underground solvent storage tanks. This was one of the issues identified
as part of acquisition due diligence. The Ohio Bureau of Underground Storage
Tanks witnessed the removal of the tanks. There is no regulatory requirement to
remediate this site. We are conducting a voluntary soil and groundwater
remediation project over a period of several years to install a groundwater
collection and treatment system. This project is currently estimated to cost
$1.0 million. The former owner of the site will contribute approximately two
thirds of the cost of this project. If costs exceed $1.5 million, insurance
totaling $10.0 million is available. As this remediation is voluntary, we have
flexibility as to the type of remediation system as well as the duration of the
operation and monitoring phase. A PCB soil contamination remediation project was
completed in 2003. During 2003, we completed the closure of all the underground
storage tanks in Cincinnati.
6
Imperial Adhesives Inc. has been identified as a "PRP" (potentially
responsible party) with regard to the remediation of a drum
reconditioning/disposal site. Imperial Adhesives Inc. settled for $0.04 million
with the U.S. EPA as a "de minimus contributor" for the remedial investigation
and feasibility study costs (RIFS). Our additional clean up cost liability is
capped at $0.07 million by the former owner.
As part of our acquisition of the Croda International Plc. adhesives
business, we acquired the Kapellen, Belgium and Newark on Trent, United Kingdom
facilities. Soil and groundwater at the Kapellen facility is contaminated with
various solvents. The former owner of the site had initiated an investigation,
which lead their consultant to believe that natural attenuation of this
contamination might be one of the feasible options. However, in the event that
active remediation is necessary, our consultant has estimated a cost of $0.7
million. The cost of this remediation is covered by a guarantee from Croda
International Plc. to the Belgian authority. Indemnification is available for
this matter from Croda International Plc., subject to certain thresholds,
deductibles, caps and cost-sharing arrangements described in the Croda
International Plc. acquisition agreement. In addition, under that agreement,
Croda International Plc. has retained responsibility for compliance with the
applicable Flemish statute on soil clean up and any other applicable laws
concerning the transfer of the Kapellen facility.
Regarding the Newark On Trent, facility in the United Kingdom, potential
issues related to soil and groundwater remediation, tank containment
improvements and site investigation monitoring were identified. Indemnification
from Croda International Plc. is available for the remediation of this matter,
and others (if required), subject to certain thresholds, deductibles, caps and
cost-sharing arrangements described in the Croda International Plc. acquisition
agreement.
As is the case with manufacturers in general, if a release of hazardous
materials occurs at real property owned or operated by us or our predecessors or
at any off-site disposal location utilized by us or our predecessors, we 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 and similar environmental laws. Typically,
liability at such sites is shared by all of the viable responsible parties based
on their relative contribution of waste to the site. We have been named
potentially responsible parties under these laws for cleanup of approximately
fifteen multi-party waste disposal sites, the liability for several of which has
been resolved, subject to standard terms, including the ability to reopen the
matter, found in these kinds of settlements. Due to what we currently believe is
our relatively minor contribution of waste to these sites, we do not believe
that our liability with respect to these sites will have a material adverse
effect on our business, financial condition or results of operations. In
addition, the agreements with former owners of our business include
indemnification for these issues.
We do not currently believe that capital expenditures relating to achieving
compliance with environmental regulations will have a material adverse effect on
our business, financial condition or results of operations. However,
environmental laws are constantly evolving and we cannot predict accurately the
effect they may have upon our capital expenditures, cash flow or competitive
position in the future. Should these laws become more stringent, the cost of
compliance would increase. If we cannot pass on future costs to our customers,
such increases may have an adverse effect on our business, financial condition
or results of operations.
Raw Materials
We use a broad variety of specialty and some commodity raw materials in our
manufacturing processes. The majority of raw materials used in manufacturing our
products are available from more than one source and are readily available on
the open market. In 2003, the company purchased approximately $201 million in
raw materials including acrylic monomers and polymers, resins, natural and
synthetic rubbers, solvents, and urethanes. Although these raw materials are
derived from crude oil or natural gas, the raw materials used by us are several
manufacturing steps removed (downstream) from these basic feedstocks. The price
of oil and gas will affect our costs for these raw materials both upward and
downward, but the magnitude of change is diluted.
We typically purchase strategic raw materials on a contract basis to
moderate price changes during the contract period, however, prices can change
significantly at the end of contract periods if supply shortages, feedstock cost
pressures, or other unforeseen market events occur. Our contracts are not long
term nor do they require minimum purchase requirements. Commodity raw materials
are available from numerous independent suppliers, and specialty raw materials
are usually available from several suppliers.
We expect the cost of many raw materials to increase over the long term. In
aggregate, we have had some success historically in passing on raw material cost
increases through price increases to our customers over time under certain
competitive market conditions, although not always in levels adequate to
maintain margins. We may not achieve historical levels of success in the future.
7
Backlog
Most orders for our products are received and shipped in the same month.
Total backlog orders at December 31, 2003 were approximately $11.8 million. All
2003 backlog orders are expected to be filled within the current year. Backlog
orders at December 31, 2002 were $10.0 million.
Geographic Financial Information
For information regarding the allocation of our revenue and long lived
assets among the U.S. and our international markets, see Note 16 to the
Consolidated Financial Statements.
Production
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. Our principal manufacturing processes are blending,
polymerization, extrusion and film coating. Blending consists of dissolving or
dispersing various compounds in organic solvents, water or solvent-free systems.
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 our manufacturing processes can be performed at more
than one of our facilities.
Item 2. Properties
We operate the manufacturing plants and facilities described in the table
below. Management believes that our 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 that we operate.
Owned/ Square
Location Leased(1) Footage Segment
---------------------------------------- -------------------------------
Akron, Ohio............................. Owned 214,300 Commercial
Newark on Trent, United Kingdom......... Owned 202,400 Commercial
Mentor, Ohio............................ Owned 175,000 Construction
Buffalo, New York....................... Owned 165,000 Commercial
Plainfield, Illinois.................... Leased(4) 154,600 Commercial
Kapellen, Belgium....................... Owned(5) 134,400 Commercial
Cincinnati, Ohio........................ Owned(5) 115,000 Commercial
Greenville, South Carolina.............. Leased(2) 104,500 Commercial
Carol Stream, Illinois.................. Owned 81,800 Commercial
LaGrange, Georgia....................... Owned 80,500 Construction
Seabrook, New Hampshire/Salisbury,
Massachusetts......................... Owned 79,100 Commercial
Kimberton, Pennsylvania................. Owned 55,900 Commercial
Mexico City, Mexico..................... Leased(3) 24,400 Commercial
Vinhedo, Brazil......................... Owned 13,800 Commercial
- ----------
(1) All of our owned facilities are subject to mortgages pursuant to our credit
agreement. In addition, the Seabrook, New Hampshire/Salisbury, Massachusetts
property is subject to mortgages relating to the financing of the
acquisition of the property.
(2) Lease expires December 31, 2008.
(3) Lease expires December 31, 2004.
8
(4) Lease expires December 31, 2014.
(5) Manufacturing operations were ceased at this facility in 2003.
Our executive offices are located in Chicago, Illinois. We also have sales
and technical offices in Singapore, United Kingdom, Canada, Sweden, France,
Italy, Switzerland and Brazil.
Item 3. Legal Proceedings
We are a party to various litigation matters incidental to the conduct of
our business. We do not believe that the outcome of any of the matters in which
we are currently involved will have a material adverse effect on our financial
condition or results of operations.
Item 4. Submission of Matters to a Vote of Security Holders
None.
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
As of February 26, 2004, we had 99 holders of record of voting common stock
and 2 holders of record of non-voting common stock. There is no public trading
market for our equity securities. We have not historically declared dividends
and do not anticipate paying cash dividends on common stock in the foreseeable
future. Any future determination as to the payment of dividends will be made at
the discretion of the Board of Directors and will depend upon our operating
results, financial condition, capital requirements, general business conditions
and such other factors as the Board of Directors deems relevant. Our debt
instruments include certain restrictions on the payment of cash dividends on our
common stock.
9
Item 6. Selected Financial Data
SELECTED HISTORICAL FINANCIAL DATA
The following table presents our selected historical financial data at the
dates and for the periods indicated. The data for each of the years presented
are derived from our audited financial statements. The information set forth
below should be read in conjunction with our consolidated financial statements
and related notes and "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and other financial information included
elsewhere herein.
Sovereign Specialty Chemicals, Inc.
-----------------------------------------------------------------
Year Ended Year Ended Year Ended Year Ended Year Ended
December 31, December 31, December 31, December 31, December 31,
2003 2002 2001 2000 1999
------------ ------------ ------------- ------------ ------------
Statement of Operations
Data:
Net sales.................. $ 371,616 $ 361,110 $ 356,701 $ 265,833 $ 243,273
Cost of goods sold......... 268,375 259,760 259,253 186,393 168,415
--------- --------- --------- --------- ---------
Gross profit............... 103,241 101,350 97,448 79,440 74,858
Selling, general and
administrative expenses.. 70,438 75,960 78,015 57,582 48,350
Special charges............ -- -- -- -- 14,153
--------- --------- --------- --------- ---------
Operating income........... 32,803 25,390 19,433 21,858 12,355
Interest expense, net...... (25,417) (25,527) (26,990) (21,276) (15,076)
Income (loss) before income
taxes, extraordinary item
and cumulative effect of
change in accounting
principle................ 7,386 (137) (7,557) 582 (2,721)
Income tax expense (benefit) 11,602 305 (1,500) 1,418 4,218
--------- --------- --------- --------- ---------
Loss before
extraordinary item....... (4,216) (442) (6,057) (836) (6,939)
Extraordinary items, net of
income tax benefit(1).... -- -- -- 4,828 1,055
Cumulative effect of change
in
accounting principle, net (17,064) -- -- --
--------- --------- --------- --------- ---------
of
income tax benefit(2)....
Net loss................... $ (4,216) $ (17,506) $ (6,057) $ (5,664) $ (7,994)
========== ========= ========= ========= =========
Balance Sheet Data
(end of period):
Cash....................... $ 8,454 $ 14,124 $ 15,584 $ 8,008 $ 17,005
Working capital............ 33,382 42,951 52,003 52,345 44,311
Total assets............... 289,744 308,668 350,290 355,029 257,839
Total indebtedness......... 210,777 223,792 252,109 246,633 158,582
Stockholders' equity....... 22,564 25,853 44,058 51,262 56,616
Other Financial Data:
Capital expenditures....... $ 8,182 $ 6,560 $ 8,040 $ 5,077 $ 6,280
- ----------
(1) Extraordinary losses relate to the write-off of deferred financing costs and
any associated premiums paid as a result of the early extinguishment of
debt.
(2) Cumulative effect of change in accounting principle relates to the write-off
of goodwill, net of income tax benefit, as a result of the adoption of SFAS
142, "Goodwill and other Intangible Assets".
10
ITEM 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion and analysis is provided to increase the
understanding of, and should be read in conjunction with, the consolidated
financial statements and accompanying notes included herein.
General
We are a leading developer and supplier of high performance specialty
adhesives, sealants and coatings for use in three primary end markets: packaging
and converting; industrial and construction. We operate in the highly fragmented
adhesives, sealants and coatings segment of the specialty chemicals industry. We
focus on select value-added market niches in which we have established
leadership positions and competitive advantages in product development,
manufacturing and distribution. An aggressive, growth oriented company, we are
strategically positioned to swiftly respond to customers' emerging needs and to
fully leverage the depth and breath of our operations, technologies, best
practices and expertise. We frequently design our products in cooperation with
our customers to meet unique specifications and to provide critical performance
attributes to their products, resulting in a significant number of long-lived
primary supplier relationships.
We are headquartered in Chicago, Illinois, and supported by operations
worldwide. We were founded as a partnership in 1995, were incorporated in 1997,
and in 1999, 75% of our common stock was acquired by SSCI Investors LLC. We have
successfully expanded our business through the integration of ten strategic
acquisitions. Currently, our business is comprised of a Commercial segment and a
Construction segment. Our Commercial segment (approximately 63% of 2003 net
sales) serves a range of industrial markets, including high-performance
specialty adhesives and coatings for transportation and furniture, product
assembly applications, flame retardant specialties and specialty polymers. Our
Commercial segment also manufactures coating and adhesive products for
packaging, paper converting and graphic arts applications. Our Construction
segment (approximately 37% of 2003 net sales) manufactures branded caulk,
sealants and adhesives which serve the following markets: distribution for
professional contractors, OEMs, Co-Op distributors and do-it-yourself retailers.
We plan to continue our growth through a combination of strong customer focus
and focus on key product areas, new product development, leveraging technology
across business units, continued market penetration, international expansion and
efficient spending programs.
Summary of Critical Accounting Policies
The discussion and analysis of our financial condition and results of
operations are based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires us to make
estimates and judgments that affect the reported amounts of assets, liabilities,
revenues and expenses, and related disclosure of contingent assets and
liabilities. On an ongoing basis, we continually evaluate our estimates. We base
our estimates on historical experience and on various other assumptions that are
believed to be reasonable under the circumstances, the results of which form the
basis for making judgments about the carrying values of assets and liabilities
that are not readily apparent from other sources. Actual results may differ from
these estimates.
We believe the following critical accounting policies affect our more
significant judgments and estimates used in the preparation of our consolidated
financial statements.
Revenue Recognition. Revenue from the sale of products is recognized at the
point of passage of title, which is at the time of shipment. We require that
persuasive evidence of a revenue arrangement exists, delivery of product has
occurred or services have been rendered, the price to the customer is fixed and
determinable and collectibility is reasonably assured before revenue is realized
and earned. Rebates, discounts, returns and other allowances are reflected as
reductions from gross sales in determining net sales. In 2003, the total of
rebates, discounts, returns and other allowances amounted to approximately 3.5%
of gross sales. Rebates are accrued based on contractual relationships with
customers as shipments are made. Customer returns and allowances and discounts
are accrued based on our history of sales returns and allowances.
Cost of Goods Sold. Cost of goods sold represents the actual cost of
purchased raw materials, direct and indirect labor, warehousing and
manufacturing overhead costs, including depreciation, utilized directly in the
production of products for which revenue has been recognized.
Selling, General & Administrative Expenses. Selling, general &
administrative expenses generally are those costs not directly related to the
production process and include all selling, marketing, research and development
customer service expenses as well as expenses related to general management,
finance and accounting, information services, human resources, legal and
corporate overhead expense.
11
Goodwill. Goodwill represents the excess of acquisition cost over the fair
value of net assets acquired and was being amortized using the straight-line
method over periods ranging from 15 to 25 years through December 31, 2001.
Accumulated amortization of goodwill was $30.1 million at December 31, 2001. On
January 1, 2002, we adopted SFAS No. 142, Goodwill and Other Intangible Assets,
which eliminated the amortization of goodwill and instead required that goodwill
be tested for impairment at least annually.
Reserve for Inventory Obsolescence. Our estimated reserves for obsolescence
or unmarketable inventory is equal to the difference between the cost of the
inventory and the estimated market value based upon assumptions about market
conditions, future demand and expected usage rates. We periodically review
inventory and if applicable, record additional inventory write-downs. If actual
market conditions are less favorable than those projected by management and
cause usage rates to vary from those estimated, additional inventory write-downs
may be required, however these would not be expected to have a material adverse
impact on our financial statements.
Allowance for Doubtful Accounts. We maintain allowances for doubtful
accounts for estimated losses resulting from the failure of our customers to
make required payments. We evaluate the adequacy of our allowance for doubtful
accounts and make judgments and estimates in determining the appropriate
allowance at each reporting period. If a customer's financial condition were to
deteriorate, additional allowances may be required. The December 31, 2003
balance in the allowance for doubtful accounts is approximately 0.3% of gross
sales for the year ended December 31, 2003.
Valuation allowance. Pursuant to the provisions of SFAS No. 109, Accounting
for Income Taxes, we evaluate the need for a valuation on our net deferred tax
asset, including an estimation of our future taxable income to determine an
allowance adequate to reduce the total deferred tax asset to an amount that will
more likely than not be realized.
Segment Reporting
We have two reportable segments: the Commercial segment and the Construction
segment. Our Commercial segment (approximately 63% of 2003 net sales) serves a
range of industrial markets, including high-performance specialty adhesives and
coatings for transportation, furniture and product assembly applications, flame
retardant specialties and specialty polymers. Our Commercial segment also
manufactures coating and adhesive products for packaging, paper converting and
graphic arts applications. Our Construction segment (approximately 37% of 2003
net sales) manufactures branded caulk, sealants and adhesives which serve the
following markets: distribution for professional contractors, OEM, Co-Op and
retail do-it-yourself.
We evaluate the performance of each segment based on operating income.
Segment profit is calculated as a reportable segment's operating income. Total
segment profits exceed consolidated operating profits to the extent of
unallocated corporate expenses included in selling, general and administrative
expenses. Unallocated corporate expenses were $9.1 million, $12.5 million, and
$9.7 million for the years ended December 31, 2003, 2002, and 2001,
respectively.
Results of Operations
2003 Compared to 2002
Net Sales. Net sales were $371.6 million in 2003, an increase of $10.5
million, or 2.8% over 2002 net sales of $361.1 million. The increase was due to
gains in the Construction segment, which were partially offset by a decrease in
net sales from the Commercial segment. Construction segment sales were $138.1
million in 2003, up $17.1 million, or 14.1% from the prior year reflecting a
continued strong housing market's impact on sales of build material applications
and increased sales to the retail do-it-yourself market. Commercial segment
sales were $233.5 million in 2003, down $6.5 million, or 2.7% from the prior
year. The lower sales were primarily a result of declines in several markets.
Notably, sales levels began to show improvement in many of the Commercial
markets late in 2003 as net sales for the fourth quarter of 2003 were 2.4%
greater than the corresponding period of 2002.
12
Cost of Goods Sold. Cost of goods sold was $268.4 million in 2003, an
increase of $8.6 million, or 3.2% over 2002 cost of sales of $259.8 million.
Gross profit as a percentage of net sales decreased in 2003 to 27.8% from 28.1%
in 2002. This reduction in gross profit percentage is related to increases in
many raw material costs year over year. We continue to try to keep margins
relatively stable despite raw material cost increases, through raw material
substitutions where possible and through selling price increases where
necessary. Raw material costs declined through early 2002 and began a build that
peaked in the first half of 2003, prices stabilized in the second half of 2003
but at higher than 2002 levels. We also have partially offset the negative
impact of raw material cost increases through reductions in manufacturing costs
year over year. The manufacturing cost reductions have been attained through the
implementation of lean manufacturing initiatives at many of our facilities.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses were $70.4 million in 2003, a decrease of $5.6 million,
or 7.8% from 2002 expenses of $76.0 million. As a percentage of net sales,
selling, general and administrative expenses decreased to 19.0% for 2003 from
21.0% in 2002. For the year ended December 31, 2003, we incurred $1.3 million of
additional plant closure and reorganization costs within our Commercial segment.
In 2002, we recorded a $4.1 million provision relative to plant closures. In
addition in 2002, we also incurred the costs of additions to our management
team, including $0.4 million of costs not expected to occur in the future; $0.5
million of professional fees related to financing alternatives; $1.2 million
incurred as a result of the reorganization of our senior management and of
management of businesses in our Commercial segment and $0.9 million of outside
consulting costs related to implementation of lean manufacturing practices at
many of our manufacturing locations. If you exclude these costs from both years,
selling, general and adminstrative expenses would have been is $69.1 million and
$68.9 million for 2003 and 2002, respectively, or 18.6% and 19.1% of net sales.
This decline in spending as a percentage of net sales, is reflective of
management focus, particularly in the control of outside professional fees.
Interest Expense. Net interest expense was $25.4 million in 2003 and $25.5
million in 2002. The weighted average interest rate on our variable rate debt
(approximately 28% of total debt) declined somewhat to 5.7% from 5.8% in the
prior year and the lower average debt levels had a positive impact which was
partially offset by an increase of $0.8 million in non cash interest expense,
amortization of deferred financing costs and debt discounts. While the reference
rate on which the interest rates under our credit agreement are based decreased
in 2003 relative to 2002, the spread on our variable rate borrowings under the
credit agreement in excess of the reference rate was increased as part of the
December 2002 amendment. This increase was in place for less than one month in
2002, but had a full year impact in 2003.
Income tax expense (benefit). Income tax expense was $11.6 million in 2003.
Income tax expense was $0.3 million in 2002. At 2003, we recorded a full
valuation allowance on the net deferred tax asset balance of $7.9 million
pursuant to the provisions of SFAS No. 109, Accounting for Income Taxes, which
require that we maintain a valuation allowance to the extent necessary to reduce
net deferred tax assets to an amount that will more likely than not be realized
through future taxable income. While our pre-tax income has increased $7.5
million for financial reporting purposes, we are in a net operating loss
position for federal income tax purposes for the year ended December 31, 2003
and for the previous two fiscal years. There are significant book and tax
differences that contribute to the tax net operating losses, including the
approximately $8.0 million of annual tax amortization of goodwill, the timing of
tax deductions relative to plant closure costs, bonuses and others. The
valuation allowance will be reduced at such time as management is able to
determine that the realization of the deferred tax assets is more likely than
not to occur in future tax years. Generally, reductions in the valuation
allowance will reduce future provisions for income tax expense.
Commercial Segment
The following table presents net sales and segment profit expressed in
millions of dollars and segment profit margin, which is segment profit expressed
as a percentage of net sales:
For the Years
Ended
December 31,
---------------------
Dollar Percentage
2003 2002 Change Change
--------------------- -------- ----------
Net sales................... $ 233.5 $ 240.1 $ (6.5) (2.7)%
========= =========
Segment profit.............. $ 22.4 $ 19.8 $ 2.6 13.4%
========= =========
Segment profit margin....... 9.6% 8.2%
========= =========
Net segment sales were $233.5 million in 2003, representing a $6.5 million
decrease from 2002. The net sales decrease year over year was primarily a result
of declines in a number of end markets. Graphic arts, primarily bookbinding,
publishing and service convertor applications were approximately $3.0 million
below prior year levels. Transportation was down $1.8 million from 2002,
primarily due to lower sales in the automotive friction and interior markets.
Industrial specialties and paper converting were down as a whole year over year,
although there were applications within those market categories that achieved
year over year gains. Notably, sales levels began to show improvement in many of
the Commercial markets late in 2003 as net sales in the fourth quarter of 2003
were 2.4% greater than the corresponding period of 2002. Domestic net sales were
$187.4 million and $194.7 million for the year ended December 31, 2003 and 2002,
respectively. The decrease in domestic net sales for the segment of $7.3 million
was offset somewhat by international sales increases of $0.7 million year over
year.
13
Gross profit and gross profit percentage was $60.9 million and 26.1%; and
$63.3 million and 26.3% for the years ended December 31, 2003 and 2002,
respectively. Segment gross profit remained essentially constant year over year
as a percentage of net sales, which reflects a slight decline in raw material
margins and some improvement in manufacturing cost levels. Due to raw material
substitutions and price increases where possible, we were able to hold segment
raw material margins relatively steady while in an environment of increasing
costs through much of the first half of 2003. Manufacturing costs have decreased
year over year and as a percentage of net sales. We expect that manufacturing
costs will significantly decrease as a percentage of net sales over the next
several quarters based on the transfer of production from the closed facilities
(which was substantially complete in the second and third quarters of 2003) and
full year impacts of lean manufacturing initiatives implemented at our
facilities. Declines in gross profit were partially offset by decreases in
selling, general and administrative expenses.
Segment profit was $22.4 million and $19.8 million for the year ended
December 31, 2003 and 2002, respectively. Both 2003 and 2002 have plant closure
and other costs not expected to occur in the future included in the segment
profit. These costs were approximately $1.3 million and $4.2 million for the
years ended December 31, 2003 and 2002, respectively. Excluding these costs
segment profit for the Commercial segment was essentially flat year over year
despite a $6.5 million decrease in the top line.
Substantially all production from our Cincinnati, Ohio plant, which
primarily produced water-borne adhesives, was transferred to our plants in
Greenville, South Carolina, and Carol Stream and Plainfield, Illinois in the
first nine months of 2003. Production relative to an insignificant product line
that had not been transferred at December 31, 2003 is expected to be in first
quarter 2004. Some of the technical, sales support, customer service, and
administrative functions have been transitioned to our other locations.
Approximately 88 employees, in both manufacturing and support functions will be
terminated as part of the closure. At December 31, 2003, 70 employees have been
terminated under the announced plan.
Our the Kapellen, Belgium plant which employed 24 people and produced
water-borne and hot-melt adhesives for the European packaging and converting
market was closed and the production was shifted to our Newark, United Kingdom
plant during the first nine months of 2003. Approximately 16 employees primarily
in manufacturing functions have been terminated as part of the plant closure. A
separate Kapellen office will continue to provide sales, technical and
distribution support to continental Europe.
These closures include the termination of certain existing employees, the
abandonment or sale at a loss of certain fixed assets, the disposal of certain
inventory and the sale of certain buildings. As a result of the announced
closures the Company recorded a charge of approximately $4.1 million in the
fourth quarter of 2002 and an additional charge of $0.4 million in the first
half of 2003, included in selling, general and administrative expense, relative
to the following costs: termination benefits of $2.0 million, loss on fixed
assets of $1.3 million and other exit costs of $1.2 million. Approximately $0.9
million of termination benefits, $0.3 million of fixed asset write offs, and
$0.4 million of other exits costs were incurred in the year ended December 31,
2003. Approximately $0.5 million of termination benefits, $1.0 million write
down of fixed assets in Cincinnati and $0.5 million of other exit costs will be
incurred in 2004 and are recorded in accrued liabilities on the balance sheet.
$0.6 million of termination benefits in Belgium are long term and this
obligation and $0.3 million in other exit costs are recorded in other long term
liabilities at December 31, 2003.
Construction Segment
The following table presents net sales and segment profit expressed in
millions of dollars and segment profit margin, which is segment profit expressed
as a percentage of net sales:
14
For the Years
Ended
December 31,
-------------------
Dollar Percentage
2003 2002 Change Change
-------------------- ------ ----------
Net sales.................... $ 138.1 $ 121.0 $ 17.1 14.1%
========= =========
Segment profit............... $ 19.5 $ 18.1 $ 1.4 7.5%
========= =========
Segment profit margin........ 14.1% 15.0%
========= =========
Net sales for the Construction segment were $138.1 million for the year
ended December 31, 2003 and $121.0 million for the year ended December 31, 2002.
The increase in sales in 2003 was primarily due to continued growth of its
building material application end markets and strength at major retail accounts.
The Construction segment was significantly impacted by the raw material cost
increases in the first half of 2003 and the lower margin percentages achieved in
the retail markets. Raw material margins decreased by approximately 1.3% as a
percentage of net sales in 2003. Manufacturing costs as a percentage of net
sales decreased slightly in 2003, reflective of lean manufacturing initiatives.
Gross profit and gross profit percentage was $42.4 million and 30.7%; and $38.3
mil lion and 31.6% for the years ended December 31, 2003 and 2002, respectively.
Segment profit increased by $1.4 million, or 7.5%.
Selling, general and administrative expenses were $22.9 million (16.7% of
net sales) and $20.1 million (16.7% of net sales) for the years ended December
31, 2003 and 2002, respectively.
2002 Compared to 2001
Net Sales. Net sales were $361.1 million in 2002, an increase of $4.4
million, or 1.2% over 2001 net sales of $356.7 million. The increase was due to
gains in the Construction segment, which were partially offset by a decrease in
net sales from the Commercial segment. Construction segment sales were $121.0
million in 2002, up $9.7 million, or 8.7% from the prior year reflecting a good
housing market and gains in the retail do-it-yourself market. Commercial segment
sales were $240.1 million in 2002, down $5.3 million, or 2.2% from the prior
year due to declines in a number of end markets including aerospace, furniture
and graphic arts, particularly high-end printing applications end markets. Sales
levels were also negatively affected by continued general economic weakness in
the United States during the year.
Cost of Goods Sold. Cost of goods sold was $259.8 million in 2002, an
increase of $0.5 million, or 0.2% over 2001 cost of sales of $259.3 million.
Gross profit as a percentage of net sales increased in 2002 to 28.1% from 27.3%
in 2001. The increase in gross profit as a percentage of net sales was due
primarily to two factors. First, we experienced decreases in certain raw
material costs primarily in the first half of the year from the prior year.
Second, as a result of productivity initiatives, including implementation of
lean manufacturing and the full year benefit during the current year of plant
closures completed during the year ended December 31, 2001, manufacturing
expenses decreased. These positive factors were offset partially by the effect
of a shift in sales mix to lower margin products. Lower sales in our aerospace
business, which carries higher than average margins for our products, was a
contributor to this shift.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses were $76.0 million in 2002, an increase of $8.0 million,
or 11.8% from 2001 expenses (excluding goodwill amortization) of $68.0 million.
As a percentage of net sales, selling, general and administrative expenses
increased to 21.0% for 2002 from 19.1% in 2001. This increase was due primarily
to a $4.1 million provision recorded relative to the announced closures of our
facilities in Cincinnati, Ohio and in Kapellen, Belgium. In addition,
contributing to the increase were: the costs of additions to our management
team, including $0.4 million of costs not expected to occur in the future; $0.5
million of professional fees related to financing alternatives; higher insurance
expenses, $1.2 million incurred as a result of the reorganization of our senior
management and of management of businesses in our Commercial segment and $0.9
million of outside consulting costs related to implementation of lean
manufacturing practices at many of our manufacturing locations in 2002.
For financial reporting purposes, we have added a line to our income
statement to segregate the impact of the adoption of SFAS No. 142 and the
discontinuation of goodwill amortization expense. Amortization of goodwill for
the year ended December 31, 2001 was $10.0 million. The elimination of goodwill
amortization contributed greatly to the $6.0 million increase in operating
income over the prior year.
Interest Expense. Net interest expense was $25.5 million in 2002 and $27.0
million in 2001. The decrease in interest expense was due primarily to a
decrease in the weighted average interest rate on our variable rate debt to 5.7%
from 7.1% and lower average debt levels partially offset by increased
amortization of deferred financing costs. In December 2002, we refinanced $45.1
million of borrowings under our existing term loan under our credit agreement
with $47.5 million of borrowings under a new term loan facility. The applicable
margin or "spread" on the new term loan facility is 75 basis points higher than
the applicable margin that was in effect for the existing term loan during most
of 2002. As a result, in the absence of continued decreases in the interest
rates on which our variable rate debt is based, we will expect to have an
increase in the weighted average interest rate of our variable rate debt in
2003.
15
Income tax expense (benefit). Income tax expense was $0.3 million in 2002.
Income tax benefit was $1.5 million in 2001. Although we have stopped recording
goodwill amortization for financial reporting purposes, we continue to be able
to deduct a portion of goodwill amortization expense for income tax purposes.
Net income (loss) before cumulative effect of change in accounting
principle. Net loss before the cumulative effect of change in accounting
principle for the year ended December 31, 2002 and 2001 was $0.4 million and
$6.0 million, respectively. The decrease in loss from the prior year is
primarily related to the $10.0 million of goodwill amortization not recorded in
2002 as a result of the adoption of SFAS No. 142, partially offset by the
provision for announced plant closures of $4.1 million.
Cumulative effect of change in accounting principle. In connection with our
completion of the transitional goodwill impairment test required by SFAS No.
142, we have recorded a $27.6 million ($17.1 million, net of income tax benefit)
goodwill impairment loss and write-down of goodwill associated with our European
reporting unit. Our assessment of our goodwill impairment for this reporting
unit is reflective of both lower operating performance in Europe and the use of
lower market multiples. The carrying value of goodwill associated with our other
reporting units was not impaired.
Commercial Segment
The following table presents net sales and segment profit expressed in
millions of dollars and segment profit margin, which is segment profit expressed
as a percentage of net sales:
For the Years
Ended
December 31,
---------------------
Dollar Percentage
2002 2001 Change Change
--------- --------- -------- ----------
Net sales.......................................... $ 240.1 $ 245.4 $ (5.3) (2.2)%
========= =========
Segment profit..................................... $ 19.8 $ 16.9 $ 3.9 23.1%
========= =========
Goodwill amortization.............................. -- $ 5.5
========= =========
Segment profit excluding goodwill amortization..... $ 19.8 $ 22.4 $ (2.6) (11.6)%
========= =========
Segment profit margin excluding goodwill
Amortization..................................... 8.2% 9.1%
========= =========
Net segment sales were $240.1 million in 2002, representing a $5.3 million
decrease from 2001. This decrease was due primarily to declines in a number of
end markets including aerospace, furniture, and graphic arts, particularly
high-end printing applications. Segment profit was $19.8 million for the year
ended December 31, 2002, representing a $2.6 million or 11.6% decrease from the
prior year $22.4 million segment profit excluding goodwill amortization. The
decrease in segment profit resulted primarily from a $4.1 million provision for
the closure of our Cincinnati, Ohio and Kapellen, Belgium facilities discussed
below and, to a lesser extent, from lower sales volume and a shift in sales mix
to products with lower profit margins. These factors were partially offset by a
decrease in expenses attributable to management's focus on cost containment, the
full year benefit in 2002 of the 2001 plant closures and lower annualized raw
material costs.
In November 2002, we announced plans for the closure in 2003 of two of our
higher-cost manufacturing plants. The first plant is located in Cincinnati,
Ohio, and employs 118 people. The Cincinnati plant primarily produces
water-borne adhesives sold to the industrial market. Production from this plant
will be transferred to our plants in Greenville, South Carolina, and Carol
Stream, Illinois and Plainfield, Illinois progressively over the next nine
months. Also housed in Cincinnati are technical, sales support, customer
service, and administrative functions, some of which will be transitioned to
other of our locations during 2003. As part of the closure, approximately 88
employees, primarily in manufacturing, but also including some technical, sales
support, customer service and administrative functions, will be terminated in
2003.
The second plant is located in Kapellen, Belgium and employs 24 people. In
accordance with the laws of Belgium, and following a consultation period, on
October 25, 2002, we announced our intent to cease manufacturing in Kapellen.
This plant produces water-borne and hot-melt adhesives for the European
packaging and converting market. This production will be shifted to the Newark,
United Kingdom plant during the first half of 2003. The Kapellen facility will
continue to provide sales, technical and distribution support to continental
Europe. Approximately 14 employees, primarily in manufacturing functions, will
be terminated as part of the closure in 2003.
16
These closures will include the termination of certain existing employees,
the abandonment or sale at a loss of certain fixed assets, the disposal of
certain inventory and the sale of certain buildings. We expect the closure of
both plants to be completed by the third quarter of 2003. The closure of these
two plants is expected to produce annual cost savings of approximately $3.0
million when the shutdowns are complete. As a result of the announced closures,
we recorded a charge of approximately $4.1 million in the fourth quarter of 2002
relative to the following costs: termination benefits of approximately $1.6
million, loss on fixed assets of $1.3 million and other exit costs of $1.2
million. These costs will be incurred over the next several quarters. Our 2003
capital spending budget of $8 million includes the capital expenditures required
to accomplish the production transfers.
Construction Segment
The following table presents net sales and segment profit expressed in
millions of dollars and segment profit margin, which is segment profit expressed
as a percentage of net sales:
For the Years
Ended
December 31,
--------------------
Dollar Percentage
2002 2001 Change Change
--------- -------- ------ ----------
Net sales.......................................... $ 121.0 $ 111.3 $ 9.7 8.7%
========= =========
Segment profit..................................... $ 18.1 $ 12.3 $ 5.8 47.7%
========= =========
Goodwill amortization.............................. -- $ 2.7
========= =========
Segment profit excluding goodwill amortization..... $ 18.1 $ 14.9 $ 3.2 21.2%
========= =========
Segment profit margin excluding goodwill
Amortization..................................... 15.0% 13.4%
========= =========
Net sales for the Construction segment were $121.0 million for the year
ended December 31, 2002 and $111.3 million for the year ended December 31, 2001.
The increase in sales in 2002 was primarily due to resilience of its end markets
and strength at major retail accounts. Segment profit increased by $5.8 million,
or 21.2%, primarily as a result of higher sales volume, management actions to
reduce costs and selective pricing increases.
Liquidity and Capital Resources
Net cash provided by operating activities was $15.7 million in 2003. Net
loss, adjusted for non-cash charges, such as depreciation and amortization,
amortization of deferred financing costs, deferred income taxes and foreign
currency gains/losses, accounted for approximately $16.4 million of cash flow.
Cash provided from operations increased as we decreased inventory levels by $2.3
million offset partially by increase in year over year accounts receivable
balances. As a percentage of net sales, receivables continues to decrease as we
continue to shorten the time frame in which we collect on our receivables..
Accounts payable balances remained relatively constant while accrued expenses
and other liabilities decreased year over year primarily due to the reduction in
plant closure related accruals. Consolidated operating working capital
(receivables plus inventory less payables) continues to decline as a percentage
of net sales due to continued management focus in this area. Operating working
capital balance and as a percentage of net sales were $46.5 million and 12.5%
and $46.2 million and 12.8% at December 31, 2003 and 2002, respectively. This is
a point in time comparison but we manage this measure on a monthly basis by
looking at a rolling twelve month average operating working capital percentage.
We have experienced significant declines throughout the year as a result of the
management focus in this area. Receivables and inventory levels were not
expected to have the same magnitude decline in balance in 2003 that was achieved
in 2002 from 2001's higher balances.
Net cash provided by operating activities was $35.3 million in 2002. Net
loss, adjusted for non-cash charges, such as depreciation and amortization,
amortization of deferred financing costs, deferred income taxes, foreign
currency gains/losses and cumulative effect of change in accounting principle,
accounted for approximately $9.2 million of cash flow. Cash provided from
operations increased as we decreased inventory levels by $9.8 million and
accounts receivable balances by $6.8 million. Accounts payable and other
liabilities increased by $6.8 million in 2002, driven primarily by the recording
of a $4.1 million liability relative to announced plant closures of our
Cincinnati and Kapellen facilities.
17
Net cash used in investing activities was $8.2 million in 2003 and resulted
from capital additions to property, plant and equipment. Current year capital
expenditures were $1.6 million greater than in 2002, reflecting a more normal
level of spending.
Net cash used in investing activities was $6.2 million in 2002 and resulted
from capital additions to property, plant and equipment of $6.6 million less
$0.4 million of proceeds from the sale of the Nashville facility in December
2002. Current year capital expenditures were $1.4 million less than 2001, due to
the construction of a manufacturing facility in Brazil in 2001 as well as
moderate spending levels in 2002.
Net cash used in financing activities was $13.6 million for the year ended
December 31, 2003. We repaid $0.5 million of principal required under our Term B
loan and decreased our borrowings under our revolving credit facility by $12.4
million during the year ended December 31, 2003.
Net cash used in financing activities was $30.6 million for the year ended
December 31, 2002. We repaid $11.3 million of principal required under our Term
A loan and decreased our borrowings under our revolving credit facility by $16.2
million during the year ended December 31, 2002. We incurred $2.2 million of
deferred financing costs associated with amendments of our credit agreement
dated March 1, 2002 and December 20, 2002.
Credit Facilities
Our credit agreement, as amended (Credit Agreement), provides for aggregate
borrowings of $108.1 million. The Credit Agreement includes (1) a $50.0 million
revolving credit facility (Credit Facility) (including letters of credit of up
to $20 million), (2) Term Loan A with an aggregate principal balance of $11.1
million at December 31, 2003 and no capacity to borrow additional funds under
that facility and (3) Term Loan B with an aggregate principal balance of $47.0
million at December 31, 2003 and no additional capacity to borrow additional
funds under that facility.
The Credit Facility matures December 30, 2005. Commitment fees on the unused
portion of the Credit Facility of 0.375% to 0.050% are payable quarterly in
arrears. At December 31, 2003, we had $1.0 million outstanding and $46.9 million
in available borrowings under the Credit Facility (net of approximately $2.1
million outstanding letters of credit). Our effective interest rate for our
borrowings under the Credit Agreement was 5.8% and 5.9%, for the years ended
December 31, 2003 and 2002, respectively.
Borrowings under the Credit Facility are available on a revolving basis and
may be used for general corporate purposes, excluding, however, loans, advances
and investments, including acquisitions, by the Company other than specified
exceptions.
On December 20, 2002 we amended our Credit Agreement and we refinanced $45.1
million of the $56.3 Term Loan A outstanding balance at that date with a new six
year, $47.5 million Term Loan B facility. The Term Loan B includes a $2.4
million discount which is being amortized through interest expense over the life
of the facility. The Term Loan B will mature December 30, 2007. Scheduled
principal repayment under the Term Loan B facility for the years ending December
31, 2003 through 2006 will be $0.5 million per year payable quarterly. The
remaining balance under Term Loan B, will be repaid in 2007. We have three
scheduled quarterly payments in 2007 at the same rate of $0.5 million per year
and a final payment due for the balance outstanding at December 30, 2007. There
is no scheduled amortization for the $11.1 million outstanding under the Term
Loan A for the years ending December 31, 2003 and 2004. The remaining $11.1
million drawn under Term Loan A will be repaid in 2005.
Borrowings under the Credit Agreement bear interest at our option at a rate
per annum equal to either (1) the higher of (a) the current base rate as offered
by JPMorgan Chase or (b) 1/2 of 1% per annum above the federal funds rate plus,
in either case, an applicable margin or (2) a Eurodollar rate plus an applicable
margin. The applicable margin varies by facility. For amounts drawn under the
Term Loan A and the Credit Facility the Eurodollar margin is 3.75% and the base
rate margin is 2.75%. For amounts drawn under the Term Loan B facility, the
Eurodollar margin is 4.50% and the base rate margin is 3.50%. Amounts
outstanding under the Credit Facility, Term Loan A and Term Loan B bear
interest, payable quarterly in the case of base rate advances and payable at the
end of the relevant interest period of one, two, three or six months (or
quarterly in certain cases) for all Eurodollar advances. Our credit ratings do
not affect the interest rates for our borrowings under our Credit Agreement.
18
Our Singapore-based sales office has a facility providing for borrowings up
to approximately $1.4 million in U.S. dollars and is secured by a letter of
credit. Interest is payable at United States prime plus 1.0%. At December 31,
2003, approximately $1.1 million was drawn on the facility.
At December 31, 2003, we had $1.0 million drawn under our Credit Facility,
and approximately $2.1 million of outstanding letters of credit. At December 31,
2003, we had approximately $46.9 million of borrowing availability under the
Credit Facility.
Our Credit Agreement obligates us to make mandatory prepayments in certain
circumstances with the proceeds of asset sales or issuance of capital stocks or
indebtedness and with certain excess cash flow. Our Credit Agreement contains
covenants that restrict our and our subsidiaries' ability to incur additional
indebtedness, incur liens, dispose of assets, prepay or amend other
indebtedness, pay dividends or purchase our stock, and change the business
conducted by us or our subsidiaries. In addition, we must also comply with
specified financial ratios and tests including maintenance of maximum total debt
to EBITDA, maximum senior debt to EBITDA, minimum EBITDA to interest expense,
and minimum asset coverage ratios (in each case, as defined in our credit
agreement) and other covenants at the end of each fiscal quarter. The covenant
ratio calculations in our credit agreement utilize non GAAP financial measures
that are specifically defined in the Credit Agreement. At December 31, 2003, we
were in compliance with all financial and other covenants as prescribed by the
Credit Agreement.
Each of these covenants continues for the term of the Credit Agreement
either at the latest level, or a more restrictive level. Deterioration in our
current operating performance could result in our failure to satisfy our
financial covenants. A failure by us to satisfy the covenants under the Credit
Agreement would trigger the lenders' right to require immediate repayment of all
or part of the indebtedness; such acceleration, in turn, would also give rise to
a right to require immediate repayment by holders of our subordinated notes. The
Credit Facility, Term Loan A and Term Loan B are secured by a security interest
in substantially all of subsidiaries' assets, including pledges of the common
stock of our our domestic and first-tier foreign subsidiaries. In addition, the
Credit Facility, Term Loan A and Term Loan B are guaranteed by our subsidiaries.
Some of our guarantees and pledges are in support of only offshore advances, if
any, under the Credit Facility.
Senior Subordinated Notes
In March 2000, we completed a private placement of $150.0 million in
principal amount of 11 7/8% Senior Subordinated Notes (the Notes) due 2010. The
Notes were subsequently exchanged for notes with substantially identical terms
that were registered with the Securities and Exchange Commission. The Notes were
issued at a discount of $1.1 million which is being amortized to interest
expense over the life of the Notes. At December 31, 2003, the unamortized
discount is $0.7 million.
The Notes mature on March 15, 2010. Interest is payable semi-annually in
arrears each March 15 and September 15. On or after March 15, 2005, the Notes
may be redeemed at our option, in whole or in part, at specified redemption
prices plus accrued and unpaid interest:
Year Redemption Price
--------------------- ------------------
2005................. 105.938%
2006................. 103.958%
2007................. 101.979%
2008 and thereafter.. 100.000%
In the event of a change in control, we would be required to offer to
repurchase the Notes at a price equal to 101.0% of the principal amount plus
accrued and unpaid interest.
The Notes are our general obligations, subordinated in right of payment to
all existing and future senior debt and are guaranteed by our wholly-owned
domestic subsidiaries -- (the Guarantor Subsidiaries). Each of the Guarantor
Subsidiaries' guarantees of the Notes are full, unconditional, and joint and
several.
The indenture under which the Notes were issued contains certain covenants
that, among other things, limit us from incurring other indebtedness, engaging
in transactions with affiliates, incurring liens, making certain restricted
payments (including dividends), and making certain asset sales.
19
Liquidity and Capital Requirements
We have a management agreement with AEA Investors Inc. under which we
receive advisory and consulting services provided by AEA Investors LLC, the
successor company to AEA Investors Inc. and sometimes referred to in this report
collectively with its successor as AEA Investors. The management agreement
provides for an annual aggregate fee of $1.0 million plus reasonable
out-of-pocket costs and expenses.
Interest payments on the amounts drawn under the Credit Agreement, as well
as other indebtedness and obligations, represent significant obligations for us.
Our remaining liquidity demands relate to capital expenditures and working
capital needs. Our capital expenditures were approximately $8.2 million in 2003
and management currently anticipates capital expenditures will be approximately
$8.0 million in 2004 and 2005, respectively. While we engage in ongoing
evaluations of, and discussions with, third parties regarding possible
acquisitions, as of the date of this report, we have no current expectations
with respect to any acquisitions. Exclusive of the impact of any future
acquisitions, joint venture arrangements or similar transactions, our management
does not expect capital expenditure requirements to increase materially in the
foreseeable future.
The following summarizes certain of our contractual obligations at December
31, 2003 and the effect of such obligations are expected to have on our
liquidity and cash flow in future periods. During the ordinary course of
business, we enter into contracts to purchase raw materials and components for
manufacture. In general, these commitments do not extend for more than a few
months.
Payments Due by Period
-------------------------------------------
Less than 1-3 4-5 After
Total 1 Year Years Years 5 years
------- --------- ------ ------ -------
Long-term debt(1) 208,230 2,122 13,075 45,600 150,000
Operating leases(2) 10,144 1,222 1,800 1,530 4,317
Capital leases(3) 3,376 738 1,507 1,131 0
Total obligations 221,750 4,082 16,382 48,261 154,317
- ----------
(1) Represent principal amounts, but not interest. See Note 9 to the
Consolidated Financial Statements
(2) As described in Note 13 to the Consolidated Financial Statements.
(3) Represents minimum future payments. See Note 14 to the Consolidated
Financial Statements for further discussion.
Our primary sources of liquidity are cash flows from operations and
borrowings under our Credit Agreement. Based on current and anticipated
financial performance, we expect that cash flow from operations and borrowings
under our Credit Agreement will be adequate to meet anticipated requirements for
capital expenditures, working capital and scheduled interest payments, including
interest payments on the amounts outstanding under the 11 7/8% Senior
Subordinated Notes, the Credit Agreement and other indebtedness through December
31, 2004. Our ability to satisfy capital requirements will be dependent upon our
future financial performance. Additionally our ability to repay or refinance our
debt obligations will also be subject to economic conditions and to financial,
business and other factors, many of which are beyond our control.
Inflation
After declining through early 2002, the costs of certain of our raw
materials have increased. We expect that raw material costs have largely
stabilized in the short term at the levels reached in mid 2003. In an attempt to
offset these increases we raised selling prices selectively and executed raw
material substitutions where possible. Historically, in aggregate, price
increases have been sufficient to recover new raw material cost increases, but
not to maintain margins. There can be no assurance as to our ability to recover
additional cost increases through price increases in the future.
Forward-looking Statements
Some of the information presented in, or connection with, this report
include "forward-looking statements" based on our current expectations and
projections about future events and involve potential risks and uncertainties.
Our future results could differ materially from those discussed in this report.
Some of the factors that could cause or contribute to such differences include:
20
-- changes in economic and market conditions that impact the demand for
our products and services;
-- risks inherent in international operations, including possible
economic, political or monetary instability;
-- uncertainties relating to our ability to consummate our business
strategy, including realizing synergies and cost savings from the
integration of acquired businesses or from plant closures.
-- the impact of new technologies and the potential effect of delays in
the development or deployment of such technologies; and,
-- changes in raw material costs and our ability to adjust selling
prices.
You should not place undue reliance on these forward-looking statements,
which are applicable only as of February 27, 2004. All written and oral
forward-looking statements attributable to us are expressly qualified in their
entirety by the foregoing factors and those identified in Exhibit 99.1 to this
report. We undertake no obligation to revise or update these forward-looking
statements to reflect events or circumstances that arise after February 27, 2004
or to reflect the occurrence of unanticipated events. New risks emerge from time
to time and it is not possible for us to predict all such risks, nor can we
assess the impact of all such risks on our business or the extent to which any
risks, or combination of risks, may cause actual results to differ materially
from those contained in any forward-looking statement.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
The principal market risks, which are potential losses in fair values, cash
flows or earnings due to adverse changes in market rates and prices, to which we
are exposed, as a result of our holdings of financial instrument and commodity
positions, are:
-- interest rates on debt;
-- foreign exchange rates; and
-- commodity prices, which affect the cost of raw materials.
Our financial instruments include short-term debt and long-term debt. Trade
accounts payable and trade accounts receivable are not considered financial
instruments for purposes of this item because their carrying amount approximate
fair value. We do not maintain a trading portfolio and do not utilize derivative
financial instruments to manage our market risks. In the future, we may enter
into foreign exchange currency hedging agreements in connection with our
international operations.
Market Risk Management
We have measured our market risk related to our financial instruments based
on changes in interest rates and foreign currency rates utilizing a sensitivity
analysis. The sensitivity analysis measures the potential loss in fair values,
cash flows and earnings based on a hypothetical change (increase and decrease)
in interest rates and a decline in the U.K. pound/dollar exchange rate. We used
market rates as of December 31, 2003 on our financial instruments to perform the
sensitivity analysis. We believe that these potential changes in market rates
are reasonably possible in the near-term (one year or less). We have conducted
an analysis of the impact of a 100 basis point change in interest rates and a
10% decline in the U.K. pound/dollar exchange rate, discussed below.
Interest Rate Exposure
Our primary interest rate exposure relates to our variable rate debt. We
utilize a combination of variable rate debt, primarily under our Credit
Agreement, and fixed rate debt, primarily under our 11 7/8% Senior Subordinated
Notes. Our Credit Agreement requires that, at least 45% of our funded
indebtedness be fixed-rate or subject to interest rate hedging agreements to
reduce the risk associated with variable-rate debt. At December 31, 2003
approximately 73% of our funded indebtedness was fixed-rate. The variable rate
debt is primarily exposed to changes in interest expense from changes in the
U.S. prime rate, the federal funds effective rate and the Eurodollar borrowing
rate, while the fixed rate debt is primarily exposed to changes in fair value
from changes in medium term interest rates. Based on our indebtedness at
December 31, 2003, we estimate that an immediate 100 basis point rise in
interest rates would result in $0.6 million increase in interest expense for the
period January 1, 2004 to December 31, 2004. For purposes of this estimate, we
have assumed a constant level of variable rate debt and a constant interest rate
over the period equal to those levels existing on December 31, 2003.
21
Currency Rate Exposure
Our primary foreign currency exchange rate exposure relates to the U.K.
pound which results in our exposure to changes in the dollar exchange rate. Our
exposure to changes in U.S. dollar exchange rates with currencies other than the
U.K. pound are not currently material. Changes in translation risk are reported
as adjustments to stockholders' equity. We estimate that the impact of a 10%
decline in the dollar/U.K. pound exchange rate from $1.76/(pound)1.00 to
$1.58/(pound)1.00 at December 31, 2003 would result in a decrease in our
earnings before taxes of $0.8 million for the period from January 1, 2004 to
December 31, 2004.
Commodities Risk
We are subject to market risk with respect to commodities because our
ability to recover increased raw materials costs through higher pricing may be
limited by the competitive environment in which we operate.
We use a broad variety of specialty and some commodity raw materials in our
manufacturing processes. In 2003, we purchased about $201 million of raw
materials including acrylic monomers and polymers, resins, natural and synthetic
rubbers, solvents, and urethanes. Although these raw materials are derived from
crude oil or natural gas, the raw materials are several manufacturing steps
removed (downstream) from these basic feedstocks. As a result, the price of oil
and gas will affect our costs for these raw materials both upward and downward,
but the magnitude of change is diluted.
We typically purchase strategic raw materials on a contract basis to
moderate price changes during the contract period, however, prices can change
significantly at the end of contract periods if supply shortages, feedstock cost
pressures, or other unforeseen market conditions arise. Commodity raw materials
are available from numerous independent suppliers, and specialty raw materials
are usually available from several suppliers.
We expect the cost of many raw materials to increase over the long term. In
aggregate, we have had some success historically in passing on raw material cost
increases through price increases to our customers over time under certain
competitive market conditions, although not always in levels adequate to
maintain margins. We may not achieve historical levels of success in the future.
These sensitivity analyses are estimates and are based on certain
simplifying assumptions. These analyses should not be viewed as predictive of
our future financial performance. Additionally, we cannot provide any assurance
that the actual impact in any particular year will not materially exceed the
amounts indicated above.
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.
Item 9A. Controls and Procedures
We carried out an evaluation, under the supervision and with the
participation of our management, including our Chief Executive Officer and Chief
Financial Officer, of the effectiveness of the design and operation of our
disclosure controls and procedures as of the end of the period covered by this
report. Based upon that evaluation, our Chief Executive Officer and Chief
Financial Officer concluded that our disclosure controls and procedures are
effective in timely alerting them to material information relating to us
(including our consolidated subsidiaries) required to be included in our
periodic SEC filings.
There were no changes in our internal controls over financial reporting
that occurred during the most recent fiscal quarter that have materially
affected, or are reasonably likely to materially affect our internal control
over financial reporting.
22
PART III
Item 10. Directors and Executive Officers of the Registrant
The following table sets forth certain information with respect to: (1) each
member of our Board of Directors; (2) each of our executive officers; and (3)
certain of our key managers and key managers of our subsidiaries.
Name Age Position*
------------------------ --------------------------------
Norman E. Wells, Jr..... 55 Chairman of the Board, and Chief
Executive Officer, Director
John R. Knox............ 38 President and Chief Operating Officer
Terry D. Smith.......... 49 Vice President, Chief Financial
Officer, Chief Accounting Officer and
Treasurer
Louis M. Pace........... 32 Vice President -- Product
Development and Commercialization
Richard W. Johnston..... 57 Vice President -- Science &
Technology
Thomas DuFore........... 50 Vice President -- Human Resources
Peter Longo............. 44 President -- OSI Sealants Inc.
Patrick W. Stanton...... 36 Principal Accounting Officer,
Assistant Secretary and Assistant
Treasurer
Robert B. Covalt........ 72 Director
John L. Garcia.......... 47 Director
John D. Macomber........ 76 Director
Robert H. Malott........ 77 Director
Daniel B. Mulholland.... 51 Director
Thomas P. Salice........ 44 Director
- ----------
* Positions are with Sovereign, unless otherwise noted.
Norman E. Wells, Jr., has served as our Chief Executive Officer since July,
2002 and has been a Director since December 1999. He became Chairman of the
Board of Directors on January 1, 2003. Mr. Wells currently is a Managing
Director and Operating Partner of AEA Investors LLC, the successor company of
AEA Investors Inc. with which he has been associated for over 10 years. Mr.
Wells has served as a Director of Rand McNally from May 2001 until the present
and served as Chairman from May 2001 until December 2002. Mr. Wells also served
as Interim Chief Executive Officer of Rand McNally from December 2000 until June
2002. Mr. Wells was retained by Rand McNally to manage a comprehensive
restructuring of the business. In February, 2003, Rand McNally filed a
prepackaged bankruptcy petition in the United States Bankruptcy Court. Prior to
the filing, the Rand McNally debt holders unanimously approved the Plan of
Reorganization. Mr. Wells served as President and Chief Executive Officer of
Easco Aluminum Inc. from November 1996 to December 1999. Mr. Wells was a
Director of CasTech Aluminum Group Inc. from June 1992 to September 1996 and
served as CasTech's President and Chief Executive Officer from March 1993 to
September 1996.
John R. Knox has served as our President and Chief Operating Officer since
September, 2002 and as our Executive Vice President and Chief Operating Officer
from February 2002 to August, 2002. Prior to joining our company, Mr. Knox was
President of the European, Middle Eastern and African operations for Valspar
Corporation's packaging and industrial coatings businesses. Mr. Knox has a B.S.
in Chemical Engineering from the University of Virginia and an MBA from Harvard
University.
Terry D. Smith has served as our Vice President and Chief Financial Officer
since November 1, 2002. Prior to joining our company, Mr. Smith was Chief
Operating Officer of Roetzel and Andress, Legal Professional Association from
March, 2000 to November, 2002. From November, 1996 until February, 2000, Mr.
Smith was Executive Vice President and Chief Financial Officer of Easco, Inc.,
and from 1987 through 1996 was Vice President and Chief Financial Officer of
Castech Aluminum Group Inc. Mr. Smith is a certified public accountant and holds
a B.S. in Accounting from the University of Akron.
23
Louis M. Pace has been our Vice President- Product Development and
Commercialization since August 2003 and Vice President of Business Development
since November 2000 and Vice President of Information Technology since October
2001. He had been Vice President -- Mergers & Acquisitions since March 1999 and
has served as our Director of Mergers & Acquisitions since January 1998. From
August 1996 to December 1997, he served as our Director of Corporate Development
and Assistant Secretary. From 1995 to August 1996, Mr. Pace was an associate
with First Chicago Equity Capital. 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.
Richard W. Johnston has served as our Vice President -- Science and
Technology 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.
Thomas DuFore has been our Vice President -- Human Resources since September
2002. Mr. DuFore has served as the Vice President of Human Resources for Grand
Eagle, Inc., Easco Aluminum, and Columbia National Group. Other positions held
include Director of Human Resources for Castech Aluminum and Corporate Director
of Compensation for Carondalet Healthcare Corporation. Mr DuFore holds a BA from
Westminster College, Pa.; MLS from The University of Pittsburgh, Pa. and a JD
from The University of Akron, Oh. He is a member of the Ohio State Bar
Association.
Peter Longo has been President of OSI Sealants Inc. since 1991. OSI
Sealants Inc. comprises the Construction Segment for financial reporting
purposes. From 1989 to 1991, Mr. Longo was Vice President of Operations of OSI
Sealants. Mr. Longo has been employed by OSI Sealants for more than 20 years and
has served in a variety of capacities, including sales and marketing. Mr. Longo
attended Lakeland Community College.
Patrick W. Stanton has served as our Principal Accounting Officer since
September 1998. From April 1998 to August 1998, he served as our Manager of
Financial Planning and Control. From 1990 to March 1998, Mr. Stanton was with
Arthur Andersen LLP. Mr. Stanton is a Certified Public Accountant and holds a
B.S. in Accounting from Marquette University.
Robert B. Covalt has served as a Director since our inception, as our
Chairman from our inception in 1996 to December 31, 2002, and as Chief Executive
Officer of our company from our inception in 1996 to August 2002. Mr. Covalt was
President from inception to July 2000. Mr. Covalt is currently President of RBC
Associates, Inc. From 1979 to 1990, Mr. Covalt served as President of the
Specialty Chemicals Group of Morton International, Inc. During this period, Mr.
Covalt grew Morton's specialty chemicals group from $175.0 million to $1.3
billion in sales and he completed 13 acquisitions ranging in size from $3.0
million to $170.0 million. From 1990 to 1993, Mr. Covalt was Morton's Corporate
Executive Vice President. Prior to that time, Mr. Covalt served in various
capacities in Morton's Chemical Division which he joined in 1956. 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, an
honorary doctorate from Purdue University, and an M.B.A. from the University of
Chicago.
John L. Garcia has been a Director since December 1999. For administrative
purposes, Mr. Garcia has also served as Vice President, Assistant Treasurer, and
Assistant Secretary since December 1999. Mr. Garcia is President of AEA
Investors LLC, the successor company of AEA Investors Inc. of which he was
President since September 2002. Previously, he was a Managing Director fo AEA
Investors Inc. from May 1999. From 1994 to 1999, Mr. Garcia was a Managing
Director with Credit Suisse First Boston, where he served as Global Head of the
Chemical Investment Banking Group and Head of the European Acquisition and
Leveraged Finance and Financial Sponsors Group. His previous experience was at
with Wertheim Schroder in New York as an investment banker and ARCO Chemicals,
in research, strategic planning and corporate development roles. Mr. Garcia is
currently a director of AEA Investors LLC, Acetex Corporation and Noveon, Inc.
Mr. Garcia is a graduate of the University of Kent in England and holds a
master's degree and Ph.D. in organic chemistry from Princeton University. He
also holds a master's degree in business administration from The Wharton School
of the University of Pennsylvania.
John D. Macomber has been a Director since December 1999. Mr. Macomber has
been a principal of JDM Investment Group since 1992 and is a Director of Lehman
Brothers Holdings Inc., Mettler-Toledo International Inc. and Textron Inc. Mr.
Macomber is the former Chairman and President of the Export- Import Bank of the
United States, Chairman and Chief Executive Officer of Celanese Corporation and
Senior Partner of McKinsey & Co.
Robert H. Malott has been a Director since December 1999. Prior to his
retirement in 1997, Mr. Malott was Chairman of the Executive Committee of FMC
Corporation from November 1991 through May 1997. Mr. Malott served as Chairman
of the Board and Chief Executive Officer of FMC Corporation from 1973 to 1991.
Mr. Malott is a former Director of FMC Corporation, Amoco Corporation and United
Technologies Corporation.
24
Daniel B. Mulholland has been a Director since April 2002. Mr. Mulholland
is currently President and Chief Executive Officer of DBMulholland & Associates,
a consulting firm. From 1996 to 2001, Mr. Mulholland served as President of
Mallinckrodt Baker, Inc., a specialty chemical manufacturer. From 1995 to 1996,
Mr. Mulholland was Vice President and General Manager of Mallinckrodt Baker,
Inc. From 1992 to 1995, Mr. Mulholland served as President of J.T.Baker, Inc.
(prior to its acquisition by Mallinckrodt Chemical Company in 1995). Mr.
Mulholland has also held numerous other positions in sales, operations, and
marketing with J.T.Baker since joining the company in 1974. Mr. Mulholland is
also a director of Nazareth National Bank. Mr. Mulholland has a B.S. degree in
Finance from Lehigh University and an MBA from Ohio State University.
Thomas P. Salice has been a Director since December 1999. For
administrative purposes, Mr. Salice has also served as Vice President, Assistant
Treasurer, and Assistant Secretary since December 1999. He is Vice Chairman of
AEA Investors LLC, the successor company of AEA Investors Inc. with which he has
been associated since June 1989. Mr. Salice is also a Director of Agere Systems,
Inc., Marbo, Inc., Waters Corporation and Mettler-Toledo International Inc. Mr.
Salice is also a trustee of Fordham University.
Board Committee Membership
Our Board of Directors has two standing committees: a compensation
committee and a separately designated audit committee. The Compensation
Committee of our Board of Directors is comprised of Messrs. Macomber and Garcia.
The audit committee is comprised of Messrs. Malott, Garcia and Mulholland. Mr.
Garcia is an audit committee financial expert as defined in Item 401(h) of
Regulation S-K under the Securities Act of 1933, as amended. Mr. Garcia is not
an independent director of the Company.
Corporate Governance and Corporate Code of Ethics
We have had an adopted Code of Business Ethics in place since our incorporation
in 1997. This Code as well as policy statements regarding conflicts of interest
and anticompetitive practices are given to employees upon commencement of
employment with us and are part of our employee manual. Annually, the Chief
Executive Officer, the Chief Financial Officer, principal accounting officer,
controllers, all of senior management and key employees must complete and sign a
questionnaire covering the Code of Business Ethics as well as the other policy
statements and assert their compliance with the policies. The Code of Business
Ethics and the policy statements referred to above are filed as exhibit 14 to
the Form 10-K and is publicly available on our website at www.sovereignsc.com.
If we make an amendment to, or grant a waiver from, a provision of the Code of
Business Ethics, we will disclose the nature of such waiver or amendment on our
website.
Item 11. Executive Compensation
The table below summarizes compensation information for our Chief Executive
Officer and each of the four other most highly compensated executive officers of
our company and/or our domestic subsidiaries for services rendered during the
years ended December 31, 2003, 2002 and 2001.
Summary Compensation Table
Annual Compensation
------------------------------ Securities All Other
Fiscal Other Annual Underlying Compensation
Year Salary($) Bonus($) Compensation(1) Options(#) ($)(2)
------ ----------- ---------- --------------- ---------- ------------
Norman E. Wells, Jr 2003 $ 350,000 $ 75,000 -- -- 6,000
Chairman and Chief
Executive Officer 2002 $ 59,680(3) $150,000 -- 60,000 5,500
John R. Knox........... 2003 $ 250,000 $330,000(4) -- 35,000(6) $5,740
President and Chief
Operating Officer 2002 223,485 $41,356 100,000(5) -- $1,697
Terry D. Smith......... 2003 240,000 50,000 -- -- 6,000
Vice President and
Chief Financial Officer 2002 40,000 50,000 -- 30,000 917
(beginning November 2002)
Peter Longo............ 2003 212,500 120,517 6,325 12,000(6) 6,000
President, OSI Sealants 2002 198,250 125,563 -- -- 5,500
Inc. (Construction 2001 196,000 31,964 -- -- 4,952
Segment)
Louis M. Pace.......... 2003 166,250 45,000 -- 15,000(6) 5,225
Vice President 2002 151,875 25,000 -- -- 4,135
Product Development & 2001 150,000 5,250 -- -- 3,946
Commercialization
- ----------
(1) Except as set forth below, the aggregate amount of perquisites and other
personal benefits for any of the executives named in the above table was
less than the lesser of $50,000 or 10% of the total annual salary and bonus
reported for the named executive officer.
(2) For fiscal year 2003, represents matching and profit sharing contributions
under the 401(K) plans in the amount of $6,000, $5,740, $6,000, $6,000 and
$5,225 for Messrs. Wells, Knox, Smith, Longo and Pace.
(3) Reflects salary paid to Mr. Wells for November and December 2002. From July
24, 2002 through October 31, 2002 we paid $105,000 in an additional
management fee to AEA Investors relative to Mr. Wells performance as Chief
Executive Officer.
(4) Includes payment made to Mr. Knox for one-time signing bonus of $275,000
paid in February, 2003.
(5) Reflects payments made to Mr. Knox for relocation expenses.
(6) On February 19, 2003, Messrs. Knox, Longo and Pace surrendered 30,000,
12,000 and 11,000 options, respectively, at an exercise price of $129.50
per share. On October 7, 2003, we granted Messrs. Knox, Longo and Pace
30,000, 12,000 and 15,000 options, respectively, at an exercise price of
$115.00 per share.
Director Compensation
Members of our Board of Directors are reimbursed for traveling costs and
other out-of-pocket expenses incurred in attending board of directors and
committee meetings. Members of the Board of Directors who are also our officers
or employees of AEA Investors do not receive additional compensation for being
on the Board of Directors or its committees. Messrs. Macomber and Malott were
given a one-time opportunity to purchase units in a partnership which owns all
of the equity in SSCI Investors LLC upon their election to the Board of
Directors but receive no compensation for their services as directors. Mr.
Mulholland was granted 2,500 options to purchase our common stock in April 2002.
Compensation Committee Interlocks and Insider Participation
Our compensation committee approved various actions with respect to the
current compensation arrangements of our executive officers. As of March 2004,
the compensation committee of our Board of Directors is comprised of John D.
Macomber, Thomas P. Salice and John L. Garcia. Messrs. Garcia and Salice are
officers of Sovereign for administrative purposes only and are officers of AEA
Investors. We have a management agreement with AEA Investors Inc. under which
AEA Investors LLC provides us with advisory and consulting services for an
annual aggregate fee of $1.0 million plus reasonable out-of-pocket costs and
expenses. Approximately 75% of our capital stock is owned by SSCI Investors LLC,
which is owned by an investor group led by AEA Investors Inc. For a more
detailed discussion of relationships between AEA Investors and Sovereign see
"Certain Relationships and Related Transactions."
26
The following table sets forth information concerning stock options granted
to each of the executive officers in the Summary Compensation Table during the
fiscal year ended December 31, 2003.
OPTION GRANTS IN LAST FISCAL YEAR
Individual Grants
---------------------------------------------------------------- Potential Realizable Value at
Number of Assumed Annual Rates of
Securities Percent of Total Stock Price Appreciation for
Underlying Options Granted Exercise Option Term(3)
Options to Employees in Price ------------------------
Name Granted(#)(1) Fiscal Year(2) ($/Sh) Expiration Date 5% ($) 10% ($)
------------------- ------------- ---------------- ----------- ----------------- ----------- ------------
Norman E. Wells, Jr. -- -- -- -- -- --
John B. Knox 35,000(4) 16.3% $ 115.00 December 1, 2013 $ 5,701,100 $ 9,078,100
Terry D. Smith -- -- -- -- -- --
Peter Longo 12,000(4) 5.6% $ 115.00 June 10, 2012 1,933,000 3,046,500
Louis M. Pace 15,000 (4) 7.0% $ 115.00 October 7, 2013 2,427,800 3,843,500
- ----------
(1) The per share exercise price is the fair market value of our common stock
on the date of grant and the options have a term of 10 years, subject to
the earlier termination in the event of termination of employment. The
vesting schedule may be accelerated in connection with a transaction that
is a "change in control" as defined in our option plan.
(2) Based on options to purchase a total of 214,100 shares of our common stock
granted during our 2003 fiscal year.
(3) Values are based on assumed rates of stock appreciation of 5% and 10%
compounded annually from the date the option was granted over the full
option term. These assumed rates of appreciation are established by the SEC
and do not represent our estimate or projection of future stock price.
(4) 30,000 options granted to Mr. Knox, 12,000 options granted to Mr. Longo and
11,000 options granted to Mr. Pace were granted in October 2003 to replace
options that were surrendered by them in February 2003. The per share
exercise price is $115.00 which is greater than the exercise price on the
date of re-issuance. The new options took on the same vesting schedule as
the old options that they replaced.
The following table sets forth information concerning the value of
unexercised in-the-money options held for each of the executives listed in the
Summary Compensation Table as of December 31, 2003.
Aggregate Option Exercises in Fiscal 2003
and Fiscal Year-End Option Values
Number of
Securities Value of
Underlying Unexercised
Unexercised In-the-Money
Options at Fiscal Options at
Shares Year-End(#) Year-End($)
Acquired on Value Exercisable/ Exercisable/
Name Exercise(#) Realized($) Unexercisable Unexercisable(1)
- --------------------- -------------------------------------------------------
Norman E. Wells, Jr.. 0 0 18,750/41,250 0/0
John Knox............ 0 0 6,000/29,000 0/0
Terry D. Smith....... 0 0 5,000/20,000 0/0
Peter Longo.......... 0 0 7,920/4,080 0/0
Louis M. Pace........ 0 0 7,600/7,400 0/0
27
- ----------
(1) There was no public trading market for our common stock at December 31,
2003. Accordingly, these values of exercisable and un-exercisable
in-the-money options are based on the fair market value of our common stock
as determined by our board of directors, and the applicable exercise price
per share.
Management Incentive Compensation Plan and Employment Agreements
We believe 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. We have instituted the
following plans and programs for this purpose.
Management Incentive Compensation Plan
Selected members of our management and corporate staff judged to have the
greatest impact on our economic results are eligible to participate in this
plan. Participants are eligible for cash bonus awards based on our financial
performance as specifically defined in this plan, measured in terms of earnings
before interest, taxes, depreciation and amortization, working capital targets,
and on other company performance goals. Participants in this program are
assigned a percentage of their base salary as their bonus target for the then
current fiscal year. Awards may be higher or lower than the target bonus as our
financial performance and/or the individual's performance is above or below the
level expected to achieve the target bonus. Target bonuses range from 20% to
100% of base salary dependent upon position. In addition, our chief executive
officer may award participants bonuses supplemental to those earned under the
plan for producing extraordinary results. The management incentive compensation
plan is administered by our chief executive officer and vice president-human
resources, under the general direction of the compensation committee of our
board of directors.
Employment Agreements
We have an employment agreement with Mr. Wells dated October 1, 2002
providing for his employment as Chief Executive Officer. Under the terms of his
employment agreement, Mr. Wells has agreed to devote substantially all of his
business time and skill to his duties under his employment agreement, except for
customary matters and the performance of his duties as a Managing Director of
AEA Investors Inc. that are expected to be part time and that do not interfere
with the performance of his duties to us and our subsidiaries. We have
employment agreements with Messrs. Smith, Knox, Longo and Pace. Pursuant to
these agreements, Messrs. Wells, Smith, Knox, Longo and Pace are entitled to
annual base salaries of $350,000, $240,000, $250,000, $205,000 and $175,000,
respectively. Messrs. Knox, Longo and Pace are eligible to receive an annual
target bonus, depending on our results of operations and personal performance of
75%, 40% and 40% respectively, of their base salary determined in accordance
with the terms of the bonus plan adopted by our Board of Directors for the
calendar year. The employment agreements for Messrs. Wells and Smith provided
for a 2002 bonus of $150,000 and $50,000, respectively. They both participate in
the management incentive compensation plan beginning with the calendar year 2003
and are eligible to receive a target bonus of 100% of base salary in the case of
Mr. Wells and 58.3% of base salary in the case of Mr. Smith. Additionally, each
executive is eligible for a discretionary bonus as determined by the Board of
Directors.
Under their respective employment agreements, the executives received
non-qualified stock options and are entitled to participate in all health,
welfare and other benefit plans we provide to our executives. The employment
agreements for Mr. Wells and Mr. Smith provide that the executives will be
reimbursed for housing and living expenses in Chicago, Illinois and for travel
expenses between Chicago, Illinois and the executives' residences in Ohio. In
addition, the executives will be paid an additional amount such that there is no
after-tax cost to the executives in connection with receiving such
reimbursements. Under Mr. Wells' employment agreement, in the event payments
received by him in connection with a change in control of our Company are
subject to an excise tax under Section 4999 of the Internal Revenue Code, he may
be entitled to a gross-up payment to negate the cost of such excise tax.
The employment agreements for Messrs. Wells, Smith, Knox, Longo and Pace
provide for terms expiring on December 31, 2004, 2005, 2004, 2004 and 2004,
respectively. All of these agreements are subject to automatic one-year renewal
terms in the absence of us or the officer giving notice to the other of its
election not to renew the agreement. If we terminate an executive's employment
without cause (as defined in the employment agreements), or an executive resigns
with good grounds (as defined in the employment agreements), we are required to
28
(1) pay the executive any unpaid portion of his base salary earned
through the date of termination or resignation,
(2) continue to pay the executive his then current annual base salary
during the one-year period following termination or resignation,
(3) continue the executive's participation in employee benefit plans
during the one-year period following termination or resignation, and
(4) pay the executive a pro rata portion of his potential target annual
bonus for the calendar year of termination if the executive resigns for good
grounds. However, if we terminate the executive's employment without cause,
in the case of Mr. Wells, the pro rata potential target annual bonus will be
paid, and in the case of all other executives, the pro rata potential annual
bonus will be paid at the discretion of the chief executive officer.
All severance benefits and payments are conditioned on the executive's
execution of a general release and his compliance with certain non-competition,
non-solicitation and non-disclosure covenants.
The employment agreement for Mr. Knox provided for the following payments
within the first year of employment: a lump-sum of $100,000 for relocation costs
and, on the date of Mr. Knox first anniversary with us, a special bonus of
$275,000.
In connection with Mr. Wells' employment as our Chief Executive Officer, AEA
Investors Inc. permitted Mr. Wells to subscribe for 10,000 units of partnership
interests in SSCI Investors LP at a price per unit of $0.05 pursuant to a
subscription agreement dated as of October 1, 2002. SSCI Investors LP is the
holding entity through which the investor group led by AEA Investors Inc. holds
our capital stock. Pursuant to the related vesting agreement between AEA
Investors Inc. and Mr. Wells, also dated as of October 1, 2002, Mr. Wells'
rights to such units vest immediately as to 20% thereof, with an additional 20%
vesting on each of the subsequent four anniversaries of the date of issuance,
subject to acceleration of vesting upon a change of control and termination of
vesting and repurchase of vested and/or unvested units by AEA Investors Inc.
under various other circumstances, including termination of Mr. Wells'
employment as our Chief Executive Officer.
Stock Option Plan
The Sovereign Specialty Chemicals, Inc. Stock Option Plan provides for the
grant of nonqualified stock options to our key employees and directors. The
maximum number of shares of common stock underlying the options available for
award under the stock option plan is 299,950 shares. Under the Plan, if any
options terminate, or expire unexercised, the shares subject to such unexercised
options are again available for grant under the stock option plan.
The stock option plan is administered by the compensation committee of the
Board of Directors. Generally, the committee interprets and implements the stock
option plan, grants options, exercises all powers, authority, and discretion of
the Board under the stock option plan, and determines the terms and conditions
of option agreements, including the vesting provisions, exercise price, and
termination date of options.
Each option is evidenced by an agreement between us and an optionee. Unless
determined otherwise by the committee, 20% of the shares subject to the option
vest on each of the first five anniversaries of the grant date. Additionally,
the committee may accelerate the vesting of any option grant. The option price
is specified in each option agreement at an amount not less than the fair market
value on the grant date, unless determined otherwise by the committee. All
optionees are required to become parties to the management shareholders
agreement, which is described under "Certain Relationships and Related
Transactions."
In the event of a transaction that constitutes a change in control of our
company, as described in the stock option plan, unless determined otherwise by
the compensation committee, all options become fully exercisable immediately
prior to the date of the transaction, and we may cancel any options unexercised
as of the change in control upon our payment to the holders of options the
difference between the fair market value of the underlying stock and the option
exercise price. In the event of specified transactions that result in holders of
common stock receiving payments or securities in respect of, or in exchange for,
their common stock that do not result in a change in control of our company, as
described in the stock option plan, unless determined otherwise by the
compensation committee, options remain subject to the terms of the stock option
plan and the applicable option agreement, and thereafter upon exercise,
optionees will be entitled to receive in respect of any option the same per
share consideration received by holders of common stock at the time of the
transaction. Options will in no event entitle the holder of the option to
ordinary cash dividends payable upon the common stock issuable upon exercise of
the options.
29
In order to prevent dilution or enlargement of the rights of participants,
the stock option plan provides that the aggregate number of shares subject to
the stock option plan, any option, the purchase price to be paid upon exercise
of an option and the amount to be received in connection with the exercise of
any option will be automatically adjusted to reflect any stock splits, reverse
stock splits or dividends paid in the form of common stock, and equitably
adjusted as determined by the committee for any other increase or decrease in
the number of issued shares of common stock resulting from the subdivision or
combination of shares or other capital adjustments.
Our Board of Directors may amend, alter, or terminate the stock option plan.
Any board action may not adversely alter outstanding options without the consent
of the optionee. The stock option plan will terminate ten years from its
effective date, but all outstanding options will remain effective until
satisfied or terminated under the terms of the stock option plan.
In January 2003, the Company offered to any participant in the stock option
plan who so elected, the opportunity to voluntarily surrender all existing
option grants, both vested and unvested, and agreed to reissue new options to
those participants approximately 181 days after the existing options have been
surrendered. All participants in the plan surrendered their options on February
19, 2003. The strike price of the new grants was $115.00 which is greater than
the fair market value of the Company's stock on the date of re-issuance. All of
the participants that held options at $129.50 per share elected to surrender all
such options and receive a like number of options at the strike price as
determined above. On October 7, 2003, we granted new options at a strike price
of $115.00 to employees that had previously surrendered them at $129.50.
Total options granted at December 31, 2003 were 288,600. No options have
been exercised at December 31, 2003. The weighted average remaining contractual
life and weighted average exercise price of the options at December 31, 2003 is
7.6 years and $115.00 per option share, respectively.
Employee Stock Purchase Plan
In 2000, we adopted the Sovereign Specialty Chemicals, Inc. Employee Stock
Purchase Plan. Under the stock purchase plan eligible employees had the
opportunity to purchase up to 20,000 shares of our voting common stock. Our
employees purchased 7,045 shares at $100.00 per share. The stock purchase plan
terminated in 2000.
Common stock acquired under the stock purchase plan was purchased pursuant
to subscription agreements which define the rights and limitations of holders of
the shares. A management subscription agreement was used for grants to employees
who have entered into the management shareholders agreement, which are described
in "Certain Relationships and Related Transactions," and are governed by the
terms of the management shareholders agreement. An employee subscription
agreement will be used for grants to other employees. A summary of the employee
subscription agreement is provided below.
The employee subscription agreement provides for (1) restrictions on
transfer, (2) the right of SSCI Investors LLC, in a sale of 50% or more of its
ownership interest in the company to compel holders of shares of common stock
acquired under the stock purchase plan to sell a proportionate number of shares
and (3) rights for holders of shares of common stock acquired under the stock
purchase plan to participate in certain sales by SSCI Investors LLC.
The agreement provides further that, if we terminate for cause the
employment of a holder of shares purchased under the stock purchase plan, then
we will have the opportunity to purchase all of the holder's shares of common
stock purchased under the stock purchase plan at the lower of (1) the price paid
for the shares and (2) the then current fair market value of the shares. If the
holder's employment is terminated other than by us for cause, then we will have
the opportunity to purchase all of his or her shares at 100% of their then
current fair market value.
30
Item 12. Security Ownership of Certain Beneficial Owners and Management
Equity Compensation Plan Information
The following table provides certain information with respect to all of our
equity compensation plans in effect as of December 31, 2003:
Number of
Number of Securities
Securities to Remaining
be Issued upon Weighted Available for
Exercise of Average Future Issuance
Outstanding Exercise of Outstanding
Options Price Options
------------ ---------- --------------
Equity compensation plans
approved by security holders...... 240,713 $115.00 --
Equity compensation plans not
approved by security holders...... 47,887 $115.00 11,350
All of the securities included in the above table represent shares of our
common stock that may be issued under the Sovereign Specialty Chemicals, Inc.
Stock Option Plan. The stock option plan as originally adopted and as approved
by our security holders provided for a maximum of 240,713 shares to be issued
upon the exercise of options granted under the plan. The stock option plan was
amended by our Board of Directors in 2002 to increase the maximum number of
shares that may be issued upon the exercise of options by 59,237. Our security
holders have not approved this amendment..
The following table presents information as of February 27, 2004 regarding
the beneficial ownership of our voting common stock by each person known by us
to beneficially own more than five percent of our voting common stock and by our
Directors, certain executive officers and key managers, individually, and as a
group.
As used in this table, beneficial ownership means the sole or shared power
to vote or direct the voting or to dispose or direct the disposition of any
security. A person is deemed to be the beneficial owner of securities that can
be acquired within 60 days from February 27, 2004 through the exercise of any
option, warrant or right. Shares of common stock subject to options, warrants or
rights that are currently exercisable or exercisable within 60 days are deemed
outstanding for the computation of the ownership percentage of the person
holding such options, warrants or rights, but are not deemed outstanding for the
computation of the ownership percentage of any other person. Our non-voting
common stock is convertible into voting common stock, unless the holder or its
affiliate is prohibited by law or regulation from holding our voting common
stock. As a result, certain holders of our non-voting common stock are deemed to
hold the voting common stock into which their non-voting common stock may be
converted.
In the table below, unless otherwise noted, the address of the person is in
care of our company.
Number of Percentage
Shares Of Shares
Five Percent Security Holders
SSCI Investors LLC(1)........................ 1,624,815.75 81.7%
Robert B. Covalt(2).......................... 166,837.25 11.6%
Officers and Directors
Norman E. Wells, Jr.(3)...................... 22,500.00 1.4%
John R. Knox................................. 12,000.00 *
Terry D. Smith............................... 5,000.00 *
Richard W. Johnston.......................... 8,400.23 *
Peter Longo.................................. 18,571.63 1.3%
Louis M. Pace................................ 9,769.65 *
Patrick W. Stanton........................... 1,849.61 *
Robert B. Covalt(2).......................... 166,837.25 11.6%
John L. Garcia(3)............................ -- *
John D. Macomber............................. -- *
Robert H. Malott............................. -- *
Daniel B. Mulholland......................... 500.00 *
Thomas P. Salice(3).......................... -- *
All executive officers, key managers,
directors as a group 14 persons)(2)(3)...... 245,428.37 17.0%
- ----------
* Represents beneficial ownership of less than one percent.
31
(1) Includes 547,636.50 shares of non-voting common stock. The address for SSCI
Investors LLC is c/o AEA Investors LLC, Park Avenue Tower, 65 East 55th
Street, New York, New York 10022. The general partner of a partnership that
wholly owns SSCI Investors LLC is a wholly owned subsidiary of AEA Investors
Inc. AEA Investors disclaims beneficial ownership of the shares owned by
SSCI Investors LLC, except to the extent of its pecuniary interest therein.
The address for AEA Investors Inc. is Park Avenue Tower, 65 East 55th
Street, New York, New York 10022.
(2) Includes 47,544.61, 642.76, and 642.76 shares of common stock held by
Tregooden Partners, L.P., Nautical Partners, L.P. and Serendipity Partners,
L.P., respectively, which may be deemed to be beneficially owned by Mr.
Covalt.
(3) Does not include shares beneficially owned by AEA Investors Inc. or SSCI
Investors LLC. Messrs. Wells, Garcia and Salice are each limited partners in
SSCI Investors LP, the partnership which owns SSCI Investors LLC. Messrs.
Salice and Garcia are also officers and directors of AEA SSC Investors Inc.,
the general partner of SSCI Investors LP. Mr. Garcia is also President of
AEA Investors Inc.
Item 13. Certain Relationships and Related Transactions
Affiliates of J.P. Morgan Securities Inc. and JPMorgan Chase Bank currently
own 63,330.71 shares of our voting common stock and 182,545.5 shares of our
non-voting common stock. J.P. Morgan Securities Inc. acted as our financial
advisor in connection with SSCI Investors LLC's acquisition of our capital
stock. J.P. Morgan Securities Inc. is also the sole lead arranger and
book-running manager and JPMorgan Chase Bank is the administrative agent and
documentation agent under our Credit Agreement. J.P. Morgan Securities Inc. and
JPMorgan Chase Bank received customary fees in connection with the December 2002
amendment of our Credit Agreement.
See also "Executive Compensation" for a description of the arrangements
between us and our shareholders who are employees.
In connection with SSCI Investors LLC's acquisition of approximately 75% of
our common stock, we, SSCI Investors LLC and several members of our management
entered into a shareholders agreement. Under the management shareholders
agreement, as amended to date, SSCI Investors LLC has agreed that, prior to the
completion of an underwritten public offering of our common stock, SSCI
Investors LLC will vote all shares of common stock owned or controlled by it,
and will take all necessary or desirable actions within its control to (1) cause
at least two members of the board of directors to be members of the investor
group led by AEA Investors Inc. who are not also officers or employees of AEA
Investors Inc. and (2) for so long as the Covalt Family Group, as defined in the
shareholders agreement, owns at least 5% of the outstanding shares of our common
stock, to elect Robert B. Covalt as a director of our company and of each of our
domestic subsidiaries and, if employed by us, to cause Mr. Covalt to hold the
position of Chairman of the Board and Chief Executive Officer of our company and
Chairman of the Board of each domestic subsidiary. The obligation to elect Mr.
Covalt to be a director and have the titles described above will terminate if:
(1) the Covalt Family Group no longer holds the minimum amount of shares; (2)
Mr. Covalt, if employed by us, is terminated by us for Cause or (3) Mr. Covalt
is in Competition with us, as each of those terms are defined in the
shareholders agreement. The management shareholders agreement also (1) imposes
certain transfer restrictions on the management parties, (2) subjects employee
parties to the right of SSCI Investors LLC, in a sale of 50% or more of its
ownership interest in our company, to compel other shareholders to sell a
proportionate number of shares, (3) provides rights to management to participate
in sales by SSCI Investors LLC, (4) provides for a call option on employees'
options and subsequently acquired shares in specified termination events, (5)
provides that employee parties may request that we purchase some of their stock
in specified events, and (6) provides employee parties with piggyback
registration rights under specified circumstances.
We have also entered into a shareholders agreement with SSCI Investors LLC
and our remaining (non-employee) shareholders. This shareholders agreement
provides for (1) board observer rights for 10% shareholders, (2) restrictions on
transfer, (3) the right of SSCI Investors LLC, in a sale of 50% or more of its
ownership interest in our company to compel other shareholders to sell a
proportionate number of shares, (4) rights for other shareholders to participate
in sales by SSCI Investors LLC, (5) preemptive rights to 5% shareholders to
purchase new issuances, (6) information rights, and (7) piggyback registration
rights.
32
We have a management agreement with AEA Investors Inc. under which AEA
Investors LLC provides us with advisory and consulting services for an annual
aggregate fee of $1.0 million plus reasonable out-of-pocket costs and expenses.
In connection with our employee stock purchase plan, which we terminated in
2000, we repurchased 7,045 shares of voting common stock from AEA Investors Inc.
at $100.00 per share. All shares repurchased were sold to our employees pursuant
to the stock purchase plan at the same price per share.
Item 14. Principal Accounting Fees and Services.
Audit Fees
The aggregate fees billed by Ernst & Young LLP, our independent auditors, for
professional services rendered for the audit of our annual consolidated
financial statements and the reviews of the consolidated financial reports
included in our Quarterly Reports on Form 10-Q for the years ended December 31,
2003 and 2002 amounted to $285,000 and $325,000 respectively.
Audit-Related Fees
The aggregate fees billed by Ernst & Young LLP for assurance and other services
reasonably related to the performance of the audit or review of our financial
statements (other than those described above under "Audit Fees", including
statutory audits and 401(k) audits) for the years ended December 31, 2003 and
2002 amounted to $88,000 and $127,000 respectively.
Tax Fees
The aggregate fees billed by Ernst & Young LLP for professional services
rendered for tax compliance, tax advice and tax planning for the years ended
December 31, 2003 and 2002 amounted to $261,450 and $645,600 respectively. Such
services consisted of international and U.S. federal, state and local tax
planning, advice and compliance (including assistance with audits); review of
federal, state, local and international income, franchise, and other tax
returns; tax advice and assistance regarding statutory, regulatory or
administrative developments.
All Other Fees
No fees were billed by Ernst & Young LLP for products and services other than
those described above under "Audit Fees," "Audit-Related Fees" and "Tax Fees"
for the year ended December 31, 2003. $29,600 was billed for the year ended
December 31, 2002 relating to due diligence work on potential acquisitions.
Audit Committee Pre-Approval Policies and Procedures
In December 2003, the Audit Committee adopted polices and procedures for
pre-approving all audit and non-audit services provided by our independent
auditors prior to the engagement of the independent auditors with respect to
such services. Under the policy, our independent auditors are prohibited from
performing certain non-audit services and are pre-approved to perform certain
other non-audit and tax related services provided that the aggregate fees for
such pre-approved non-audit and tax related services do not exceed a pre-set
minimum. All audit services, audit-related services, tax services and other
services provided by Ernst & Young LLP have been pre-approved by the Audit
Committee.
33
PART IV
Item 15. 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"
included on page F-2 of this report.
2. Financial statement schedule. Schedule II -- Valuation and Qualifying
Accounts included on page S-1 of this report.
3. The exhibits listed in the "Exhibit Index" included on pages E-1, E-2
and E-3 of this report.
(b) Reports on Form 8-K.
On October 30, 2003, we filed a current report of Form 8-K, Item 12.
Disclosure of Results of Operations and Financial Condition, disclosing
that we had issued a press release on October 30, 2003 to provide an update
on our operating results for the quarter ended September 30, 2003.
(c) Exhibits. The response to this portion of Item 15 is submitted as a
separate section of this report.
(d) Financial statement schedule. See Item 15(a)(2).
34
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 February 27, 2004.
SOVEREIGN SPECIALTY CHEMICALS, INC.
By: /s/ NORMAN E. WELLS, JR.
- --------------------------------------------------------------------------------
Norman E. Wells, Jr.
Chairman and Chief Executive Officer
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 February 27, 2004.
Signature Capacity
------------------------------------ ------------------------------
/s/ NORMAN E. WELLS JR. Chairman, Chief Executive Officer and
------ ----------------------- Director
Norman E. Wells Jr. (Principal Executive Officer)
/s/ TERRY D. SMITH Vice President, Chief Financial
------ ------------------ Officer, Chief Accounting Officer
Terry D. Smith and Treasurer, (Principal Financial
Officer)
/s/ JOHN R. KNOX President and Chief Operating Officer
------ ----------------
John R. Knox
/s/ PATRICK W. STANTON Principal Accounting Officer,
------ ---------------------- Assistant Secretary
Patrick W. Stanton
/s/ ROBERT B. COVALT Director
------ --------------------
Robert B. Covalt
/s/ JOHN L. GARCIA Director
------ ------------------
John L. Garcia
/s/ JOHN D. MACOMBER Director
------ --------------------
John D. Macomber
/s/ ROBERT H. MALOTT Director
------ --------------------
Robert H. Malott
/s/ DANIEL B. MULHOLLAND Director
------ ------------------------
Daniel B. Mulholland
/s/ THOMAS P. SALICE Director
------ --------------------
Thomas P. Salice
35
Supplemental Information to be Furnished With Reports Filed Pursuant to Section
15(d) of the Act by Registrants Which Have Not Registered Securities Pursuant to
Section 12 of the Act.
The registrant has not sent an annual report or proxy materials to its
security holders during the last fiscal year. The registrant does not currently
intend to send an annual report or proxy materials to security holders
subsequent to this filing.
36
ANNUAL REPORT ON FORM 10-K
ITEMS 8 AND 15(a)
INDEX TO FINANCIAL STATEMENTS
F-1
SOVEREIGN SPECIALTY CHEMICALS, INC.
AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
CONTENTS
Consolidated Financial Statements.................. F-2
Report of Independent Auditors..................... F-3
Consolidated Balance Sheets........................ F-4
Consolidated Statements of Operations.............. F-5
Consolidated Statements of Stockholders' Equity.... F-6
Consolidated Statements of Cash Flows.............. F-7
Notes to Consolidated Financial Statements......... F-8
F-2
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, 2003
and 2002, and the related consolidated statements of operations, stockholders'
equity, and cash flows for each of the three years in the period ended December
31, 2003. Our audits also included the financial statement schedule listed in
the index at Item 15(a). 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 auditing standards generally
accepted in the United States. 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, 2003 and 2002, and
the consolidated results of their operations and their consolidated cash flows
for each of the three years in the period ended December 31, 2003, in conformity
with accounting principles generally accepted in the United States. 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.
As discussed in Note 2 and Note 3, in 2002 the Company changed its method of
accounting for goodwill and other intangible assets to conform to Statement of
Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets".
ERNST & YOUNG LLP
Chicago, Illinois
February 17, 2004
F-3
SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31,
2003 2002
(Dollars in thousands,
except per share data)
ASSETS
Current assets:
Cash and cash equivalents................................................. $ 8,454 $ 14,124
Accounts receivable, less allowance of $1,405 and
$1,940................................................................. 51,205 49,554
Inventories............................................................... 26,574 28,203
Deferred income taxes..................................................... -- 5,257
Other current assets...................................................... 3,785 3,879
----------- -----------
Total current assets........................................................ 90,018 101,017
Property, plant, and equipment, net......................................... 67,877 67,950
Goodwill, net............................................................... 124,388 124,388
Deferred financing costs, net............................................... 7,274 9,350
Deferred income taxes....................................................... -- 5,872
Other assets................................................................ 187 91
----------- -----------
Total assets................................................................ $ 289,744 $ 308,668
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................................... $ 31,327 $ 31,606
Accrued expenses.......................................................... 22,758 24,017
Current portion of long-term debt......................................... 2,122 2,041
Current portion of capital lease obligations.............................. 429 402
----------- -----------
Total current liabilities................................................... 56,635 58,066
Long-term debt, less current portion........................................ 206,108 218,853
Capital lease obligations, less current portion............................. 2,118 2,496
Other long-term liabilities................................................. 2,319 3,400
Stockholders' equity:
Common stock, $0.01 par value, 2,700,000 shares
authorized, 1,441,189 issued and
outstanding............................................................ 15 15
Common stock, non-voting, $0.01 par value, 2,100,000
shares authorized, 730,182 issued and outstanding...................... 7 7
Additional paid-in capital................................................ 64,073 64,073
Accumulated deficit....................................................... (40,488) (36,272)
Accumulated other comprehensive loss...................................... (1,043) (1,970)
-----------------------
Total stockholders' equity.................................................. 22,564 25,853
----------- -----------
Total liabilities and stockholders' equity.................................. $ 289,744 $ 308,668
=========== ===========
See accompanying notes to consolidated financial statements.
F-4
SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
December 31,
2003 2002 2001
------------------------ --------
(Dollars in thousands)
Net sales...................................................... $ 371,616 $ 361,110 $ 356,701
Cost of goods sold............................................. 268,375 259,760 259,253
----------- ----------- -----------
Gross profit................................................... 103,241 101,350 97,448
Selling, general, and administrative expenses.................. 70,438 75,960 78,015
----------- ----------- -----------
Operating income............................................... 32,803 25,390 19,433
Interest expense, net.......................................... (25,417) (25,527) (26,990)
----------------------- -----------
Income (loss) before income taxes and
the cumulative effect of change in accounting principle...... 7,386 (137) (7,557)
Income tax expense (benefit)................................... 11,602 305 (1,500)
----------- ----------- -----------
Loss before cumulative effect of change in accounting principle (4,216) (442) (6,057)
Cumulative effect of change in accounting principle, net of
income tax benefit............................................. -- (17,064) --
----------- ----------- -----------
Net loss....................................................... $ (4,216)$ (17,506) $ (6,057)
======================= ===========
See accompanying notes to consolidated financial statements.
F-5
SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Accumulated
Common Additional Other
Common Stock, Paid-In Accumulated Comprehensive
Stock Non-Voting Capital Deficit Income (Loss) Total
------ ----------- ---------- ----------- ------------- ---------
(Dollars in thousands)
Balance at January 1, 2001. 15 7 63,678 (12,709) 271 51,262
Comprehensive loss:
Net loss................. -- -- -- (6,057) -- (6,057)
Minimum pension liability
adjustments, net of tax -- -- -- -- (433) (433)
Translation adjustments.. -- -- -- -- (1,114) (1,114)
Total comprehensive ---------
Loss................... (7,604)
Sale of common stock....... -- -- 400 -- -- 400
----- ----- -------- --------- -------- ---------
Balance at December 31, 2001 15 7 64,078 (18,766) (1,276) 44,058
Comprehensive loss:
Net loss................. -- -- -- (17,506) -- (17,506)
Minimum pension liability
adjustments, net of tax -- -- -- -- (259) (259)
Translation adjustments.. -- -- -- -- (435) (435)
Total comprehensive ---------
Loss................... (18,200)
Repurchase of common stock. -- -- (5) -- -- (5)
----- ----- -------- --------- -------- ---------
Balance at December 31, 2002 $ 15 $ 7 $ 64,073 $ (36,272) $ (1,970) $ 25,853
Comprehensive income:
Net loss................. -- -- -- (4,216) -- (4,216)
Minimum pension liability
adjustments, net of tax -- -- -- -- 128 128
Translation adjustments.. -- -- -- -- 799 799
Total comprehensive ---------
Income................. ($3,289)
Balance at December 31, 2003 $ 15 $ 7 $ 64,073 $ (40,488) $ (1,043) $ 22,564
===== ===== ======== ========== ========= =========
See accompanying notes to consolidated financial statements.
F-6
SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
December 31,
2003 2002 2001
------------ ----------- -----------
(Dollars in thousands)
Operating activities
Net loss..................................................... $ (4,216) $ (17,506) $ (6,057)
Adjustments to reconcile net loss to net cash provided by
operating activities:
Depreciation and amortization............................. 9,310 9,149 19,262
Cumulative effect of change in accounting principle,
net of income tax benefit............................... -- 17,064 --
Deferred income taxes..................................... 11,129 19 (922)
Amortization of deferred financing costs.................. 2,076 1,790 1,363
Foreign exchange (gains) losses........................... (1,707) (1,442) 458
Amortization of debt discounts............................ 583 82 132
Loss on sale of Nashville facility........................ -- 72 --
Changes in operating assets and liabilities (net of
acquisitions):
Accounts receivable..................................... (729) 6,788 (2,159)
Inventories............................................. 2,261 9,815 4,691
Prepaid expenses and other assets....................... 61 2,688 177
Accounts payable and other liabilities.................. (3,039) 6,768 1,626
------------ ----------- -----------
Net cash provided by operating activities...................... 15,729 35,287 18,571
Investing activities
Acquisition of businesses.................................... -- -- (8,261)
Proceeds from sale of property, plant and equipment.......... -- 362 --
Purchase of property, plant, and equipment................... (8,182) (6,560) (8,040)
------------ ----------- -----------
Net cash used in investing activities........................ (8,182) (6,198) (16,301)
Financing activities
Capital contributions........................................ -- (5) 400
Proceeds from credit facilities.............................. 29,000 7,000 41,840
Payments on credit facilities................................ (40,965) (34,578) (37,302)
Payments on long-term debt................................... (775) -- --
Deferred financing costs..................................... -- (2,196) (404)
Proceeds from acquisition notes payable...................... -- -- 1,273
Payments on acquisition notes payable........................ (507) (472) (200)
Payments on capital lease obligations........................ (351) (391) (255)
------------ ----------- -----------
Net cash provided by (used in) financing activities.......... (13,598) (30,642) 5,352
Effect of exchange rate changes on cash...................... 381 91 (46)
----------- ----------- -----------
Net increase (decrease) in cash and cash equivalents......... (5,670) (1,460) 7,576
Cash and cash equivalents at beginning of year............... 14,124 15,584 8,008
----------- ----------- -----------
Cash and cash equivalents at end of year..................... $ 8,454 $ 14,124 $ 15,584
=========== =========== ===========
See accompanying notes to consolidated financial statements.
F-7
SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the periods ended December 31, 2003, 2002 and 2001
(Dollars in thousands, unless otherwise noted)
1. Nature of Business
The Company develops, produces and distributes adhesives, sealants and
coatings utilized in numerous industrial and commercial applications. Currently,
the Company's operations are comprised of two reportable segments: a Commercial
segment and a Construction segment. The commercial segment serves a range of
industrial markets, including high-performance specialty adhesives and coatings
for transportation, furniture, product assembly, flame retardant specialties and
specialty polymers. The commercial segment also manufactures coating and
adhesive products for packaging, paper converting and graphic arts applications.
The construction segment manufactures branded caulk, sealants and adhesives
which serve the following markets: distributors for professional contractors,
OEMs, Co-Op distributors and do-it-yourself retailers. Products are sold and
distributed throughout the United States, Europe, Latin America and Asia.
2. Summary of Significant Accounting Policies
Principles of Consolidation
The accompanying consolidated financial statements include the accounts and
transactions of the Company and its wholly owned subsidiaries. All significant
intercompany balances and transactions have been eliminated in consolidation.
Cash and Cash Equivalents
The Company considers all highly liquid debt instruments with original
maturities of three months or less to be cash equivalents.
Inventories
Inventories are valued at the lower of cost or market. Cost is determined
primarily 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 fifteen years for machinery and equipment; five
to fifteen years for furniture and fixtures, and 39 to 40 years for buildings.
Leasehold improvements are amortized over the lesser of the lease term or 40
years. Depreciation expense was $ 9,310, $8,632, and $8,159, for the years ended
December 31, 2003, 2002, and 2001, respectively.
Goodwill
Goodwill has been amortized through December 31, 2001, on a straight-line basis
over its estimated useful life. Accumulated amortization of goodwill was $30.1
million at December 31, 2001. Effective January 1, 2002, pursuant to the
adoption of SFAS 142, Goodwill and Other Intangible Assets, goodwill is longer
subject to amortization. However, goodwill is reviewed for impairment on at
least an annual basis by comparing the fair value of the Company's reporting
units (construction, commercial domestic and commercial international) to the
individual units's carrying value. If the fair value of the reporting units
exceeds carrying value, no impairment is recognized. If the carrying value
exceeds the fair value of the reporting unit, the implied value of goodwill is
compared to the carrying value of goodwill to determine the extent, if any, of
impairment. In 2002, in accordance with the initial adoption of SFAS 142, the
Company performed the transitional impairment test of goodwill and recognized
goodwill impairment of $17.1 million, net of income tax benefit. The adoption of
SFAS No. 142 resulted in a $10.0 million decrease in amortization expense in
2002 (See Note 3).
F-8
Deferred Financing Costs
The costs of obtaining financing are capitalized and are being amortized as
interest expense over the term of the related financing using a method which
approximates the interest method. Accumulated amortization was $6,403 and $4,327
at December 31, 2003 and 2002, respectively.
Impairment of Long-Lived Assets
Long-lived assets are reviewed for impairment whenever 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.
Income Taxes
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, goodwill amortization, net operating loss
carry-forwards, inventory reserves and capitalization, the allowance for
doubtful accounts, and various accruals. The requirement for a valuation
allowance on deferred tax assets isdetermined based on management's estimate of
the ultimate realization of such assets.
Revenue Recognition
Revenue is recognized when products are shipped to the customer and title
transfers.
Research and Development
Research and development costs are charged to expense as incurred. Research
and development expenses were $7.0 million, $7.0 million and $6.4 million for
the years ended December 31, 2003, 2002 and 2001, respectively.
Translation of Foreign Currencies
The Company's foreign subsidiaries use the local currency of each
operation's home country as their functional currency. Accordingly, assets and
liabilities are translated using the exchange rates as of the balance sheet
dates and the statement of operations account balances are translated using a
weighted-average exchange rate during the applicable period. Adjustments
resulting from such translation are included in accumulated other comprehensive
loss, a separate component of stockholders' equity.
Fair Value of Financial Instruments
The carrying value of cash and cash equivalents, trade accounts receivable
and accounts payable approximate their fair value at December 31, 2003 and 2002,
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
re-priced 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.
The fair value of the Company's 11 7/8% Senior Subordinated Notes
approximated $150.0 million at December 31, 2003 based upon the trading value of
the notes in public debt market.
F-9
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. 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 allowance for
doubtful accounts.
At December 31, 2003 and 2002, the Company maintained cash deposits with
certain financial institutions which were in excess of federally insured limits.
Use of Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Actual results could differ from those
estimates.
Reclassifications
Certain prior years' amounts have been reclassified to conform to the 2003
presentation.
Stock Options
The Company accounts for stock options granted to employees and directors in
accordance with Accounting Principles Board Opinion No. 25, Accounting for Stock
Issued to Employees (APB 25). In accordance with APB 25, employee and director
compensation expense is recognized based upon the excess of fair value of the
underlying stock over the option exercise price on the measurement date, the
date at which both the exercise price and the number of shares to be issued are
known.
Had the provisions of SFAS 123 "Accounting for Stock Based Compensation"
been used in the calculation of compensation expense (calculated using the
minimum value method for non-public companies), pro forma net loss would have
been as follows for the three years ended December 31, 2003:
Year Ended December 31,
-------------------------------
2003 2002 2001
--------- --------- ---------
(In thousands)
Net loss, as reported..................... $ (4,216) $(17,056) $ (6,057)
Compensation expense under SFAS 123,
net of tax Effect........................ (477) (557) (625)
--------- --------- ---------
Pro forma net loss........................ $ (4,693) $(17,613) $ (6,682)
========= ========= =========
New Accounting Standards
In April 2002, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 145, Rescission of FASB
Statements No. 4, 44, and 62, Amendment of FASB Statement No. 13, and Technical
Corrections. SFAS 145 requires that certain gains and losses on extinguishments
of debt be classified as income or loss from continuing operations rather than
as extraordinary items as previously required under SFAS No. 4, Reporting Gains
and Losses from Extinguishment of Debt. This statement also amends SFAS No. 13,
Accounting for Leases, to require certain modifications to capital leases be
treated as sale-leaseback and modifies the accounting for sub-leases when the
original lessee remains a third party obligor (or guarantor). The Company
adopted SFAS No. 145 on January 1, 2003. The initial adoption of SFAS No. 145
did not affect the Company's results of operations or its financial position.
In August 2002, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 146 (SFAS 146), "Accounting for Costs
Associated with Exit or Disposal Activities." SFAS 146 nullifies the guidance of
the Emerging Issues Task Force (EITF) Issue No. 94-3, "Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs incurred in a Restructuring)." SFAS 146 requires that a
liability for a cost that is associated with an exit or disposal activity be
recognized when the liability is incurred. SFAS 146 also establishes that fair
value is the objective for the initial measurement of the liability. The
provisions of SFAS 146 are required for exit or disposal activities that are
initiated after December 31, 2002. The initial adoption of SFAS No. 146 did not
affect the Company's results of operations or its financial position.
F-10
In December 2002, the FASB issued Statement of Financial Accounting Standards
No. 148, Accounting for Stock-Based Compensation--Transition and Disclosure
("SFAS 148"). SFAS 148 amends SFAS 123 and provides alternative methods of
transition for a voluntary change to the fair value based method of accounting
for stock-based employee compensation. SFAS 148 also amends the disclosure
requirements of SFAS 123 to require prominent disclosures in both annual and
interim financial statements about the method of accounting for stock-based
employee compensation and the effect of the method used on reported results.
SFAS 148 is effective for financial statements for annual periods ending after
December 15, 2002, and interim periods beginning after December 31, 2002. The
Companyhas adopted the disclosure requirements of SFAS 148 but will continue to
use APB 25 to account for stock-based compensation.
In January 2003, the FASB issued FASB Interpretation (Interpretation) No. 46,
Consolidation of Variable Interest Entities. Interpretation No. 46 addresses
consolidation by business enterprises of variable interest entities (VIEs) which
have one or both of the following characteristics: (1) the equity investment at
risk is not sufficient to permit the entity to finance its activities without
additional subordinated support from other parties, which is provided through
other interests that will absorb some or all of the expected losses of the
entity; or (2) the equity investors lack one or more of the following essential
characteristics of a controlling financial interest: (a) the direct or indirect
ability to make decisions about the entities' activities through voting rights
or similar rights; or (b) the obligation to absorb the expected losses of the
entity if they occur, which makes it possible for the entity to finance its
activities; or (c) the right to receive the expected residual returns of the
entity if they occur, which is the compensation for the risk of absorbing the
expected losses. Interpretation No. 46 is applied immediately to VIEs created
after January 31, 2003. Pursuant to FASB revision to Interpretation No. 46 (FSP
46-6), a public entity need not apply the provisions of Interpretation No. 46 to
an interest held in a VIE or a potential VIE until the end of the first interim
or annual period ending after March 15, 2004, if the VIE was created before
February 1, 2003, and the public entity has not issued financial statements
reporting that VIE as consolidated in accordance with Interpretation No. 46. The
Company does not expect the adoption of Interpretation 46 to have any impact on
our consolidated results of operations or financial position.
In December 2003, the FASB issued a revision of FASB Statement No. 132,
Employers' Disclosures about Pensions and Other Postretirement Benefits (SFAS
132), to improve financial statement disclosures for defined benefit plans. The
change replaced existing disclosure requirements for pensions. The standard
requires that companies provide more details about their plan assets, benefit
obligations, cash flows, benefit costs and other relevant information. Companies
now are required to provide financial statement users with a breakdown of plan
assets by category, such as equity, debt and real estate and a description of
investment policies and strategies and target allocation percentages, or target
ranges, for these asset categories. Cash flow information will include
projections of future benefit payments and an estimate of contributions to be
made in the next year to fund pension and other postretirement benefit plans. In
addition to expanded annual disclosures, companies now are required to report
the various elements of pension and other postretirement benefit costs on a
quarterly basis. The provisions of SFAS 132 remain in effect until the
provisions of this Statement are adopted. Except for disclosure of information
about foreign plans, which is effective for fiscal years ending after June 15,
2004, and disclosure of estimated future benefit payments, which are effective
for fiscal years ending after June 15, 2004, this Statement is effective for
financial statements with fiscal years ending after December 15, 2003. The
interim-period disclosures required by this Statement are effective for interim
periods beginning after December 15, 2003.
.
3. Goodwill and Intangible Assets
On January 1, 2002, the Company adopted Statement of Financial Accounting
Standards No. 142 "Goodwill and Other Intangible Assets" (SFAS 142). The
adoption of SFAS 142 eliminated the amortization of goodwill beginning January
1, 2002 and instead required that goodwill be tested for impairment. The
adoption of SFAS No. 142 resulted in a $10.0 million decrease in amortization
expense in 2002. In connection with our adoption of SFAS No. 142, the
transitional intangible asset impairment test required an impairment of goodwill
charge of $27.6 million ($17.1 million, net of income tax benefit). The loss was
recorded as a cumulative effect of change in accounting principle. The
impairment loss and write-down of goodwill was recorded relative to the
Company's European reporting unit of its commercial segment.
Actual results of operations for the years ended December 31, 2003 and 2002
and the pro forma results of operations for the year ended December 31, 2001 had
we applied the non-amortization provisions of SFAS 142 in the prior period are
as follows:
F-11
Year Ended December 31,
-------------------------------
2003 2002 2001
--------- --------- ---------
(In thousands)
Net loss, as reported................... $ (4,216) $(17,506) $ (6,057)
Elimination of goodwill amortization,
net of tax Effect...................... -- -- 6,206
--------- --------- ---------
Pro forma net income (loss)............. $ (4,216) $ (17,506) $ 149
========= ========= ========
4. Plant Closure Costs
In November 2002, the Company announced the closure of two of its
higher-cost manufacturing plants in 2003. At the time of the announcement, the
Cincinnati, Ohio plant employed 118 people, and primarily produced water-borne
adhesives sold to the industrial market. Substantially all production from this
plant was transferred to the Company's plants in Greenville, South Carolina, and
Carol Stream and Plainfield, Illinois in the first nine months of 2003.
Production related to the final product line to be transferred will be complete
in the first quarter of 2004. Some of the technical, sales support, customer
service, and administrative functions have been transitioned to other Company
locations. Approximately 88 employees, in both manufacturing and support
functions will be terminated as part of the closure. At December 31, 2003, 70
employees have been terminated under the announced plan.
At the time of the November 2002 announcement, the Kapellen, Belgium plant
employed 24 people and produced water-borne and hot-melt adhesives for the
European packaging and converting market. This production was shifted to the
Newark, United Kingdom plant during the first nine months of 2003. Approximately
16 employees primarily in manufacturing functions have been terminated as part
of the plant closure. A separate Kapellen office will continue to provide sales,
technical and distribution support to continental Europe.
These closures include the termination of certain existing employees, the
abandonment or sale at a loss of certain fixed assets, the disposal of certain
inventory and the sale of certain buildings. As a result of the announced
closures the Company recorded a charge of approximately $4.1 million in the
fourth quarter of 2002 and an additional charge of $0.4 million in the first
half of 2003, included in selling, general and administrative expense, relative
to the following costs: termination benefits of $2.0 million, loss on fixed
assets of $1.3 million and other exit costs of $1.2 million. Approximately $0.9
million of termination benefits, $0.3 million of fixed asset write offs, and
$0.4 million of other exits costs were incurred in the year ended December 31,
2003. Approximately $0.5 million of termination benefits, $1.0 million write
down of fixed assets in Cincinnati and $0.5 million of other exit costs will be
incurred in 2004 and are recorded in accrued liabilities on the balance sheet.
Approximately $0.6 million of termination benefits in Belgium are long term and
this obligation and $0.3 million in other exit costs are recorded in other long
term liabilities at December 31, 2003.
The following provides an analysis of the changes in the plant closure
liability for the year ended December 31, 2003:
Liability for plant closures, balance at January 1, 2003......... $ 4,066
Add: Adjustment to severance liability for Kapellan.............. 393
Less: Plant closure costs incurred year ended December 31, 2003.. (1,605)
---------
Total liability for plant closures, balance at December 31, 2003. $ 2,854
=========
5. Business Combinations
Effective June 30, 2001, the Company completed the purchase of certain
distribution activities and inventory of IMPAG, a long standing European
distributor of products produced by Sovereign for $1.7 million. Consideration
was payable in four installments. In July, 2001, the Company paid $0.5 million.
Approximately $0.3 million was paid in January, 2002 and $0.5 million was paid
in January 2003 and 2004. The Company recognized $1.5 million in goodwill.
This acquisition was accounted for under the purchase method of accounting.
Accordingly, the allocation of the cost of the acquired assets and liabilities
was made on the basis of the fair value. The consolidated financial statements
include the operating results of the acquired business from the date of
acquisition.
F-12
6. Inventories
Inventories are summarized as follows:
December 31
--------------------
2003 2002
--------- ----------
Raw materials..... $ 9,235 $ 8,920
Work in process... 478 440
Finished goods.... 16,861 18,843
--------- ----------
$ 26,574 $ 28,203
========= ==========
7. Property, Plant, and Equipment
Property, plant, and equipment are summarized as follows:
December 31
-----------------------
2003 2002
----------- -----------
Land.............................. $ 5,787 $ 5,681
Building and improvements......... 32,112 30,226
Machinery and equipment........... 79,326 70,155
Furniture and fixtures............ 2,313 2,138
Construction-in-progress.......... 1,237 3,469
----------- -----------
120,685 111,669
Less: Accumulated depreciation.... 52,808 43,719
----------- -----------
$ 67,877 $ 67,950
=========== ===========
8. Accrued Expenses
Accrued expenses are summarized as follows:
December 31
-------------------
2003 2002
-------- --------
Interest...................... $ 6,024 $ 5,441
Compensations and benefits.... 7,492 9,003
Plant closures................ 1,954 2,453
Rebates....................... 3,694 3,112
Other......................... 3,594 4,008
-------- --------
$22,758 $24,017
======== ========
9. Long-Term Debt
Long-term debt is summarized as follows:
December 31
-----------------------
2003 2002
----------- -----------
11 7/8% Senior Subordinated Notes due 2010,
net of unamortized discount............... $ 149,333 $ 149,226
Credit facilities.......................... 58,397 70,356
Acquisition notes payable.................. 500 1,312
----------- -----------
208,230 220,894
Less: Current maturities................... 2,122 2,041
----------- -----------
$ 206,108 $ 218,853
=========== ===========
Senior Subordinated Notes
In March 2000, the Company completed a private placement of $150.0 million
in principal amount of 11 7/8% Senior Subordinated Notes (the Notes) due 2010.
The Notes were subsequently exchanged for notes with substantially identical
terms that were registered with the SEC. The Notes were issued at a discount of
$1.1 million which is being amortized to interest expense over the life of the
Notes. At December 31, 2003 the unamortized discount is $0.7 million.
F-13
The Notes mature on March 15, 2010. Interest is payable semi-annually in
arrears each March 15 and September 15. On or after March 15, 2005, 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
2005................. 105.938%
2006................. 103.958%
2007................. 101.979%
2008 and thereafter.. 100.000%
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 domestic subsidiaries -- (the Guarantor Subsidiaries).
Each of the Guarantor Subsidiaries' guarantees of the Notes are full,
unconditional, and joint and several.
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.
Credit Facilities
The Company's credit agreement, as amended (Credit Agreement), provides for
aggregate borrowings of $108.1 million. The Credit Agreement includes (1) a
$50.0 million revolving credit facility (Credit Facility) (including letters of
credit of up to $20 million), (2) Term Loan A with an aggregate principal
balance of $11.1 million at December 31, 2003 and no capacity to borrow
additional funds under that facility and (3) Term Loan B with an aggregate
principal balance of $47.0 million at December 31, 2003 and no additional
capacity to borrow additional funds under that facility.
The Credit Facility matures December 30, 2005. Commitment fees on the unused
portion of the Credit Facility of 0.375% to 0.050% are payable quarterly in
arrears. At December 31, 2003, the Company had $1.0 million outstanding and
$46.9 million in available borrowings under the Credit Facility (net of
approximately $2.1 million outstanding letters of credit). The Company's
effective interest rate for its borrowings under the Credit Agreement was 5.8%
and 5.9%, for the years ended December 31, 2003 and 2002, respectively.
Borrowings under the Credit Facility are available on a revolving basis and
may be used for general corporate purposes, excluding, however, loans, advances
and investments, including acquisitions, by the Company other than specified
exceptions.
On December 20, 2002 the Company amended its Credit Agreement and refinanced
$45.1 million of the $56.3 Term Loan A outstanding balance at that date with a
new six year, $47.5 million Term Loan B facility. The Term Loan B includes a
$2.4 million discount which is being amortized through interest expense over the
life of the facility. The Term Loan B will mature December 30, 2007. Scheduled
principal repayment under the Term Loan B facility for the years ending December
31, 2003 through 2006 will be $0.5 million per year payable quarterly. The
remaining balance under Term Loan B, will be repaid in 2007. The Company has
three scheduled quarterly payments in 2007 at the same rate of $0.5 million per
year and a final payment due for the balance outstanding at December 30, 2007.
There is no scheduled amortization for the $11.1 million outstanding under the
Term Loan A for the years ending December 31, 2003 and 2004. The remaining $11.1
million drawn under Term Loan A will be repaid in 2005.
Borrowings under the Credit Agreement bear interest at the Company's option
at a rate per annum equal to either (1) the higher of (a) the current base rate
as offered by JPMorgan Chase or (b) 1/2 of 1% per annum above the federal funds
rate plus, in either case, an applicable margin or (2) a Eurodollar rate plus an
applicable margin. The applicable margin varies by facility. For amounts drawn
under the Term Loan A and the Credit Facility the Eurodollar margin is 3.75% and
the base rate margin is 2.75%. For amounts drawn under the Term Loan B facility,
the Eurodollar margin is 4.50% and the base rate margin is 3.50%. Amounts
outstanding under the Credit Facility, Term Loan A and Term Loan B bear
interest, payable quarterly in the case of base rate advances and payable at the
end of the relevant interest period of one, two, three or six months (or
quarterly in certain cases) for all Eurodollar advances.
F-14
The Company's Singapore-based sales office has a facility providing for
borrowings up to approximately $1.4 million in U.S. dollars and is secured by a
letter of credit. Interest is payable at United States prime plus 1.0%. At
December 31, 2003, approximately $1.1 million was drawn on the facility.
At December 31, 2003, the Company had $1.0 million drawn under our Credit
Facility, and approximately $2.1 million of outstanding letters of credit. At
December 31, 2003, the Company had approximately $46.9 million of borrowing
availability under the Credit Facility.
The Credit Agreement obligates us to make mandatory prepayments in certain
circumstances with the proceeds of asset sales or issuance of capital stocks or
indebtedness and with certain excess cash flow. The Credit Agreement contains
covenants that restrict the Company's and its subsidiaries' ability to incur
additional indebtedness, incur liens, dispose of assets, prepay or amend other
indebtedness, pay dividends or purchase our stock, and change the business
conducted. In addition, the Company must also comply with specified financial
ratios and tests including maintenance of maximum total debt to EBITDA, maximum
senior debt to EBITDA, minimum EBITDA to interest expense, and minimum asset
coverage ratios (in each case, as defined in our credit agreement) and other
covenants at the end of each fiscal quarter. The covenant ratio calculations in
the credit agreement utilize non GAAP financial measures that are specifically
defined in the Credit Agreement. At December 31, 2003, the Company was in
compliance with all financial and other covenants as prescribed by the Credit
Agreement.
Each of these covenants continues for the term of the Credit Agreement
either at the latest level, or a more restrictive level. Deterioration in
current operating performance could result in the failure to satisfy financial
covenants. A failure to satisfy the covenants under the Credit Agreement would
trigger the lenders' right to require immediate repayment of all or part of the
indebtedness; such acceleration, in turn, would also give rise to a right to
require immediate repayment by holders of the subordinated notes. The Credit
Facility, Term Loan A and Term Loan B are secured by a security interest in
substantially all of the subsidiaries' assets, including pledges of the common
stock of the Company's domestic and first tier foreign subsidiaries. In
addition, the Credit Facility, Term Loan A and Term Loan B are guaranteed by its
subsidiaries. Some of our guarantees and pledges are in support of only offshore
advances, if any, under the Credit Facility.
Acquisition Notes Payable
In connection with its 2001 acquisition of IMPAG, the Company will pay $1.3
million in consideration in three installments. Approximately $0.3 million and
$0.5 million was paid in January 2002 and 2003, respectively, and approximately
$0.5 million will be paid in January 2004.
Annual Maturities
Annual maturities of the Company's long-term debt are as follows at December
31, 2003:
2004........................... 2,122
2005........................... 12,600
2006........................... 475
2007........................... 45,600
2008 and thereafter............ 150,000
-----------
210,797
Less: un-amortized discounts... (2,567)
-----------
Total long-term debt........... $ 208,230
===========
10. Income Taxes
The components of the provision for income taxes are as follows for the
years ended December 31, 2003, 2002 and 2001:
F-15
2003 2002 2001
------------ ---------- ----------
Current income tax expense (benefit):
Federal............................................. $ -- $ -- $ (774)
State............................................... (85) 46 (97)
Foreign............................................. 558 238 293
----------- ---------- ----------
473 284 (578)
Deferred income tax expense........................... 11,129 19 (922)
----------- ---------- ----------
11,602 305 (1,500)
Cumulative effect of change in
accounting principle................................ -- (10,546) --
----------- --------- ----------
Income tax expense (benefit).......................... $ 11,602 $(10,241) $ (1,500)
=========== ======== ==========
The reconciliation of income tax expense computed at the U.S. federal
statutory tax rates to income tax expense (benefit), inclusive of tax benefits
on extraordinary items, is as follows for the years ended December 31, 2003,
2002 and 2001:
2003 2002 2001
----------- ----------- ----------
Income tax expense (benefit) at federal
statutory rate.............................. $ 2,351 $ (9,492) $ (2,569)
State tax expense (benefit), net of federal
benefit..................................... 298 (1,187) (321)
Foreign income taxes......................... 558 238 65
Non-deductible amortization of goodwill...... -- -- 866
Change in deferred tax asset valuation
allowance................................... 7,899 -- --
Other........................................ 496 200 459
----------- ----------- ----------
Income tax expense (benefit)................. $ 11,602 $ (10,241) $ (1,500)
=========== =========== ==========
Pre tax income for the foreign operations was $909 for the year ended
December 31, 2003. 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
---------------------
2003 2002
---------- ----------
Deferred tax assets:
Allowance for doubtful accounts............... $ 360 $ 550
Inventory obsolescence reserve................ 762 723
Inventory capitalization...................... 244 332
Plant closure liability....................... 852 1,554
Accrued expenses.............................. 401 995
Goodwill amortization......................... 3,221 6,689
Net operating loss carry-forwards,
which expire in 2023......................... 4,759 2,227
Deferred financing costs...................... -- 510
Minimum pension liability..................... 292 464
Amortization of non-compete agreements........ 833 953
Other......................................... 46 914
---------- ----------
Deferred tax assets............................. 11,760 15,911
Deferred tax liabilities:
Accelerated depreciation...................... (3,037) (3,487)
Other......................................... (824) (1,294)
---------- ----------
Deferred tax liabilities........................ (3,861) (4,782)
---------- ----------
Net deferred tax asset, subject to valuation.... 7,899 11,129
Less: Valuation allowance.................... (7,899) --
Net deferred tax asset.......................... $ -- $ 11,129
=====================
In 2003, a valuation allowance was established on the net deferred tax asset
balance of $7.9 million based on the Company's estimate of the ultimate
realization of such assets and to reduce the deferred tax assets to an amount
that will more likely than not be realized through future taxable income.
F-16
11. Retirement Plans
The Company sponsors a defined benefit pension plan covering certain salaried
employees of one subsidiary of the Company. The plan is frozen to new
participants. Participants in the plan were given credit for prior years of
service. The Company also has a pension plan covering all union employees of a
different 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. The number of plan participants in aggregate
at December 31, 2003, total 112, 88 of which are active or terminated and fully
vested and 24 are retired and receiving benefits.
None of the plan assets of either pension plan are invested in equity of the
Company or equity investments in any related party.
The following tables set forth the Company's two defined benefit plans as of
a measurement date of September 30, 2003 and 2002, respectively:
2003 2002
---------- ----------
Change in projected benefit obligations
Projected benefit obligation at beginning of year....... $ 2,474 $ 2,168
Service cost............................................ 61 68
Interest cost........................................... 156 158
Actuarial losses........................................ 3 213
Benefits paid........................................... (132) (133)
---------- ----------
Projected benefit obligation at end of year............. $ 2,562 $ 2,474
========== ==========
Change in plan assets
Fair value of plan assets at beginning of year.......... $ 1,039 $ 1,287
Actual return on plan assets............................ 205 (199)
Company contributions................................... 404 83
Benefits paid........................................... (132) (133)
---------- ----------
Fair value of plan assets at end of year................ $ 1,516 $ 1,038
========== ==========
Funded status
Funded status........................................... $ (1,046) $ (1,436)
Unrecognized net actuarial loss......................... 1,187 1,371
Accumulated other comprehensive loss.................... (1080) (1,291)
---------- ----------
Accrued benefit cost.................................... $ (939) $ (1,356)
========== ==========
Amounts recognized in the consolidated balance sheets
consist of:
Accrued benefit liability............................... $ (180) $ (137)
Long term pension liability............................. (759) (1,219)
---------- ----------
Accrued benefit cost.................................... $ (939) $ (1,356)
========== ==========
2003 2002
------- -------
Weighted-average assumptions as of December 31
Discount rate...................................... 6.5% 6.5%
Expected return on plan assets..................... 8.5% 8.0%
Rate of compensation increase...................... 3.5% 3.5%
2003 2002 2001
------------------ -------
Components of net periodic benefit cost:
Service cost............................. $ 61 $ 68 $ 67
Interest cost............................ 156 158 148
Recognized loss.......................... 75 42 --
Expected return on plan assets........... (93) (126) (254)
--------- -------- --------
Net periodic benefit cost (benefit)...... $ 199 $ 142 $ (39)
======== ======== ========
The expected return on plan assets is based on long term return assumptions for
the plan assets adjusted for past fund performance. Approximately 98% of plan
assets are invested in equity mutual funds. The Company projects a contribution
into the plans in 2004 of approximately $379,000. The Company does not expect
benefit payments to materially increase from the amounts paid in 2003 and 2002.
The Company has a minimum pension liability, recorded net of income tax benefit,
in other comprehensive income of approximately $470,000 at December 31, 2003
relative to the long term pension liability.
F-17
The Company sponsored several defined contribution savings plans (IRS
qualified 401(k) plans) for employees of their U.S. based subsidiaries.
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 under these
plans of $1,835, $1,674 and $1,583 for the periods ended December 31, 2003, 2002
and 2001, respectively.
No significant Company sponsored employee savings plans were provided to
non-U.S. employees during the three years ended December 31, 2003.
12. Management Incentive Plans
The Company has implemented certain management incentive plans as described
below.
Stock Option Plan
The Company's Stock Option Plan (the Plan), provides incentives to key
employees and directors (including non-employee directors) of the Company by
granting them nonqualified stock options of up to 299,950 shares of the
Company's common stock. The Plan is administered by a committee of the Board of
Directors which has the authority to determine the employees to whom options
will be granted, the number of options, and other terms and conditions of the
options. The committee increased the number of options available for grant from
240,713 to 299,950 in 2002. Options are granted at not less than the fair value
on the date of grant. Options granted from the Plan are subject to a five year
maximum vesting period and expire ten years from the date of grant. Options
available for grant are 11,350 at December 31, 2003. Options to date have been
granted only to employees and two directors. At December 31, 2003, 137,520
options were exercisable by participants at $115.00. No options have been
exercised at December 31, 2003. The weighted average remaining contractual life
and weighted average exercise price of the options at December 31, 2003 are 7.6
years and $115.00 per option share, respectively.
The Company has stock options outstanding as follows:
Exercise
Options Price
--------- ----------
Balance at January 1, 2001....... 168,050
Granted.......................... 15,500 $ 129.50
Forfeitures...................... (18,000) $ 129.50
---------
Balance at December 31, 2001..... 165,550
=========
Granted.......................... 61,900 $ 129.50
Granted.......................... 92,500 $ 115.00
Forfeitures...................... (38,000) $ 129.50
---------
Balance at December 31, 2002..... 281,950
=========
Surrendered...................... (189,450) $ 129.50
Granted.......................... 214,100 $ 115.00
Forfeitures...................... (18,000) $ 129.50
---------
Balance at December 31, 2003..... 288,600
=========
The fair value of each award is estimated on the date of award using the
Minimum Value award-pricing model with risk free interest rate of 4.0% and
expected award lives of up to ten years for 2003. The Company has not paid and
does not anticipate paying dividends; therefore, the expected dividend yield is
assumed to be zero.
Because the Company's options have characteristics significantly different
from those of traded stock options, and because changes in subjective input
assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its awards.
In January 2003, the Company offered to any participant in the stock option
plan who so elected, the opportunity to voluntarily surrender all existing
option grants, both vested and unvested, and agreed to reissue new options to
those participants approximately 181 days after the existing options have been
surrendered. The strike price of the new grants was $115.00, greater than the
fair market value of the Company's stock on the date of re-issuance. All of the
participants that held options at $129.50 per share elected to surrender all
such options on February 19, 2003 and receive a like number of options at the
strike price as determined above. On October 7, 2003, the Company granted new
options to employees that had surrendered them previously at a strike price of
$115.00.
F-18
13. Operating Leases
The Company leases buildings, machinery and equipment under operating leases
which expire on various dates through 2014. Rent expense for all operating
leases was $2,190, $1,892 and $1,849 for the years ended December 31, 2003, 2002
and 2001, respectively. Future minimum lease payments under non-cancelable
operating leases with terms in excess of one year are as follows:
2004................. $ 1,222
2005................. 984
2006................. 816
2007................. 762
2008................. 768
2009 and thereafter.. 4,317
---------
$ 10,144
14. Capital Leases
Property under capital leases included within property, plant, and equipment
are as follows:
December 31
------------------
2003 2002
-------- ---------
Buildings......................... $ 1,912 $ 1,912
Machinery and equipment........... 423 386
-------- ---------
2,335 2,298
Less: Accumulated depreciation.... 1,344 1,140
-------- ---------
$ 991 $ 1,158
======== =========
Future minimum lease payments under capital leases at December 31, 2003,
together with the present value of the minimum lease payments are as follows:
2004................................... $ 738
2005................................... 765
2006................................... 742
2007................................... 737
2008................................... 394
Total minimum payments................. 3,376
Less: Amounts representing interest.... 829
---------
Present value of minimum payments...... 2,547
Less: Current portion.................. 429
---------
Total long-term portion................ $ 2,118
=========
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 relating 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 clean up, and for certain damages resulting from past spills,
disposals, or other releases of hazardous substances. In connection with its
acquisitions 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 require or may require
remediation. In addition, 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.
F-19
The Company has negotiated contractual indemnifications from previous owners
of acquired businesses, which, supplemented by commercial 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 potential additional expenses for
environmental liabilities will have a material adverse effect on the financial
condition or results of operations of the Company.
16. Segment Reporting
The Company has two reportable segments: the commercial segment and the
construction segment. Applications sold by the commercial segment consist
primarily of flexible packaging adhesives and coatings for a number of
applications, high performance, specialty adhesives and coatings for automotive,
aerospace, manufactured housing and textile applications. Through the
construction segment, the Company manufactures and sells housing repair,
remodeling and construction sealants and adhesives used in exterior and interior
applications.
The Company evaluates performance and defines segment profit based upon
operating income. The reportable segments' accounting policies are the same as
those described in the summary of significant accounting policies (see Note 2.)
Segment profit is calculated as a reportable segment's operating income. Total
segment profits exceed consolidated operating profits to the extent of
unallocated corporate expenses included in selling, general and administrative
expenses. Unallocated corporate expenses were $9.1 million, $12.5 million and
$9.7 million for the years ended December 31, 2003, 2002 and 2001, respectively.
The reportable segments are each managed and measured separately primarily
due to the differing customers, production processes, products sold and
distribution channels. The reportable segments are as follows:
Commercial Construction Totals
----------- ------------ -----------
As of and for the year ended December 31,
2003:
Revenues from external customers........... $ 233,518 $ 138,098 $ 371,616
Depreciation and amortization expense...... 6,440 2,546 8,986
Segment profit............................. 22,407 19,459 41,866
Segment assets............................. 192,949 95,272 288,221
Goodwill................................... 73,935 49,007 122,942
Expenditures for long-lived assets......... 5,686 1,937 7,623
As of and for the year ended December 31,
2002:
Revenues from external customers........... $ 240,067 $ 121,043 $ 361,110
Depreciation and amortization expense...... 6,304 2,581 8,885
Segment profit............................. 19,766 18,105 37,871
Segment assets............................. 190,685 98,356 289,041
Goodwill................................... 73,935 49,007 122,942
Expenditures for long-lived assets......... 4,337 1,627 5,964
As of and for the year ended December 31,
2001:
Revenues from external customers........... $ 245,375 $ 111,326 $ 356,701
Depreciation and amortization expense...... 12,453 4,891 17,344
Segment profit............................. 16,908 12,259 29,167
Segment assets............................. 208,059 100,726 308,785
Expenditures for long-lived assets......... 5,182 2,507 7,689
A reconciliation of the reportable segments to consolidated net sales,
operating income and consolidated assets are as follows:
F-20
As of and for the
Years Ended December 31,
2003 2002 2001
----------- ----------- -----------
Net sales:
External revenues from reportable Segments..... $ 371,616 $ 361,110 $ 356,701
=========== =========== ===========
Profit:
Total profit for reportable segments........... $ 41,866 $ 37,871 $ 29,167
Unallocated corporate expense.................. (9,063) (12,481) (9,734)
----------- ----------- -----------
Operating income............................ $ 32,803 $ 25,390 $ 19,433
=========== =========== ===========
Assets:
Total assets for reportable segments........... $ 288,221 $ 289,041 $ 308,785
Elimination of intercompany accounts........... (1,612) (1,611) (1,807)
Unallocated corporate assets................... 3,135 21,238 43,312
----------- ----------- -----------
Consolidated assets......................... $ 289,744 $ 308,668 $ 350,290
=========== =========== ===========
There is no significant inter-segment revenue or cost of sales to be
eliminated. The valuation allowance of $7,899 against the deferred tax asset
balance at December 31, 2003 is included in the unallocated corporate asssets
line in the above reconciliation (See Note 10). Other significant items as
disclosed within the reportable segments are reconciled to the consolidated
totals as follows:
Segment Unallocated
Totals Corporate ItemsConsolidated
Other significant items:
For the year ended December 31, 2003
Expenditures for long-lived assets....... $ 7,623 $ 559 $ 8,182
Goodwill................................. $ 122,942 $ 1,446 $ 124,388
Depreciation and amortization............ $ 8,986 $ 324 $ 9,310
For the year ended December 31, 2002
Expenditures for long-lived assets....... $ 5,964 $ 596 $ 6,560
Goodwill................................. $ 122,942 $ 1,446 $ 124,388
Depreciation and amortization............ $ 8,885 $ 264 $ 9,149
For the year ended December 31, 2001
Expenditures for long-lived assets....... $ 7,689 $ 351 $ 8,040
Depreciation and amortization............ $ 17,344 $ 1,918 $ 19,262
Revenues and long-lived assets by geographic area are determined by the
location of the Company's facilities as follows:
As of and for the Years Ended
December 31,
2003 2002 2001
----------- ----------- --------
Net sales:
United States........................... $ 325,483 $ 315,759 $ 313,689
Mexico, South America, Europe, Asia..... 46,133 45,621 43,012
----------- ----------- ----------
Consolidated net sales.................. $ 371,616 $ 361,110 $ 356,701
=========== =========== ==========
Long-lived assets:
United States........................... $ 176,604 $ 176,475 $ 204,006
Mexico, South America, Europe, Asia..... 15,661 15,863 18,014
----------- ----------- ----------
Consolidated long lived assets.......... $ 192,265 $ 192,338 $ 222,020
=========== =========== ==========
F-21
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 years
ended December 31, 2003, 2002 and 2001:
2003 2002 2001
-------------------- -------
Cash paid for:
Interest...... $ 22,286 $ 24,007 $ 24,650
Income taxes.. 509 370 303
18. Selected Quarterly Data (Unaudited)
Quarter
---------------------------------------------
First Second Third Fourth
---------- ----------- ---------- -----------
2003
Net sales.................................... $ 89,821 $ 92,560 $ 98,747 $ 90,488
Operating income ............................ 6,826 9,064 10,066 6,847
Net income (loss) ........................... 95 1,372 2,226 (7,909)
2002
Net sales.................................... $ 86,748 $ 94,933 $ 95,023 $ 84,406
Operating income (loss)...................... 5,941 9,640 10,596 (787)
Cumulative effect of change in accounting
principle, net of income tax benefit....... -- (17,064) -- --
Net income (loss)............................ (287) (15,390) 2,558 (4,387)
2001
Net sales.................................... $ 88,877 $ 91,767 $ 92,503 $ 83,554
Operating income............................. 4,597 6,109 7,924 803
Net income (loss)............................ (3,104) 747 (186) (3,514)
Net loss for the fourth quarter of 2003 includes tax expense of $7.9 million
relative to the recording of a valuation allowance on the net deferred tax asset
balance (See Note 10). Operating income for the fourth quarter of 2002 includes
a $4.1 million provision for plant closure costs relative to the planned
closures of two of the Company's manufacturing facilities in 2003 (see Note 4).
19. Related Parties
The Company has a management agreement with AEA Investors Inc., the majority
stockholder of the Company, under which AEA Investors LLC provides us with
advisory and consulting services for an annual aggregate fee of $1.0 million,
payable in four quarterly installments, plus reasonable out-of-pocket costs and
expenses.
20. Other Financial Information
The Company is a holding company with no independent assets or operations.
Full separate financial statements of its 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, 2002,
2001 and 2000, respectively of the Guarantor Subsidiaries and the Non-Guarantor
Subsidiaries are below.
F-22
The following sets forth the financial data at December 31, 2003 and for the
year then ended.
Guarantor Non-Guarantor
Subsidiaries Subsidiaries Parent Eliminations Total
Statement of Operations Data for
the Year Ended December 31,
2003:
Net sales...................... $ 325,483 $ 46,133 $ -- $ -- $ 371,616
Cost of goods sold............. 234,013 34,362 -- -- 268,375
--------- -------- ---------- ---------- ----------
Gross profit................... 91,470 11,771 -- -- 103,241
Selling, general, and
Administrative expenses...... 52,435 9,559 8,443 -- 70,437
--------- -------- ---------- ---------- ----------
Operating income (loss)........ 39,035 2,212 (8,443) -- 32,804
Interest expense............... (22,944) (821) (1,652) -- (25,417)
--------- -------- ---------- ---------- ----------
Income (loss) before income taxes
and extraordinary item and
cumulative effect of change in
accounting principle......... $ 16,091 $ 1,391 $ (10,095) $ -- $ 7,387
========= ======== =========== ========== ==========
Balance Sheet Data:
Assets:
Current assets................. $ 83,569 $ 21,686 $ 6,413 $ (21,650)$ 90,018
Property, plant and equipment,
Net.......................... 54,259 12,626 992 -- 67,877
Goodwill, net.................. 121,353 3,035 -- -- 124,388
Deferred financing costs, net.. 5,602 -- 1,672 -- 7,274
Deferred income taxes.......... 6,004 863 (6,867) -- --
Other assets................... 5,022 28 282,633 (287,494) 187
--------- -------- ---------- ---------- ----------
Total assets................... $ 275,809 $ 38,238 $ 284,843 $ (309,144)$ 289,744
========= ======== ========== ========== ==========
Liabilities and stockholders'
equity:
Current liabilities............ $ 59,354 $ 15,498 $ 3,433 $ (21,650)$ 56,635
Long-term liabilities.......... 210,019 8,632 206,267 (213,373) 211,545
Total stockholders' equity..... 6,436 14,108 75,143 (74,121) 21,564
--------- -------- ---------- ---------- ----------
Total liabilities and
stockholders' $ 275,809 $ 38,238 $ 284,843 $ (309,144)$ 289,744
========= ======== ========== ========== ==========
Equity.......................
Statement of Cash Flows Data
Operating Activities
Net loss....................... $ 10,158 $ 151 $ (14,525) $ -- $ (4,216)
Depreciation and amortization.. 7,634 1,353 323 -- 9,310
Deferred income taxes.......... 84 (43) 11,088 -- 11,129
Foreign exchange gains (losses) (243) (1,464) -- -- (1,707)
Amortization of deferred
financing Costs................ 1,542 534 -- 2,076
Amortization of bond discounts. -- -- 583 -- 583
Other.......................... (5,982) (1,515) 6,051 -- (1,446)
--------- -------- ---------- ---------- ----------
Changes in operating activities 13,193 (1,518) 4,054 -- 15,729
Investing activities
Purchase of property,
Equipment, net............... (6,848) (775) (559) -- (8,182)
--------- -------- ---------- ---------- ----------
Net cash used in investing
Activities................... (6,848) (775) (559) -- (8,182)
Financing activities
Intercompany financing......... (11,971) 2,615 9,356 --
Payments on long term
debt......................... (300) (507) (475) -- (1,282)
Payments on capital leases..... (392) 38 -- (354)
Net payments on revolving credit
facilities................... 44 370 (12,376) -- (11,959)
--------- -------- ---------- ---------- ----------
Net cash....................... (12,619) 2,516 (3,495) -- (13,598)
(37) 418 -- 381
--------- -------- ---------- ---------- ----------
Net increase (decrease) in cash (6,311) 641 -- -- (5,670)
Net increase (decrease) in cash 11,378 2,746 -- -- 14,124
--------- -------- ---------- ---------- ----------
Cash and cash equivalents, end
of period...................... $ 5,067 $ 3,387 -- -- $ 8,454
========= ======== ========== ========== ==========
F-23
The following sets forth the financial data at December 31, 2002 and for the
year then ended.
Guarantor Non-Guarantor
Subsidiaries Subsidiaries Parent Eliminations Total
Statement of Operations Data for
the Year Ended December 31,
2002:
Net sales...................... $ 315,758 $ 45,352 $ -- $ -- $ 361,110
Cost of goods sold............. 225,980 33,780 -- -- 259,760
--------- -------- ---------- ---------- ----------
Gross profit................... 89,778 11,572 -- -- 101,350
Selling, general, and
administrative expenses...... 52,854 10,730 12,376 -- 75,960
--------- -------- ---------- ---------- ----------
Operating income (loss)........ 36,924 842 (12,376) -- 25,390
Interest expense............... (23,004) (941) (1,582) -- (25,527)
--------- -------- ---------- ---------- ----------
Income (loss) before income taxes
and extraordinary item and
cumulative effect of change in
accounting principle......... $ 13,920 $ (99) $ (13,958) $ -- $ (137)
========= ======== ========== ========== ==========
Balance Sheet Data:
Assets:
Current assets................. $ 84,629 $ 20,497 $ 6,597 $ (10,706)$ 101,017
Property, plant and equipment,
net.......................... 55,011 12,183 756 -- 67,950
Goodwill, net.................. 121,353 3,035 -- -- 124,388
Deferred financing costs, net.. 7,144 -- 2,206 -- 9,350
Deferred income taxes.......... 6,730 863 (1,721) -- 5,872
Other assets................... 10,941 38 282,633 (293,521) 91
--------- -------- ---------- ---------- ----------
Total assets................... $ 285,808 $ 36,616 $ 290,471 $ (304,227)$ 308,668
========= ======== ========== ========== ==========
Liabilities and stockholders'
equity:
Current liabilities............ $ 51,084 $ 14,156 $ 3,532 $ (10,706)$ 58,066
Long-term liabilities.......... 210,748 18,722 218,352 (223,073) 224,749
Total stockholders' equity..... 23,976 3,738 68,587 (70,448) 25,853
--------- -------- ---------- ---------- ----------
Total liabilities and
stockholders' equity........... $ 285,808 $ 36,616 $ 290,471 $ (304,227)$ 308,668
========= ======== ========== ========== ==========
Statement of Cash Flows Data
Operating Activities
Net loss....................... $ (8,820) $ (1,817) $ (6,869) $ -- $ (17,506)
Depreciation and amortization.. 7,658 1,228 263 -- 9,149
Cumulative effect of change in
accounting principle, net of
income tax benefit........... 15,547 1,433 84 -- 17,064
Deferred income taxes.......... 19 -- -- 19
Foreign exchange gains (losses) 89 (1,531) -- -- (1,442)
Amortization of deferred
financing Costs................ 1,305 -- 485 -- 1,790
Amortization of bond discount and
Other........................ 72 -- 82 -- 154
Changes in operating assets and
liabilities.................. 25,277 3,995 275 (3,487) 26,060
--------- -------- ---------- ---------- ----------
Net cash provided by (used in)
operating activities......... 41,146 3,308 (5,680) (3,487) 35,287
Investing activities
Proceeds from sale of property,
plant and equipment.......... 362 -- -- -- 362
Purchase of property, plant &
equipment.................... (4,575) (1,370) (615) -- (6,560)
--------- -------- ---------- ---------- ----------
Net cash used in investing
activities................... (4,213) (1,370) (615) -- (6,198)
Financing activities
Capital contributions.......... -- -- (5) -- (5)
Intercompany financing......... (35,946) -- 35,946 -- --
Payments on acquisition note
payable...................... (203) (266) -- (3) (472)
Deferred financing costs....... -- -- (2,196) -- (2,196)
Payments on capital leases..... (391) -- -- -- (391)
Net payments on revolving credit
facilities................... -- (128) (27,455) -- (27,578)
--------- -------- ---------- ---------- ----------
Net cash provided by (used in)
financing activities......... (36,543) (394) 6,295 -- (30,642)
Effect of foreign currency
changes on cash............... 31 60 -- -- 91
--------- -------- ---------- ---------- ----------
Net increase (decrease) in cash 423 1,604 -- (3,487) (1,460)
Cash and cash equivalents,
beginning of period.......... 10,955 1,142 -- 3,487 15,584
--------- -------- ---------- ---------- ----------
Cash and cash equivalents, end of
period....................... $ 11,378 $ 2,746 $ -- $ -- $ 14,124
========= ======== ========== ========== ==========
F-24
The following sets forth the financial data at December 31, 2001 and for the
year then ended.
Guarantor Non-Guarantor
Subsidiaries Subsidiaries Parent Eliminations Total
Statement of Operations Data for
the Year Ended December 31,
2001:
Net sales...................... $ 313,689 $ 43,012 $ -- $ -- $ 356,701
Cost of goods sold............. 226,901 31,792 -- -- 259,253
--------- -------- ---------- ---------- ----------
Gross profit................... 86,228 11,220 -- -- 97,448
Selling, general, and
administrative expenses...... 59,180 10,941 7,894 -- 78,015
--------- -------- ---------- ---------- ----------
Operating income............... 27,048 279 (7,894) -- 19,433
Equity in undistributed earnings
of (1,656) -- (1,832) 3,488 --
subsidiaries.................
Interest expense............... (24,701) (1,174) (1,115) -- (26,990)
--------- -------- ---------- ---------- ----------
Income (loss) before
extraordinary items and
income taxes................... $ 691 $ (895) $ (10,841) $ 3,488 $ (7,557)
========= ======== ========== ========== ==========
Cash Flows Data
Operating Activities
Net income (loss).............. $ 458 $ (1,077) (8,925) $ 3,487 $ (6,057)
Depreciation and amortization.. 17,538 1,595 129 -- 19,262
Deferred income taxes.......... (922) -- -- (922)
Foreign exchange losses........ -- 458 -- -- 458
Amortization of deferred
financing costs................ 1,303 -- 60 -- 1,363
Amortization of bond discount.. -- -- 132 -- 132
Changes in operating assets and
liabilities.................. 888 1,428 2,019 -- 4,335
--------- -------- ---------- ---------- ----------
Net cash provided by (used in)
operating activities......... 19,265 2,404 (6,585) 3,487 18,571
Investing activities
Acquisition of business........ (6,388) (1,737) (136) (8,261)
Purchase of property, plant &
equipment.................... (5,693) (1,996) (351) -- (8,040)
--------- -------- ---------- ---------- ----------
Net cash used in investing
activities................... (12,081) (3,733) (487) -- (16,301)
Financing activities
Capital contributions.......... -- -- 400 -- 400
Payments on acquisition note
payable...................... -- -- -- -- --
Proceeds from long term debt... -- 1,273 -- -- 1,273
Payments on long term debt..... (200) -- -- -- (200)
Deferred financing costs....... -- -- (404) -- (404)
Payments on capital leases..... (255) -- -- -- (255)
Net proceeds from revolving
credit facilities............. -- (974) 5,512 -- 4,538
--------- -------- ---------- ---------- ----------
Net cash provided by (used in)
financing activities.......... (455) 299 5,508 -- 5,352
Effect of foreign currency
changes on cash................ -- (46) -- -- (46)
--------- -------- ---------- ---------- ----------
Net decrease in cash........... 6,729 (1,076) (1,564) 3,487 7,576
Cash and cash equivalents,
beginning of period.......... 4,226 2,218 1,564 -- 8,008
--------- -------- ---------- ---------- ----------
Cash and cash equivalents, end of
period....................... $ 10,955 $ 1,142 $ -- $ 3,487 $ 15,584
========= ======== ========== ========== ==========
F-25
ANNUAL REPORT ON FORM 10-K
ITEMS 14(A) AND 14(C)
EXHIBIT INDEX
Exhibit
Number Description
- -------- ------------------------------------------------------------------
3.1 Certificate of Incorporation Sovereign Specialty Chemicals,
Inc., incorporated by reference to the Company's
Registration Statement on Form S-8 as filed on January 28,
2000
3.2 By-Laws of Sovereign Specialty Chemicals, Inc., as amended
September 16, 2002, incorporated by reference to the
Company's Registration Statement on Form 10-Q/A as filed on
December 19, 2002
4.1 Amended and Restated Credit Agreement,
dated as of April 6, 2000 incorporated by
reference to the Company's registration
Statement on Form S-4 as filed on May 12,
2000
4.1A Amendment No. 1 and Waiver, dated October 30, 2000, among
Sovereign Specialty Chemicals, Inc., the Guarantors and
Merrill Lynch, Pierce, Fenner & Smith Incorporated, J.P.
Morgan Securities Inc. and JPMorgan Chase Bank (formerly the
Chase Manhattan Bank) as filed on Form 8-K/A as filed on
January 16, 2001 and incorporated by reference herein
4.1B Amendment No. 2, dated January 26, 2001, among Sovereign
Specialty Chemicals, Inc., the Guarantors and Merrill Lynch,
Pierce, Fenner & Smith Incorporated, J.P. Morgan Securities
Inc. and JPMorgan Chase Bank (formerly the Chase Manhattan
Bank) as filed on Form 10-K/A as filed on June 20, 2001 and
incorporated by reference herein
4.1C Amendment No. 3, dated March 1, 2002 among Sovereign
Specialty Chemicals, Inc., the Guarantors and Merrill Lynch,
Pierce, Fenner & Smith Incorporated, J.P. Morgan Securities
Inc. and JPMorgan Chase Bank (formerly the Chase Manhattan
Bank) as filed on Form 10-K as filed March 29, 2002 and
incorporated by reference herein
4.1D Amendment No. 4, dated December 20, 2002 among Sovereign
Specialty Chemicals, Inc., the Guarantors and JPMorgan Chase
Bank as filed on Form 10-K as filed March 14,2003 and incorporated
by reference herein
4.2 Amended and Restated Shareholders
Agreement, dated May 12, 2000 between and
among Sovereign Specialty Chemicals, Inc.,
SSCI Investors LLC and the Shareholders
listed on Schedule I Thereto, incorporated
by reference to the Company's Registration
Statement on Form S-4 as filed on May 12,
2000
(Registration No. 333-36898)
4.3 Amended and Restated Shareholders Agreement, dated December
14, 1999, by and among Sovereign Specialty Chemicals, Inc.
SSCI Investors LLC, and Sovereign Specialty Chemicals L.P.
as filed on Form 10-K as filed on March 27, 2001 and
incorporated by reference herein
4.3A Amendment No. 1 to Amended and Restated Shareholders
Agreement dated December 14, 1999, by and among Sovereign
Specialty Chemicals, Inc., SSCI Investors LLC, and Sovereign
Specialty Chemicals, L.P. as filed on Form 10-K as filed on
March 27, 2001 and incorporated by reference herein
4.3B Amendment No. 1 (sic) to Amended and Restated Shareholders
Agreement, dated as of December 31, 2002, by and among
Sovereign Specialty Chemicals, Inc., SSCI Investors LLC, and
Robert B. Covalt as filed on Form 10-K as filed on March 14, 2003
and incorporated by reference herein
E-1
4.4 Indenture dated March 29, 2000 among Sovereign Specialty
Chemicals, Inc., the Guarantors and The Bank of New York, as
Trustee. Incorporated by reference to exhibit 4.4 of the
Company's Registration Statement on Form S-4 filed on May
12, 2000 (Registration No. 333-36898)
4.5 Forms of 11 7/8% Senior Subordinated Notes
due 2010, Series A and Series B Notes
(contained in Exhibit 4.4 as Exhibit A and
B thereto, respectively). Incorporated by
reference to Exhibit 4.5 of the Company's
Registration Statement on Form S-4 filed on
May 12, 2000 (Registration No. 333-36898)
4.6 Form of Guarantee (contained in Exhibit 4.4
as Exhibit A and B thereto). Incorporated
by reference to exhibit 4.6 of the
Company's Registration Statement on Form
S-4 filed on May 12, 2000 (Registration No.
333-36898)
4.7 Registration Rights Agreement dated March
29, 2000 among Sovereign Specialty
Chemicals, Inc., the Guarantors, J.P.
Morgan Securities Inc., Merrill Lynch,
Pierce Fenner & Smith Incorporated and
Chase Securities Inc. Incorporated by
Reference to exhibit 4.7 of the Company's
Registration Statement on Form S-4 filed on
May 12, 2000 (Registration No. 333-36898)
4.8 First Supplemental Indenture dated as of March 22, 2001
among Sovereign Specialty Chemicals Inc., the Guarantor
party thereto and the Bank of New York, as trustee as filed
on Form 10-K as filed on March 27, 2001 and incorporated by
Reference herein
10.2 Employment Agreement, dated February 11,
2002 between Sovereign Specialty Chemicals
and John R. Knox as filed on Form 10-K as
filed March 29, 2002 and incorporated by
Reference herein
10.3 Employment Agreement, dated December 29, 1999 between
Sovereign Specialty Chemicals, Inc. and Peter Longo as filed
on Form 10-K as filed on March 27, 2001 and incorporated by
Reference herein
10.4 Employment Agreement, dated October 1, 2002 between
Sovereign Specialty Chemicals Inc and Norman E. Wells, Jr.
as filed on Form 8-K as filed on December 3, 2002 and
incorporated by reference herein
10.5 Employment Agreement, dated October 31, 2002 Sovereign
Specialty Chemicals, Inc and Terry D. Smith as filed on Form
8-K as filed on December 3, 2002 and incorporated by
Reference herein
10.6 Sovereign Specialty Chemicals, Inc. Management Incentive
Compensation Plan dated January 1, 2000 as
filed on Form 10-K as filed on March 27,
2001 and incorporated by Reference herein
10.7 Sovereign Specialty Chemicals, Inc. Stock Option Plan, dated
December 29, 1999 as filed on Form 10-K as
filed on March 27, 2001 and incorporated by
reference herein
10.8 Non-qualified Stock Option Agreement between Sovereign
Specialty Chemicals, Inc. and Robert B. Covalt, dated
December 31, 1999 as filed on Form 10-K as
filed on March 27, 2001 and incorporated by
reference herein
10.8A First Amendment to Non-qualified Stock Option Agreement
between Sovereign Specialty Chemicals, Inc. and Robert B.
Covalt, dated January 4, 2000 as filed on Form 10-K as filed
on March 27, 2001 and incorporated by reference herein
E-2
10.8B Non-qualified Stock Option Agreement between Sovereign
Specialty Chemicals, Inc, and Norman E. Wells, Jr., dated
October 1, 2002 as filed on Form 8-K as
filed on December 3, 2002 and incorporated
by reference herein
10.10 Non-qualified stock option Agreement between Sovereign
Specialty Chemicals, Inc. and the individuals listed in
Schedule 1 thereto, dated December 29, 1999 as filed on Form
10-K as filed on March 27, 2001 and incorporated by
Reference herein
10.14 Asset Purchase Agreement dated March 31, 1996 among The
BFGoodrich Company, Sovereign Engineered Adhesives, L.L.C.
and the Parent Partnership+
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+
10.20 Stock Purchase Agreement, dated March 5, 1998, by among
Burke Industries, Inc., Mercer and the Company+
10.21 Stock Purchase Agreement by and among Mini Crown Funding
Corp (Buyer), Sovereign Specialty Chemicals, Inc. (Parent),
Imperial Adhesives Inc. and NS Group Inc. (Seller) dated
September 13, 2000. incorporated by reference to the
Company's Form 8-K/A dated December 22, 2000
10.22 Business and Share Agreement for the sale
of a Specialty Adhesives business dated
October 31, 2000, among Croda Holdings LLC,
Croda Adhesives do Brasil Ltda, and
Sovereign Specialty Chemicals, Inc.
incorporated by reference to the Company's
Form 8-K/A dated January 16, 2001
10.23 Management Agreement between AEA Investors Inc and Sovereign
Specialty Chemicals, Inc. dated December 31, 1999
14.0 Code of Ethics and Policy Statements - Conflict of Interest and
Competitive Practice
21.1 Subsidiaries of the Company
31.1 Certifications as required by Section 302(a) of the Sarbanes-Oxley
Act of 2002
31.2 Certifications as required by Section 302(a) of the Sarbanes-Oxley
Act of 2002
31.4 Audit Committee of the Board of Directors, Audit and Non-Audit
Services Pre-Approval Policy
99.1 Cautionary Statements Regarding Forward Looking Statements
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+ Incorporated by reference to the Company's Registration Statement on Form S-4,
as amended (Registration No. 333-39373)
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SOVEREIGN SPECIALTY CHEMICALS, INC.
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
Additions
---------------------
Balance at Charged to Charged to
Beginning Costs and Other Balance at End
of Period Expenses Accounts Deductions of Period
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(Dollars in thousands)
Year ended December 31, 2001
Reserve and allowances deducted
From asset accounts:
Allowance for uncollectible
Accounts..................... 1,270 694 -- 353(1) 1,611
Reserve for inventory
Obsolescence................. 1,197 2,549 -- 1,863(1) 1,883
Plant closure reserves........ 852 -- 1,310(2) (2,102) 60
Year ended December 31, 2002
Reserve and allowances deducted
From asset accounts:
Allowance for uncollectible
Accounts..................... 1611 828 -- (500) 1,940
Reserve for inventory
Obsolescence................. 1,883 1,693 -- (1,911) 1,664
Plant closure reserves........ 60 4,066 -- (60) 4,066
Year ended December 31, 2003
Reserve and allowances
deducted from asset
accounts:
Allowance for uncollectible
Accounts................... 1,940 682 -- (1,217) 1,405
Reserve for inventory
Obsolescence.............. 1,664 875 -- (769) 1,770
Plant closure reserves..... 4,066 396 -- (1,608) 2,854
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(1) Accounts written off, net of recoveries. (2) Balances added relative to
acquisitions.
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