S-2:
Published on January 22, 1998
As filed with the Securities and Exchange Commission on January 22, 1998
Registration No. 333-
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SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
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Form S-2
REGISTRATION STATEMENT
Under
THE SECURITIES ACT OF 1933
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SUNSOURCE INC.
(Exact name of registrant as specified in its charter)
Delaware 23-2874736
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
3000 One Logan Square
Philadelphia, Pennsylvania 19103
(215) 282-1290
(Address, including zip code, and telephone number, including area code,
of registrant's principal executive offices)
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JOSEPH M. CORVINO
Vice President - Finance, Chief Financial Officer,
Treasurer and Secretary
SunSource Inc.
3000 One Logan Square
Philadelphia, Pennsylvania 19103
(215) 282-1290
(Name, address, including zip code, and telephone number,
including area code, of agent for service)
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Copies to:
DONALD A. SCOTT, ESQUIRE JOHN E. RILEY, ESQUIRE
Morgan, Lewis & Bockius LLP Simpson Thacher & Bartlett
2000 One Logan Square 425 Lexington Avenue
Philadelphia, Pennsylvania 19103-6993 New York, New York 10017
(215) 963-5000 (212) 455-2000
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Approximate date of commencement of proposed sale to the public: As soon as
practicable after the effective date of this Registration Statement.
If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act,
check the following box. [ ]____________
If the registrant elects to deliver its latest annual report to security
holders, or a complete and legal facsimile thereof, pursuant to item 11(a)(1) of
this Form, check the following box. [ ]____________
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering. [ ]____________
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]____________
If this Form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]____________
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [ ]
CALCULATION OF REGISTRATION FEE
(1) Estimated solely for the purpose of calculating the registration fee in
accordance with Rule 457(c) under the Securities Act of 1933 based on the
average of the high and low prices reported on the New York Stock Exchange
Composite Tape on January 16, 1998.
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The Registrant hereby amends this Registration Statement on such date or
dates as may be necessary to delay its effective date until the Registrant shall
file a further amendment which specifically states that this Registration
Statement shall thereafter become effective in accordance with Section 8(a) of
the Securities Act of 1933 or until the Registration Statement shall become
effective on such date as the Commission, acting pursuant to said Section 8(a),
may determine.
Information contained herein is subject to completion or amendment. A
registration statement relating to these securities has been filed with the
Securities and Exchange Commission. These securities may not be sold nor may
offers to buy be accepted prior to the time the registration statement becomes
effective. This prospectus shall not constitute an offer to sell or the
solicitation of an offer to buy nor shall there be any sale of these securities
in any State in which such offer, solicitation or sale would be unlawful prior
to registration or qualification under the securities laws of any such State.
Subject to Completion, dated January 22, 1998
PROSPECTUS 2,512,169 Shares
[LOGO]
Common Shares
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Of the 2,512,169 shares of Common Stock, par value $.01 per share (the
"Common Shares"), of SunSource Inc. ("SunSource" or the "Company") offered
hereby, 500,000 shares are being issued and sold by the Company and 2,012,169
shares are being sold by the Selling Stockholders (collectively, the
"Offering"). The Selling Stockholders are affiliates of Lehman Brothers Inc. See
"Security Ownership of Certain Beneficial Owners, Management and Selling
Stockholders." The Company will not receive any of the proceeds from the shares
being sold by the Selling Stockholders.
The Company's Common Shares are listed on the New York Stock Exchange
under the symbol "SDP." On January 20, 1998, the reported last sale price of the
Common Shares on the New York Stock Exchange Composite Tape was $23.50 per
share.
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An investment in the Common Shares offered hereby involves various risks.
See "Risk Factors" beginning on page 8.
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THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION
PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
(1) The Company and the Selling Stockholders have agreed to indemnify the
Underwriters against certain liabilities, including liabilities under the
Securities Act of 1933, as amended. See "Underwriting."
(2) Before deducting estimated expenses of the Offering of $500,000 payable
by the Company.
(3) The Company has granted to the Underwriters a 30-day option to purchase up
to 375,000 Common Shares on the same terms and conditions as the
securities offered hereby solely to cover over-allotments, if any. If such
option is exercised in full, the total Price to Public, Underwriting
Discounts and Commissions and Proceeds to the Company will be $ ,
$ and $ , respectively. The Proceeds to the Selling Stockholders
will not change if such option is exercised. See "Underwriting" and
"Security Ownership of Certain Beneficial Owners, Management and Selling
Stockholders."
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The Common Shares offered by this Prospectus are offered by the
Underwriters subject to prior sale, to withdrawal, cancellation or modification
of the offer without notice, to delivery to and acceptance by the Underwriters
and to certain further conditions. It is expected that delivery of the shares
will be made at the offices of Lehman Brothers Inc., New York, on or about
, 1998.
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Lehman Brothers
Robert W. Baird & Co.
Incorporated
Furman Selz
Legg Mason Wood Walker
Incorporated
, 1998
[Organizational chart of the Company]
CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS THAT
STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE COMMON SHARES. SUCH
TRANSACTIONS MAY INCLUDE THE PURCHASE OF COMMON SHARES PRIOR TO THE PRICING OF
THE OFFERING FOR THE PURPOSE OF MAINTAINING THE PRICE OF THE COMMON SHARES AND
THE PURCHASE OF COMMON SHARES FOLLOWING THE PRICING OF THE OFFERING TO COVER A
SYNDICATE SHORT POSITION IN THE COMMON SHARES OR FOR THE PURPOSE OF MAINTAINING
THE PRICE OF THE COMMON SHARES. FOR A DESCRIPTION OF THESE ACTIVITIES, SEE
"UNDERWRITING."
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PROSPECTUS SUMMARY
The following summary is qualified in all respects by the more detailed
information set forth elsewhere in this Prospectus and the documents
incorporated by reference herein. Unless the context suggests otherwise, (i)
SunSource or the Company refers to SunSource Inc. and its predecessors and (ii)
all information provided herein assumes no exercise of the Underwriters'
over-allotment option. This Prospectus contains forward-looking statements that
address, among other things, projected revenue, cash flow and income, the
implementation of new management information systems, cost savings, profit
growth and acquisition strategy. These statements may be found under
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and "Business," as well as in this Prospectus generally. Actual
events or results may differ materially from those discussed in forward-looking
statements as a result of various factors, including without limitation, those
discussed in "Risk Factors" and matters set forth in this Prospectus generally.
As used herein, (i) the term "Conversion" means the conversion of the Company on
September 30, 1997 from partnership to corporate form, (ii) the term
"Refinancing" means the refinancing of the Company's senior notes and bank
revolving credit which occurred on September 30, 1997 and (iii) the term
"Partnership" means SunSource L.P., the predecessor partnership to the Company.
The Company
SunSource is one of the largest providers of industrial products and
related value-added services in North America. Through its applications
engineers and technical support personnel, SunSource provides customized
solutions to complex problems encountered by its customers. The Company believes
that it differentiates itself from other industrial distributors by providing
superior technical and problem-solving capabilities in addition to an extensive
product offering and broad array of related services, such as engineering design
and integrated supply arrangements. The Company has more than 180,000 customers,
none of which represents more than 5% of annual net sales. The Company's
distribution and related services support more than 1,300 product lines,
consisting of approximately 175,000 stock keeping units.
The Company has targeted three businesses within the distribution industry
which are characterized by a potential for value-added services, economies of
scale and opportunities for further consolidation.
Industrial Services. SunSource Industrial Services Company, with sales of
$455 million in 1996, provides a broad range of products and services throughout
North America through the sales and marketing activities of SunSource Technology
Services ("STS") and Sun Inventory Management Company ("SIMCO"). The Company
believes that STS is a leading provider of systems and parts and engineering
services for hydraulic, pneumatic, electrical and related systems to major
industrial concerns, as well as small and medium-size businesses. STS provides
services, including engineering and design of both products and processes and
the assembly and repair of complex systems, which enable its customers to
outsource engineering and other functions which they previously performed
in-house. SIMCO provides inventory management services enabling its customers to
reduce inventory investment and the associated expenses of purchasing,
receiving, disbursing and accounting for parts and materials.
Hardware Merchandising Services. Hardware Merchandising Services, which
operates under the name Hillman ("Hillman"), with sales of $103 million in 1996,
provides small hardware items and merchandising services to retail hardware
stores through a nationwide sales and service organization. Hillman offers a
full range of fasteners, letters, numbers, signs, keys, rope and chain
accessories and many other inexpensive "specialty" goods, which are the
"must-have" items for hardware retailers that cannot be managed economically by
the retailer's own employees because of the large number of items and their low
prices. Hillman maintains a 235 person nationwide sales and service organization
which seeks to ensure that its customers' inventories are maintained at
appropriate levels with a minimum of administrative effort or expense. Hillman
also provides inventory management software that ties into retailers'
point-of-sale systems. Through its merchandising system, Hillman assists
retailers with rack positioning, store layout, new package design and color
coding systems to permit ease of shopping by consumers.
Glass Merchandising. Glass Merchandising, which operates under the name
Harding ("Harding"), with sales of $90 million in 1996, operates one of the
largest networks of full service retail glass shops in the United States.
Harding is comprised of approximately 85 retail locations throughout the
Southwest and, to a lesser degree, along the East Coast. Harding sells and
installs automotive glass and also sells, fabricates and installs flat glass.
Customers include individual retail consumers, insurance companies and
commercial accounts.
The markets in which the Company participates are currently impacted by
the following trends:
o Manufacturers are increasing their reliance on distributors in order
to enhance their profitability and improve their returns on capital;
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o Customers are increasing their reliance on value-added distributors as
their contacts with the manufacturers diminish or cease altogether;
o Customers are outsourcing non-core functions to high-quality service
providers;
o Channels of distribution are in the process of consolidation; and
o Managerial skills required for success in industrial distribution are
changing dramatically.
The Company's growth has resulted from its ability to capitalize on these
trends due to its competitive strengths in the following areas:
o Acquisition Integration Capability - The ability to integrate acquired
companies while improving operational efficiencies and enhancing their
effectiveness in the marketplace.
Since the organization of its predecessor in 1975 and through 1991,
the Company grew primarily through acquisitions of existing
distribution companies. During this period, a series of acquisitions
expanded the Company's operations both geographically and in the
number and types of products offered. Thirty-five of these
acquisitions had purchase prices in excess of $1 million and
approximately 40 more had purchase prices under $1 million. The
Company's ability to make acquisitions since 1991 was hindered by its
previous partnership structure and associated restrictions in its
credit agreement. As a result of the Conversion, the Refinancing and
this Offering, the Company expects to have the necessary financial
capacity to resume its acquisition program. The Company intends to
seek acquisition candidates that have developed attractive market
niches, have strong management and have demonstrated their ability to
achieve stable growth and high returns on invested capital.
o Ability to Capitalize on Industry Trends - The ability to execute
dynamic business strategies to capitalize on opportunities arising
from rapid structural changes in the marketplace.
The Company has established separate organizations for its three
businesses, each headed by a chief executive officer who is supported
by sales, marketing, financial, logistics and information systems
resources. This organizational structure enables the Company to manage
each of its businesses within the context of the varying market
opportunities, rates of change and competitive threats affecting those
businesses. The Company's small headquarters staff shapes and guides
the strategic decisions of its operating companies. Performance
benchmarks are established as part of this process and progress is
monitored to ensure that initiatives remain on track.
o Technology for Competitive Advantage - The ability to use technology
and technical expertise as competitive advantages to build and defend
attractive market niches.
For example, STS is implementing a new integrated information system
which will permit (i) the centralization of the purchasing function,
resulting in a smaller staff with a higher level of professional
skills; (ii) a reduction in the number of warehouses from 36 to fewer
than ten; (iii) higher customer order fill rates; and (iv) lower
exposure to obsolete or slow-moving inventory.
SunSource believes that each of its three operating businesses is well
positioned to capture opportunities in the markets in which it participates:
o SunSource Industrial Services Company's strategy is to capitalize on
the trends among industrial customers toward consolidation of
suppliers, outsourcing the procurement function for goods and
outsourcing in-plant services for which they lack expertise or
sufficient resources.
o Hillman's strategy is to capitalize on the desire of its customers to
outsource the burden of maintaining a complex, low value inventory as
well as to continually expand its product line.
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o Harding's strategy is to take advantage of the trend toward
consolidation in the retail glass business. Multiple acquisitions,
most of which are quite small, can be integrated because of Harding's
management information systems and the increased number of management
personnel dedicated to making acquisitions.
The Company traces its origins to 1975, when Sun Company, Inc. ("Sun")
decided to pursue a diversification strategy outside of its traditional energy
business. After an extensive analysis of strategic alternatives, Sun concluded
that the industrial distribution business offered substantial opportunities for
growth, high returns on invested capital, and relatively low business risk. Sun
pursued this strategy through Sun Distributors, Inc., which became an industry
consolidator and acquired 16 companies between 1975 and 1985. In 1986, Sun
decided to refocus its efforts on its core energy business and sell its
non-energy businesses. The Company was purchased by a predecessor affiliate of
the Selling Stockholders in October 1986. In February 1987, the Company made an
initial public offering of its limited partnership interests and became a
publicly traded master limited partnership.
The Company continued to make acquisitions after its initial public
offering, but its ability to make acquisitions after 1991 was hindered by its
partnership structure and associated restrictions in the Company's credit
agreements. In 1994 and 1995, the Company divested three non-strategic
businesses with aggregate 1994 sales of $177.1 million. The Company converted
from partnership to corporate form on September 30, 1997.
The Offering
Risk Factors
An investment in the Common Shares offered hereby involves various
risks. See "Risk Factors."
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SUMMARY HISTORICAL AND
PRO FORMA FINANCIAL INFORMATION
(In thousands except per share amounts)
The following tables set forth summary consolidated historical and pro
forma financial data of the Company and the Partnership as of the dates and for
the periods indicated. The historical financial information as of September 30,
1997 and for the nine months ended September 30, 1997 and 1996 is derived from
unaudited financial statements included elsewhere herein. The historical
information for each of the three years in the period ended December 31, 1996 is
derived from audited financial statements included elsewhere herein. The
historical financial information for each of the two years in the period ended
December 31, 1993 are derived from audited financial statements not included
elsewhere herein. The summary unaudited pro forma income statement information
for the nine months ended September 30, 1997 and 1996 and for the twelve months
ended December 31, 1996 gives effect to the Conversion, the Refinancing, the
Offering and the elimination of other non-recurring charges and credits as of
the beginning of each period presented. The pro forma financial information
should be read in conjunction with the unaudited pro forma consolidated
financial statements and related notes thereto appearing elsewhere herein. See
"Index to Financial Statements," "Selected Historical and Pro Forma Financial
Information" and "Management's Discussion and Analysis of Financial Condition
and Results of Operations."
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(1) Includes results of operations from divisions sold as follows:
Years Ended December 31,
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1995 1994 1993 1992
----------- ----------- ------------ ------------
Net sales $ 29,070 $ 177,107 $ 162,270 $ 159,912
EBITDA (3) 608 10,338 8,539 10,106
EBITA (3) 305 9,085 6,989 8,315
Income from operations 270 8,588 6,637 8,017
(2) Includes $3,053 of Conversion-related transaction and other costs for the
nine months ended September 30, 1997 and $2,150 for the year ended December
31, 1996, $5,950 of restructuring charges for the year ended December 31,
1996 and management fee expense of $2,491 for the nine-month periods ending
September 30, 1996 and 1997 and $3,330 in each year in the five year period
ending December 31, 1996.
(3) "EBITDA" is defined as income from operations before depreciation and
amortization; "EBITA" is defined as income from operations before
amortization. EBITDA and EBITA are not measures of performance under
Generally Accepted Accounting Principles ("GAAP"). While EBITDA and EBITA
should not be considered in isolation or as a substitute for net income,
cash flows from operating activities and other income or cash flow statement
data prepared in accordance with GAAP, the Company believes that EBITDA and
EBITA are accepted within the business segments in which the Company
operates as generally recognized measures of performance. Moreover,
substantially all of the Company's financing agreements contain covenants in
which EBITDA and/or EBITA are used as measures of financial performance. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" for a discussion of other measures of performance determined in
accordance with GAAP.
(4) Assumes the Offering closed on September 30, 1997 with net proceeds of
$10,604,000 to the Company for 500,000 Common Shares issued.
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RISK FACTORS
An investment in the Common Shares of the Company offered hereby
involves various risks. In addition to general investment risks and those
factors set forth elsewhere in this Prospectus, prospective investors should
consider, among other things, the following factors:
Restructuring
In December 1996, the Company announced a restructuring plan to
integrate and consolidate its five domestic STS divisions. The Company expects
the restructuring plan to result in the elimination of approximately 175
employees in the STS divisions and produce certain net annualized cost savings
of approximately $5.0 million per year upon its completion. The STS divisions
consist of hydraulic and pneumatic distributors that were acquired by the
Company between 1976 and 1991. Until the restructuring, each of the STS
divisions was operated on a decentralized basis. The announced restructuring
plan is a three-year project to consolidate all financial and other
administrative responsibilities for the STS divisions in one location, and
includes a migration to one management information system. The integration and
consolidation of the finance and administrative functions is expected to be
completed in the first half of 1999. The restructuring of the sales organization
and distribution network has begun; however, management's current estimate is
that completion of this phase will require approximately an additional 18 months
due to the need for further analysis of STS' customer base and logistics
requirements. The failure to complete the restructuring or successfully
integrate the STS divisions would have an adverse impact on the Company's
ability to fully achieve the net cost savings indicated above. Although the
Company believes that STS will be successful with its restructuring plan, there
can be no assurance that it will be able to complete the plan effectively or on
a timely basis. See "Business--Industrial Services--SunSource Technology
Services."
Changing Industry Environment
The industrial distribution industry is undergoing significant change.
Historically, industrial distributors have served as suppliers of industrial
products and as extensions of manufacturers' sales forces, selling products
through the distribution channels to original equipment manufacturers,
retailers, end users and other customers. In recent years, both manufacturers
and customers have been increasingly relying on industrial distributors such as
the Company to reduce purchasing costs and provide a broad range of value-added
services, including inventory management programs, integrated supply
arrangements, electronic ordering capabilities, engineering design and technical
support services. In addition, customers' desire to consolidate their supplier
relationships has required industrial distributors to achieve purchasing
efficiencies, expand their geographic coverage and increase product and service
offerings through acquisitions of other distributors. These changes in the
industrial distribution industry could cause the industry to become more
competitive. Although the Company believes that it is well positioned to take
advantage of these changing industry dynamics, there can be no assurance that
the Company will be able to compete effectively in or adapt to the changing
industry environment. See "Business--Industry Overview" and "Business--Business
Strategy."
Risks Associated with Acquisitions
An element of the Company's future growth strategy is to pursue
selected acquisitions that either expand or complement its businesses in new or
existing markets. However, there can be no assurance that the Company will be
able to identify or acquire acceptable acquisition candidates on terms favorable
to the Company and in a timely manner to the extent necessary to fulfill the
Company's growth strategy. Future acquisitions may be financed through the
issuance of Common Shares, which may be dilutive to the Company's stockholders,
or through the incurrence of additional indebtedness. Furthermore, there can be
no assurance that competition for acquisition candidates will not escalate,
thereby increasing the costs of acquisitions. The process of integrating
acquired businesses into the Company's operations may result in unforeseen
difficulties and may require a disproportionate amount of resources and
management's attention, and there can be no assurance that the Company will be
able to successfully integrate acquired businesses into its operations. The
failure to complete or successfully integrate
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prospective acquisitions may have an adverse impact on the Company's growth
strategy. The Company is not currently a party to any agreement or understanding
regarding a material acquisition but is pursuing discussions with a number of
prospective sellers of businesses. See "Business--Business Strategy."
Competition
The distribution industry is highly competitive, with the principal
methods of competition being price, quality of service, quality of products,
product availability, credit terms and the provision of value-added services,
such as engineering design, integrated supply and inventory management. The
Company encounters competition from a large number of regional and local
distributors and from several national distributors, some of which have greater
financial resources than the Company and offer a greater variety of products.
See "Business."
Seasonality and Industry Cycles
The Company has in the past experienced seasonal fluctuations in sales
and operating results from quarter to quarter. Typically, the first calendar
quarter is the weakest due to the effect of weather on construction activity
which produces a slowdown of sales of material and equipment in the construction
market. Fluctuations in the Company's quarterly operating results could result
in significant volatility in, and otherwise adversely affect, the market price
of the Common Shares.
Some of the principal markets for the products and services offered by
the Company are subject to cyclical fluctuations that generally affect demand
for industrial, commercial and consumer durable goods. Cyclical fluctuations can
affect a number of factors such as pricing, availability and demand for the
Company's products, growth rates in the markets served by the Company's
customers, the delivery and performance of vendors, and the availability of
suitable acquisition candidates. Changes in general economic conditions could
have a material adverse effect on the Company's business, results of operations
and financial condition.
Dependence on Information Systems; Year 2000 Issue
The Company believes that its proprietary computer software programs
are an integral part of its business and growth strategies. The Company depends
on its information systems generally to process orders, to manage inventory and
accounts receivable collections, to purchase, sell and ship products efficiently
and on a timely basis, to maintain cost-effective operations and to provide
superior service to its customers. While the Company has taken precautions
against certain events that could disrupt the operation of its information
systems, there can be no assurance that such a disruption will not occur. Any
such disruption could have a material adverse effect on the Company's business
and results of operations. See "Business."
The Company faces the "Year 2000" issue. The Year 2000 issue is the
result of computer programs being written using two digits (rather than four) to
define the applicable year, resulting in incorrect calculations for the year
2000 and beyond. The Company's issues relate not only to its own systems being
Year 2000 compliant, but also the systems of its suppliers and customers. The
Company presently believes that, with modifications to existing software and
converting to new software, the Year 2000 issue will not pose significant
operational problems for its computer systems as so modified or converted.
However, if such modifications and conversions are not completed in a timely
manner, or if the Company's suppliers and customers fail to address the problem,
the Year 2000 issue could have a material adverse effect on the operations of
the Company.
Future Dilution of Common Stock
The Company is permitted to issue additional equity or debt securities,
including shares of Preferred Stock. Issuances of additional Common Shares or
shares of Preferred Stock could adversely affect stockholders' equity interest
in the Company and could adversely affect the market price of the Common Shares,
and the interests in the
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assets, liabilities, cash flow and results of operations of the Company
represented by Common Shares may be diluted. Holders of Common Shares are not
entitled to preemptive rights.
Provisions that May Discourage Changes of Control
The Company's Certificate of Incorporation and Bylaws and the
Stockholders Agreement and Stockholders Rights Plan described under "Description
of Capital Stock" contain certain provisions that may have the effect of
encouraging persons considering an acquisition or takeover of the Company to
negotiate with the Board of Directors rather than to pursue non-negotiated
acquisitions or takeover attempts that a stockholder might consider to be in the
stockholders' best interests, including offers that might result in a premium
over the market price for the Common Shares.
In addition to the Stockholders Rights Plan, these provisions include
authorization for the Board of Directors to issue classes or series of Preferred
Stock and a requirement that stockholders notify the Company in advance of any
director nominees or items of business to be proposed at any meeting of
stockholders. In addition, the deferred compensation plans of the Company
provide that, upon the occurrence of a change in control as defined in the
plans, the vesting provisions of awards under the plans will be accelerated.
These provisions may reduce interest in the Company as a potential acquisition
target or reduce the likelihood of a change in the management or voting control
of the Company without the consent of the then incumbent Board of Directors.
Limited Trading Market and Volatility of Common Shares
The Common Shares have traded on the New York Stock Exchange since the
effective date of the Conversion on October 1, 1997. Prior to that time the
Class B limited partnership interests of the Partnership had limited trading
volume because institutional and other investors do not typically invest in
limited partnership interests for various tax and administrative reasons. The
limited trading volume in the Common Shares has continued since October 1, 1997.
From time to time after the Offering, there may be significant
volatility in the market price for the Common Shares. Operating results of the
Company or of other companies participating in the industrial distribution
industry, changes in general economic conditions and the financial markets, or
other developments affecting the Company or its competitors could cause the
market price for the Common Shares to fluctuate substantially.
Reliance on Executive Officers
The Company is highly dependent upon the skills, experience and efforts
of its executive officers. Loss of the services of one or more of the Company's
executive officers could have a material adverse effect on the Company's
business and development. The Company's continued growth also depends in part on
its ability to attract and retain qualified managers, sales representatives and
other key employees and on its executive officers' ability to implement the
Company's strategy successfully. No assurance can be given that the Company will
be able to attract and retain such employees or that such executive officers
will be able to implement the Company's strategy successfully. See "Management."
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THE COMPANY
SunSource Inc. is a Delaware corporation organized in 1996 to
accomplish the Conversion. The Conversion was effected by the merger of the
Partnership into the Company effective on September 30, 1997. In the Conversion,
each Class A limited partnership interest of the Partnership was exchanged for
$1.30 in cash and 0.38 of a Guaranteed Preferred Beneficial Interest in the
Company's Junior Subordinated Debentures (the "Trust Preferred Securities");
each Class B limited partnership interest was exchanged for 0.25 Common Share of
the Company; and the general and limited partnership interests in the general
partner of the Partnership were exchanged for 1,000,000 Common Shares.
The Partnership was organized in 1986 under the name Sun Distributors
L.P. to conduct the business formerly conducted by Sun Distributors, Inc. when
it was a subsidiary of Sun. The name was changed to SunSource L.P. in April
1996.
The principal executive office of the Company is located at 3000 One
Logan Square, Philadelphia, PA 19103 and its telephone number is (215) 282-1290.
USE OF PROCEEDS
The net proceeds to the Company from the Offering (estimated at
$10,604,000) will be used to repay borrowings under the Company's revolving
credit facility. As of December 31, 1997, the balance on the Company's revolving
credit facility was approximately $33.0 million. The funds borrowed by the
Company under the revolving credit facility were used to pay transaction costs
and other payments related to the Conversion and for working capital purposes.
The interest rate on borrowings under the revolving credit facility are based on
London Interbank Offered Rate ("LIBOR") plus 1.0% to 1.5% or prime. At December
31, 1997, such interest rate was approximately 7.37% per annum.
The Company will receive no proceeds from the sale of Common Shares in
the Offering by the Selling Stockholders.
DIVIDEND POLICY
The Company paid a cash dividend of $.10 per Common Share on January 6,
1998. The Company expects to declare future quarterly dividends on the Common
Shares of $.40 per Common Share annually, subject to the discretion of the Board
of Directors and dependent upon, among other things, the Company's future
earnings, financial condition, capital requirements, funds needed for
acquisitions, level of indebtedness, contractual restrictions and other factors
that the Board of Directors deems relevant.
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CAPITALIZATION
The following table sets forth the capitalization of the Company as of
September 30, 1997 and as adjusted to give effect to the Offering and repayment
of borrowings under the Company's revolving credit facility (assuming the
Offering closed on September 30, 1997 with net proceeds of $10,604,000 to the
Company). The table should be read in conjunction with the historical and pro
forma consolidated financial statements of the Company and the Partnership and
related notes thereto included elsewhere herein and the unaudited pro forma
financial statements and related notes thereto included elsewhere herein.
(1) Subsequent to September 30, 1997, distributions payable of $17,557 were
funded through the bank revolving credit facility.
(2) The Company's accumulated deficit is primarily a result of the exchange of
Class A limited partnership interests for cash and guaranteed preferred
beneficial interests in the Company's junior subordinated debentures. The
guaranteed preferred beneficial interests are classified between total
liabilities and equity on the Company's balance sheet and were recorded at
their fair value on September 30, 1997. (See page F-10 for further
information on Conversion-related adjustments).
12
PRICE RANGE OF COMMON SHARES
As a result of the Conversion which was effective at the close of
business on September 30, 1997, the Common Shares began trading on the New York
Stock Exchange on October 1, 1997 under the symbol "SDP". The following table
sets forth the high and low closing sale prices on the New York Stock Exchange
Composite Tape for the Common Shares since that date:
High Low
1998
First Quarter (to January 20)......... $23 9/16 $23 5/16
1997
Fourth Quarter........................ $25 13/16 $23 1/2
For a recent reported last sale price of the Common Shares on the New
York Stock Exchange Composite Tape see the cover page of this Prospectus. As of
January 20, 1998, there were approximately 776 holders of record of the Common
Shares.
As discussed above under "The Company," in the Conversion each Class B
limited partnership interest of the Partnership was exchanged on September 30,
1997 for 0.25 of a Common Share, effectively a one-for-four reverse split. The
following table shows the quarterly range of high and low closing sales prices
on the New York Stock Exchange Composite Tape for the Class B limited
partnership interests for the periods indicated, adjusted for the one-for-four
reverse split:
High Low
1997
First Quarter................................ $ 18 $ 16 1/2
Second Quarter............................... 20 1/2 16
Third Quarter................................ 23 1/2 19
1996
First Quarter................................ $ 20 1/2 $ 16
Second Quarter............................... 18 16
Third Quarter................................ 18 17
Fourth Quarter............................... 18 1/2 16 1/2
13
SELECTED HISTORICAL AND PRO FORMA FINANCIAL INFORMATION
(In thousands, except for per unit and per share data)
The following table sets forth selected consolidated historical and pro
forma financial data of the Company and the Partnership as of the dates and for
the periods indicated. The historical financial information as of September 30,
1997 and for the nine months ended September 30, 1997 and 1996 is derived from
unaudited financial statements included elsewhere herein. The historical
financial information as of December 31, 1996 and 1995 and for each of the three
years in the period ended December 31, 1996 is derived from audited financial
statements included elsewhere herein. The historical financial information as of
September 30, 1996, December 31, 1994, 1993, 1992 and for each of the two years
in the period ended December 31, 1993 is derived from financial statements not
included elsewhere herein. The selected unaudited pro forma income statement
information for the nine months ended September 30, 1997 and 1996 and for the
twelve months ended December 31, 1996 gives effect to the Conversion, the
Refinancing, the Offering and the elimination of other non-recurring charges and
credits as of the beginning of each period presented. The pro forma financial
information should be read in conjunction with the unaudited consolidated pro
forma financial statements and notes thereto appearing elsewhere herein. See
"Index to Financial Statements" and "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
14
- -------------------
(1) Includes results of operations from divisions sold as follows:
(2) The pro forma earnings per common share for the nine months ended September
30, 1997 gives effect to the Conversion as of the beginning of the year
presented and excludes non-recurring charges and credits directly related
to the Conversion.
(3) "EBITDA" is defined as income from operations before depreciation and
amortization; "EBITA" is defined as income from operations before
amortization. EBITDA and EBITA are not measures of performance under
Generally Accepted Accounting Principles ("GAAP"). While EBITDA and EBITA
should not be considered in isolation or as a substitute for net income,
cash flows from operating activities and other income or cash flow
statement data prepared in accordance with GAAP, the Company believes that
EBITDA and EBITA are accepted within the business segments in which the
Company operates as generally recognized measures of performance. Moreover,
substantially all of the Company's financing agreements contain covenants
in which EBITDA and/or EBITA are used as measures of financial performance.
See "Management's Discussion and Analysis of Financial Condition and
Results of Operations" for a discussion of other measures of performance
determined in accordance with GAAP.
15
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
General
The Company is one of the largest providers of industrial products and
related value-added services in North America. The Company is organized into
three businesses which are SunSource Industrial Services Company, Hillman and
Harding. SunSource Industrial Services Company is comprised of STS and SIMCO.
Conversion
The Conversion resulted in the Company reporting a stockholders'
deficit as of September 30, 1997, due to the exchange of Trust Preferred
Securities and cash for all of the Class A partnership interests which was
recorded at fair value aggregating $130.4 million. The Trust Preferred
Securities have both equity characteristics and certain creditors' rights, and
therefore are classified between total liabilities and stockholders' equity on
the Company's balance sheet. The Trust Preferred Securities bear interest at an
annual rate of 11.6% and are cumulative and callable, at the Company's option,
after September 30, 2002. The interest payments on the Junior Subordinated
Debentures underlying the Trust Preferred Securities of approximately $12.2
million annually are deductible for federal income tax purposes under current
law and will remain an obligation of the Company until the Trust Preferred
Securities are redeemed or upon their maturity in 2027.
Restructuring
In December 1996, the Company recorded restructuring charges of $6.0
million (on a pre-tax basis) related to a restructuring and consolidation of STS
(approximately $4.4 million) and the one-time write-off of certain
non-performing assets of Harding (approximately $1.6 million). The restructuring
plan is expected to result in the elimination of approximately 175 employees in
the STS divisions and result in net cost savings of approximately $5.0 million
annually upon its completion. The restructuring plan is a three-year project
that will consolidate all financial and administrative responsibilities for STS
in a centralized location which is expected to be completed in the first half of
1999. However, the Company has deferred completion of restructuring of the STS
sales organization and distribution network for an additional eighteen months
pending further analysis of its customer base and logistics requirements. Of the
$4.2 million of restructuring charges that will result in cash payments, $0.2
million was paid by the Company through December 31, 1996, and an additional
$1.8 million was paid during the nine months ended September 30, 1997.
Sale of Certain Divisions
The Company sold its Downey Glass division on October 27, 1995, its
Dorman Products division on January 3, 1995 and its three Electrical Group
divisions on December 5, 1994, for an aggregate cash consideration, net of
expenses, of approximately $70.6 million (subject to certain post-closing
adjustments) and the assumption of certain liabilities. The proceeds from these
divestitures were used to reduce debt and for general purposes including
acquisitions. The Company recorded gains on the sale of these divisions
aggregating $24 million. See Note 14 of the Notes to the Consolidated Financial
Statements of the Partnership for the three years in the period ended December
31, 1996 regarding litigation pertaining to the sale of the Dorman Products
division.
Sales from the divested divisions aggregated $29.1 million for the year
ended December 31, 1995 and $177.1 million for the year ended December 31, 1994.
Income from operations from the divested divisions aggregated $0.3 million in
1995 and $8.6 million in 1994.
Acquisitions
The Company recently resumed its strategy to acquire retail glass shops
for integration with Harding. Since August 31, 1997, Harding acquired the assets
of three retail glass shops for net cash consideration of $0.8 million. Sales
from the acquired shops aggregated approximately $2.5 million for the
twelve-month period prior to acquisition.
16
On April 11, 1996, STS purchased certain assets of Hydraulic Depot,
Inc. for an aggregate purchase price of $0.7 million. Sales of Hydraulic Depot
were $2.2 million for the nine months ended September 30, 1997 and $2.0 million
from the acquisition date through December 31, 1996.
On November 13, 1995, Hillman purchased certain assets of the retail
division of Curtis Industries ("Curtis") for an aggregate purchase price of $8.0
million and the assumption of certain liabilities. Curtis was integrated with
the Hillman division and its sales were $11.0 million for the twelve months
ended December 31, 1996 and $1.6 million from the acquisition date through
December 31, 1995.
Income Taxes
The Company's pro forma effective income tax rate for the nine months
ended September 30, 1997 was 44.9%. The Company incurs federal, state and local
income taxes on its domestic operations and foreign income taxes on its
operations in Canada and Mexico. In addition, the Company has recorded goodwill
in connection with acquisitions and the Conversion that is not deductible for
federal income tax purposes. Consequently, the Company expects that its
consolidated effective income tax rate will continue to be approximately 45.0%.
Results of Operations
The following discussion provides information which management believes
is relevant to an assessment and understanding of the Company's operations and
financial condition. The discussion pertains to the consolidated statements of
income and cash flows of the Company for the nine months ended September 30,
1997 and 1996 (pro forma) and for the years ended December 31, 1996, 1995 and
1994 (historical) and the consolidated balance sheets dated September 30, 1997,
December 31, 1996 and 1995 (historical) and should be read in conjunction with
these consolidated financial statements and notes thereto appearing elsewhere
herein. Reference is also made, where appropriate, to the unaudited consolidated
pro forma financial statements and the notes thereto contained elsewhere herein.
Pro Forma Results for the Nine Months Ended September 30, 1997 and 1996
Net income on a pro forma basis for the nine months ended September 30,
1997 was $9.3 million or $1.35 per Common Share compared with $7.1 million or
$1.03 per Common Share for the same period in 1996, an increase of $2.1 million
or 30.3%.
Net sales increased $39.7 million or 8.1% in the first nine months of
1997 to $529.2 million from $489.5 million in the first nine months of 1996.
Sales for the nine months ended September 30, 1997 and 1996 and
respective sales variances by business segment are as follows:
17
Sales of STS increased $18.3 million or 8.1% in the first nine months
of 1997 to $242.8 million from $224.5 million in the comparable 1996 period due
primarily to an increase in the volume of products sold and value-added services
provided to STS's customer base. SIMCO's sales increased $13.6 million or 11.7%
in the first nine-months of 1997 to $130.5 million from $116.9 million in the
comparable 1996 period due to sales from new in-plant inventory management
programs aggregating $9.1 million and an increase in expediter maintenance
product sales of $4.5 million.
Hillman's sales increased $9.9 million or 12.4% in the first
nine months of 1997 to $89.3 million from $79.4 million in the comparable 1996
period as a result primarily of expansion into complementary product lines, such
as keys, letters, numbers, signs and rope and chain accessories.
Harding's sales decreased $2.1 million or 3.0% in the first nine months
of 1997 to $66.6 million from $68.7 million in the comparable 1996 period. The
decline is attributable to decreases in wholesale glass and other product lines
aggregating $2.7 million, offset by an increase in retail automotive sales of
$0.6 million. In recent years, Harding has discontinued certain low-margin
product lines and has withdrawn from non-strategic markets. Growth in Harding's
retail glass shops is expected to continue as a result of internal sales
programs and acquisitions.
Cost of sales increased $21.3 million or 7.2% in the first nine months
of 1997 to $315.0 million from $293.7 million in the comparable 1996 period, due
primarily to increased sales levels in the comparison period.
Gross margins were 40.5% in the first nine months of 1997 compared with
40.0% in the comparable 1996 period, comprised by business segment as follows:
Nine Months Ended
September 30,
------------------------
1997 1996
----- -----
SunSource Industrial Services Company
STS....................................... 26.1% 25.7%
SIMCO..................................... 58.6% 61.4%
Total SunSource Industrial
Services Company...................... 37.5% 37.9%
Hillman........................................ 52.8% 49.9%
Harding........................................ 40.8% 38.4%
Total Company......................... 40.5% 40.0%
The improvement in STS' gross margin is due primarily to labor
efficiencies in its service and repair business and lower freight costs. The
decrease in SIMCO's gross margin is due mainly to competitive pricing pressures
and changes in sales mix as a result of new inventory management programs.
Hillman's gross margins increased due primarily to a significant reduction in
packaging costs in the first nine months of 1997 from the comparable 1996
period. The increase in Harding's gross margins was due primarily to improved
purchasing management in auto and flat glass, exiting from low-margin product
lines and efforts to improve margins in the wholesale flat glass business.
Selling, warehouse and delivery and general & administrative
("S,G&A") expenses increased by $13.9 million or 8.5% in the first nine months
of 1997 to $178.2 million from $164.2 million in the comparable 1996 period.
Selling expenses increased $4.8 million comprised of increases in SunSource
Industrial Services Company and Hillman to support expanded sales and Harding as
a result of increased marketing efforts in retail glass. Warehouse and delivery
expenses increased $2.6 million to support increased sales in the 1997 period.
General and administrative expenses increased $6.5 million consisting of: (i) an
increase of $5.3 million to support the overall increase in 1997 sales levels
and the increased number of SIMCO system accounts and (ii) an increase of $1.3
million in corporate expenses compared to the 1996 period which included an
expense reduction of $0.8 million as a result of incentive-based compensation
plans and a non-recurring reduction in insurance reserves of $0.4 million.
18
The Company is subject to federal, state and local income taxes on its
domestic operations and foreign income taxes on its Canadian and Mexican
operations as accounted for in accordance with Statement of Financial Accounting
Standard No. 109, "Accounting for Income Taxes" ("SFAS 109"). Deferred income
taxes represent differences between the financial statement and tax bases of
assets and liabilities as classified on the Company's balance sheet. The
Company's provision for income taxes on a pro forma basis in the first nine
months of 1997 increased $1.2 million from the first nine months of 1996 due to
higher income levels in the 1997 period. The Company's effective income tax rate
decreased from 47.0% in the 1996 period to 44.9% in the 1997 period as a result
of certain expenses that are non-deductible permanently for tax purposes, such
as goodwill.
Operating Results Excluding Divisions Sold for the Three Years Ended
December 31, 1996
The table below reflects the results from ongoing operations of the
Company for each of the three years in the period ended December 31, 1996, which
excludes the sales, gross profit and operating expenses of divisions sold in
1995 and 1994. The management fee to general partner represents a payment made
by the Company to its general partner while operating as a master limited
partnership. Since the Company's conversion to corporate form, the management
fee is retained by a wholly owned subsidiary of the Company.
Years Ended December 31, 1996 and 1995
Net income for the year ended December 31, 1996 was $19.3 million
compared with $44.1 million in 1995. As previously discussed, 1996 net income
included a $4.9 million charge (net of $1.1 million in deferred tax benefits),
related to the restructuring of STS and Harding and a $2.1 million charge for
transaction costs associated with the Conversion. The 1995 net income included a
gain of $20.6 million from the sale of the Downey Glass division in October 1995
and the Dorman Products division in January 1995. Net income for 1995 also
included a $0.6 million charge related to the early retirement of debt and $0.3
million of operating income from the Downey Glass division. Excluding these
non-recurring items, net income for 1996 amounted to $26.3 million or 10.5%
above the comparable 1995 net income of $23.8 million.
After giving effect to the Offering, the Conversion, the Refinancing
and the elimination of gains and results of operations from divisions sold, as
well as non-recurring items, pro forma net income for the twelve months ended
December 31, 1996 was $9.1 million or $1.31 per Common Share or 10.2% above
comparable 1995 net income of $8.2 million. See Notes to Pro Forma Consolidated
Financial Statements for adjustments that affect comparability to historical
results.
19
Net sales increased $49.4 million or 8.2% in 1996 to $649.3 million
from $599.9 million in 1995 resulting primarily from an increase in the volume
of products sold due to continued strengthening in existing product markets as
well as additional market penetration from new product lines and value-added
services.
Sales for the years ended December 31, 1996 and 1995 and sales
variances by business segment are as follows:
Sales of STS increased $13.6 million or 4.8% in 1996 to $299.1 million
from $285.5 million in 1995 due to continued strength in existing product
markets. SIMCO sales increased $18.2 million or 13.1% in 1996 to $156.4 million
from $138.2 million in 1995 as a result of sales growth from new inventory
management programs of $10.5 million and an increase in expediter maintenance
product sales of $7.7 million.
Hillman's sales increased $18.8 million or 22.2% in 1996 to $103.4
million from $84.6 million in 1995 due to contributions from the Curtis
acquisition in the amount of approximately $11.0 million and the balance of $7.8
million in growth from new accounts, expansion of existing product lines and
market penetration of new product lines.
Harding's sales declined $1.2 million or 1.3% in 1996 to $90.4 million
from $91.6 million in 1995 due to a decrease in wholesale glass, brokerage and
other product line sales of $2.8 million and the discontinuation of certain low
margin product lines and markets served aggregating $0.2 million, offset by an
increase in retail glass sales of $1.8 million or 4.2% from the comparable 1995
period.
Cost of sales increased $31.3 million or 8.8% in 1996 to $386.3 million
from $355.0 million in 1995 due primarily to increased sales levels.
Gross margins were 40.5% in 1996 compared with 40.8% in 1995, comprised
by business segment as follows:
Years Ended December 31,
------------------------
1996 1995
---- ----
SunSource Industrial Services Company
STS..................................... 26.7% 27.4%
SIMCO................................... 61.1% 64.5%
Total SunSource Industrial
Services Company.................. 38.6% 39.5%
Hillman.................................... 50.8% 52.4%
Harding.................................... 38.8% 35.9%
Total Company..................... 40.5% 40.8%
The decline in SunSource Industrial Services Company's gross margin was
due mainly to competitive pricing pressures and changes in sales mix. Hillman's
gross margins decreased due to reduced packaging productivity levels and costs
associated with integration of the Curtis acquisition and for other business
expansion
20
programs. Harding's gross margins increased due to improved purchasing
management and increased sales in retail glass which carries higher margins than
the other product lines in this segment.
S,G&A expenses increased by $16.4 million or 8.0% to $221.6 million in
1996 from $205.2 million in 1995, comprised as follows: increased selling
expenses of $7.4 million supporting increased 1996 sales levels; increased
warehouse and delivery expenses of $6.3 million due to the integration of the
Curtis acquisition, expansion programs by certain operating units and the
addition of seven large in-plant accounts by SIMCO; and increased general and
administrative expenses of $2.7 million.
Years Ended December 31, 1995 and 1994
Net income for the year ended December 31, 1995 was $44.1 million
including a combined gain of $20.6 million from the sale of the Dorman Products
and Downey Glass divisions, compared with $29.5 million of net income in 1994,
which included a gain of $3.5 million from the sale of the Electrical Group
divisions in December 1994. Net income for 1995 also included a $0.6 million
charge related to the early retirement of debt and a reduction in net interest
cost of approximately $3.2 million from the prior year. Net income for the year
ended December 31, 1994 included income from divisions sold aggregating $8.6
million. Excluding operating income and gains from divisions sold, as well as
the extraordinary loss on early extinguishment of debt, net income for 1995
amounted to $23.8 million or 36.7% above comparable 1994 net income of $17.4
million.
After giving effect to the Conversion, the Refinancing, the Offering
and the elimination of gains and results of operations from divisions sold, as
well as non-recurring items, net income for the year ended December 31, 1995
would have been $8.2 million, an increase of 103% from the comparable 1994 net
income of $4.1 million. See Notes to Pro Forma Consolidated Financial Statements
for adjustments that affect comparability to historical results.
Net sales increased $41.1 million or 7.4% in 1995 to $599.9 million
from $558.8 million in 1994, resulting primarily from an increase in the volume
of products sold due to strengthening in most product markets and significant
growth from sales programs and services initiated since 1992.
Sales for the years ended December 31, 1995 and 1994 and sales
variances by business segment were as follows:
Sales of SunSource Industrial Services Company increased $35.2 million
or 9.1% in 1995 to $423.7 million from $388.5 million in 1994 due primarily to
an increase in the volume of products sold as a result of strengthening in most
product markets.
Hillman's sales increased $11.8 million or 16.2% in 1995 to $84.6
million from $72.8 million in 1994 due primarily to continued geographic
expansion and the introduction of new product lines.
Harding's sales decreased $5.9 million or 6.1% in 1995 to $91.6 million
from $97.5 million in 1994 due to a decline in sales volume primarily
attributable to the discontinuation of certain product lines and markets served.
21
Cost of sales increased $23.4 million or 7.1% in 1995 to $355.0 million
from $331.6 million in 1994, due primarily to increased sales levels in the
existing businesses in the comparison period.
Gross margins were 40.8% in 1995 compared with 40.7% in 1994, comprised
by business segment as follows:
Years Ended December 31,
------------------------
1995 1994
---- ----
SunSource Industrial Services Company
STS..................................... 27.4% 27.7%
SIMCO................................... 64.5% 65.9%
Total SunSource Industrial
Services Company................... 39.5% 40.3%
Hillman..................................... 52.4% 51.0%
Harding..................................... 35.9% 34.4%
Total Company...................... 40.8% 40.7%
Changes in sales mix were the principal contributors to the changes in
gross margins.
S,G&A expenses increased by $15.9 million or 8.4% to $205.2 million in
1995 from $189.3 million in 1994, comprised as follows: increased selling
expenses of $8.9 million, increased warehouse and delivery expenses of $3.2
million and increased general and administrative expenses of $3.8 million. The
increase in S,G&A expenses supported increased 1995 sales levels and expansion
programs by certain operating units. S,G&A as a percentage of sales increased
from 33.9% in 1994 to 34.2% in 1995 due mainly to increased support payments,
incentive programs and marketing efforts for the sales force.
Interest expense, net decreased $3.0 million to $6.9 million in 1995
from $9.9 million in 1994 due to reduced financing costs of approximately $1.5
million from the prepayment of senior notes on March 14, 1995, $1.1 million from
reduced borrowing levels under the Company's revolving credit facility and
increased interest income of approximately $0.4 million.
Other income, net was $0.7 million for the twelve months ended December
31, 1995, compared to $1.4 million of other expense recorded in 1994. This
change was primarily due to the favorable settlement of certain non-recurring
insurance and legal matters in 1995.
Liquidity and Capital Resources
On a historical basis, net cash provided by operations was $23.0
million in the first nine months of 1997 compared with $20.6 million in the
first nine months of 1996, an increase of $2.4 million. This increase was due
primarily to increased net income of $5.4 million offset by increased working
capital investment in operations in the comparison period of approximately $0.5
million, and other non-cash items of $2.5 million. The Company's net interest
coverage ratio on a pro forma basis (earnings before interest, distributions on
guaranteed preferred beneficial interests and taxes over net interest expense
and distributions on guaranteed preferred beneficial interests) improved to
2.16x in the first nine months of 1997 from 1.95x in the comparable 1996 period.
The Company's cash position of $2.7 million as of September 30, 1997
increased $1.0 million from the balance at December 31, 1996. Cash was provided
during this period primarily from operations of $23.0 million and proceeds from
the sale of property and equipment of $0.7 million. Cash was used during this
period predominantly for capital expenditures ($3.3 million), cash distributions
to partners ($13.9 million), pre-payment penalty on senior notes ($4.3 million)
and other items ($1.2 million).
The Company's working capital position of $105.4 million at September
30, 1997 represents an increase of $4.6 million from the December 31, 1996 level
of $100.8 million. The Company's current ratio decreased to 2.02x
22
at September 30, 1997 from 2.16x at December 31, 1996, principally due to an
increase in distributions payable of $14.4 million related to the Conversion.
Excluding this item, the Company's current ratio was 2.34x as of September 30,
1997.
On September 30, 1997, the Company issued a $60.0 million 7.66% Senior
Note due 2002 and amended its credit agreement to increase the aggregate
availability under the existing revolving line of credit to $90.0 million at
variable borrowing rates of LIBOR plus 1.0% to 1.5% or prime. SunSource
anticipates interest cost savings of approximately 100 basis points through its
new debt facilities compared to its previous debt structure. The Company's
current borrowing capacity along with proceeds from the Offering is expected to
provide the Company with sufficient working capital for reinvestment in its
businesses and acquisition capital in the near future.
As of September 30, 1997, the Company had $70.8 million available under
its new credit facilities. As of September 30, 1997, the Company had $79.2
million of outstanding indebtedness consisting of the aforementioned $60.0
million Senior Note, bank borrowings totaling $17.0 million, and letter of
credit commitments aggregating $2.2 million. In addition, an indirect,
wholly-owned Canadian subsidiary of the Company has a $2.5 million Canadian
dollar line of credit for working capital purposes, of which no amount was
outstanding at September 30, 1997.
As of September 30, 1997, the Company's total debt (including
distributions payable) as a percentage of its consolidated capitalization (total
debt, Trust Preferred Securities and stockholders' deficit) was 45.8% compared
with 44.7% as of December 31, 1996. The Company's consolidated capitalization
(including distributions payable) as of September 30, 1997 was $208.2 million
compared to $173.0 million at December 31, 1996.
Proceeds from the Offering will be used to repay borrowings under the
Company's revolving credit facility. As a result of the Offering, the Company's
net worth would be $7.5 million on an as adjusted basis as of September 30,
1997, resulting in total debt as a percentage of consolidated capitalization
ratio of 40.7% as defined above.
The Company spent approximately $5.0 million for capital expenditures
in 1997, primarily for warehouse, machinery and equipment and computer hardware
and software.
The Company has recorded an estimated liability of $2.9 million at
September 30, 1997 for remaining tax distributions due to Class B interest
holders of the Partnership, related to taxable income for the nine months ended
September 30, 1997 that is expected to be paid by March 31, 1998.
As a result of the Conversion of the Partnership to corporate form, the
Company's cash flow is expected to improve due to the following: (i) retention
of the management fee payable to the general partner of SDI Operating Partners,
L.P. in the amount of $3.3 million per year, (ii) retention of distributions on
the general partner's ownership in the Partnership and SDI Operating Partners,
L.P. amounting to approximately $0.4 million annually and (iii) a reduction in
income tax rates.
The Board of Directors of the Company declared on December 10, 1997 a
cash dividend of $.10 per share of Common Stock which was paid on January 6,
1998, to holders of record as of December 22, 1997. The Company expects to
declare future quarterly dividends on the Common Stock to aggregate $.40 per
Common Share annually, subject to the discretion of its Board of Directors and
dependent upon, among other things, the Company's future earnings, financial
condition, capital requirements, funds needed for acquisitions, level of
indebtedness, contractual restrictions and other factors that the Board of
Directors deems relevant.
The Company has deferred tax assets aggregating $15.9 million as of
September 30, 1997. Management believes that the Company's deferred tax assets
will be realized through the reversal of existing temporary differences between
the financial statement and tax bases. The minimum level of future taxable
income necessary to realize the Company's recorded deferred tax assets at
September 30, 1997, is approximately $39.8 million. For the year ended December
31, 1996, the Company's consolidated federal taxable income was $28.6 million.
23
Recent Accounting Pronouncements
In June 1997, the FASB issued SFAS 130, "Reporting Comprehensive
Income," which requires changes in comprehensive income be shown in a financial
statement that is displayed with the same prominence as other financial
statements. Additionally, the FASB issued SFAS 131, "Disclosures about Segments
of an Enterprise and Related Information," which requires disclosures in
financial statements based on management's approach to segment reporting and
industry requirements to report selected segment information, disclosures about
products and services and major customers, on a quarterly basis. The Company
will be required to adopt SFAS 130 and 131 during fiscal 1998. The impact of
these new standards on the Company's future financial statements and disclosures
has not been determined.
Inflation
Inflation in recent years has had a modest impact on the operations of
the Company. Continued inflation, over a period of years at higher than current
rates, would result in significant increases in inventory costs and operating
expenses. However, such higher cost of sales and operating expenses can
generally be offset by increases in selling prices, although the ability of the
Company's operating divisions to raise prices is dependent on competitive market
conditions.
24
BUSINESS
General
SunSource is one of the largest providers of industrial products and
related value-added services in North America. Through its applications
engineers and technical support personnel, SunSource provides customized
solutions to complex problems encountered by its customers. The Company believes
that it differentiates itself from other industrial distributors by providing
superior technical and problem-solving capabilities in addition to an extensive
product offering and broad array of related services, such as engineering design
and integrated supply arrangements. The Company has more than 180,000 customers,
none of which represents more than 5% of annual net sales. The Company's
distribution and related services support more than 1,300 product lines,
consisting of approximately 175,000 stock keeping units.
The Company traces its origins to 1975, when Sun decided to pursue a
diversification strategy outside of its traditional energy business. After an
extensive analysis of strategic alternatives, Sun concluded that the industrial
distribution business offered substantial opportunities for growth, high returns
on invested capital, and relatively low business risk. Sun pursued this strategy
through Sun Distributors, Inc., which became an industry consolidator and
acquired 16 companies between 1975 and 1985. In 1986, Sun decided to refocus its
efforts on its core energy business and sell its non-energy businesses. The
Company was purchased by a predecessor affiliate of the Selling Stockholders in
October 1986. In February 1987, the Company made an initial public offering of
its limited partnership interests and became a publicly traded master limited
partnership.
The Company continued to make acquisitions after its initial public
offering, but its ability to make acquisitions after 1991 was hindered by its
partnership structure and associated restrictions in the Company's credit
agreements. In 1994 and 1995, the Company divested three non-strategic
businesses with aggregate 1994 sales of $177.1 million. The Company converted
from partnership to corporate form on September 30, 1997.
The Company has targeted three businesses within the distribution
industry which are characterized by a potential for value-added services,
economies of scale and opportunities for further consolidation.
Industrial Services. SunSource Industrial Services Company, with sales
of $455 million in 1996, provides a broad range of products and services
throughout North America through the sales and marketing activities of STS and
SIMCO. The Company believes that STS is a leading provider of systems, parts and
engineering services for hydraulic, pneumatic, electrical and related systems to
major industrial concerns, such as Ford Motor Company, Hillrom and Vermeer
Manufacturing, as well as small and medium-size businesses. STS provides
services, including engineering and design of both products and processes and
the assembly and repair of complex systems, which enable its customers to
outsource engineering and other functions which they previously performed
in-house. SIMCO provides inventory management services enabling its customers to
reduce inventory investment and the associated expenses of purchasing,
receiving, disbursing and accounting for parts and materials.
Hardware Merchandising Services. Hillman, with sales of $103 million in
1996, provides small hardware items and merchandising services to retail
hardware stores through a nationwide sales and service organization. Hillman
offers a full range of fasteners, letters, numbers, signs, keys, rope and chain
accessories and many other inexpensive "specialty" goods, which are "must-have"
items for retailers that cannot be managed economically by the retailer's own
employees because of the large number of items and their low prices. Hillman
maintains a 235 person nationwide sales and service organization which seeks to
ensure that its customers' inventories are maintained at appropriate levels with
a minimum of administrative effort or expense. Hillman also provides inventory
management software that ties into retailers' point-of-sale systems. Through its
merchandising system, Hillman assists retailers with rack positioning, store
layout, new package design and color coding systems to permit ease of shopping
by consumers.
25
Glass Merchandising. Harding, with sales of $90 million in 1996,
operates one of the largest networks of full service retail glass shops in the
United States. Harding is comprised of approximately 85 retail locations
throughout the Southwest and, to a lesser degree, along the East Coast. Harding
sells and installs automotive glass and also sells, fabricates and installs flat
glass. Customers include individual retail consumers, insurance companies and
commercial accounts.
The table below provides the sales and gross profit for each of the
Company's three businesses for the nine months ended September 30, 1997 and 1996
and for each of the three years in the period ended December 31, 1996, excluding
sales and gross profit from divisions sold. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
FINANCIAL INFORMATION BY BUSINESS (UNAUDITED)
(In thousands)
Industry Overview
The Company operates in large, fragmented industries characterized by
multiple channels of supply. These channels of supply are currently experiencing
significant changes driven by the higher quality and widespread availability of
management information systems. With better information, manufacturers,
distributors and customers are all able to track their expenses, investments and
returns on investments more accurately. The distribution industry is driven by
the following trends which are rendering the traditional producer-controlled
channels obsolete and subject to being replaced by new channels organized around
customer requirements and value-added services.
Manufacturers are increasing their reliance on distributors in order to
enhance their profitability and improve their returns on capital. Manufacturers
are attempting to (i) reduce their logistics expense by making less frequent,
larger shipments to fewer locations; (ii) reduce their sales expense by
shrinking their direct sales forces; (iii) lower their marketing expense by
trimming or eliminating technical support of their product lines; (iv) control
their inventory investment with computer systems that enable them to track the
inventory held by their distributors; and (v) improve their credit exposure by
dealing with fewer, better capitalized distributors.
Customers are increasing their reliance on value-added distributors as
their contacts with the manufacturers diminish or cease altogether. Customers
are beginning to rely on their distributors for technical
26
support, engineering, repair and other services no longer available from the
downsized manufacturers. The Company believes that the percentage of products
sold through distributors will continue to increase as customers move to
consolidate supply sources to streamline operations and reduce administrative
costs. Customers can monitor their inventory requirements through the
distributor's information system and avoid stocking such inventory until
necessary. In addition, current information systems enable customers to measure
precisely the economic benefits provided by their distributors.
Customers are outsourcing non-core functions to high quality service
providers. Many companies have chosen to outsource primary supply chain
functions including procurement, delivery and inventory management functions to
high-quality service providers. Others have outsourced primary engineering,
maintenance and repair functions. The Company expects this trend to continue as
customers increasingly concentrate resources on developing their core
capabilities.
Channels of distribution are in the process of consolidation. The
increasing demands upon distributors from both vendors and customers are forcing
them to make substantial investments in technology, training and logistics
systems. Many smaller distributors that cannot afford to make these investments
are being acquired by larger competitors that can provide the requisite
services. The surviving, larger distributors enjoy multiple benefits, such as
greater purchasing power with vendors, a larger revenue base over which to
spread substantial fixed costs and lower costs of capital.
Managerial skills required for success in industrial distribution are
changing dramatically. Management today must deal with complex and sophisticated
national distribution channels while remaining responsive to increasingly
individualized customer demands. Future success will require management to adapt
to changing technology and develop sophisticated organizations that are
comfortable with change and can react quickly.
Business Strategy
While each of the Company's three businesses has its roots in
traditional wholesale distributor activities, the evolution of each business has
been affected in significantly different ways by the trends discussed above.
However, commonalities among the businesses have enabled the Company to build a
record of strong, profitable growth on the basis of three core competencies:
o Acquisition Integration Capability - The ability to integrate
acquired companies while improving operational efficiencies and
enhancing their effectiveness in the marketplace.
Since the organization of its predecessor in 1975 and through 1991, the
Company grew primarily through acquisitions of existing distribution
companies. During this period, a series of acquisitions expanded the
Company's operations both geographically and in the number and types of
products offered. Thirty-five of these acquisitions had purchase prices
in excess of $1 million and approximately 40 more had purchase prices
under $1 million. The Company's ability to make acquisitions since 1991
was hindered by its previous partnership structure and associated
restrictions in its credit agreement. As a result of the Conversion,
the Refinancing and this Offering, the Company expects to have the
necessary financial capacity to resume its acquisition program. The
Company intends to seek acquisition candidates that have developed
attractive market niches, have strong management and have demonstrated
their ability to achieve stable growth and high returns on invested
capital.
o Ability to Capitalize on Industry Trends - The ability to execute
dynamic business strategies to capitalize on opportunities arising from
rapid structural changes in the marketplace.
The Company has established separate organizations for its three
businesses, each headed by a chief executive officer who is supported
by sales, marketing, financial, logistics and information systems
resources. This organizational structure enables the Company to manage
each of its businesses within the
27
context of the varying market opportunities, rates of change, and
competitive threats affecting those businesses. The Company's small
headquarters staff shapes and guides the strategic decisions of its
operating companies. Performance benchmarks are established as part of
this process and progress is monitored to ensure that initiatives
remain on track.
o Technology for Competitive Advantage - The ability to use technology
and technical expertise as competitive advantages to build and defend
attractive market niches.
Technology offers significant opportunities for improving both the
Company's internal operations and its product and service offerings to
its customers. For example, STS is implementing a new integrated
information system which will permit (i) the centralization of the
purchasing function, resulting in a smaller staff with a higher level
of professional skills; (ii) a reduction in the number of warehouses
from 36 to fewer than ten; (iii) higher customer order fill rates; and
(iv) lower exposure to obsolete or slow-moving inventory. Hillman has
developed a new sales tracking program that will enable it to closely
monitor the performance of its sales representatives with respect to
increasing product line penetration within their accounts. Harding's
new management information system improves its ability to manage
operations and fully utilize its purchasing power. It also permits
Harding to integrate acquisitions substantially faster than was
previously possible.
Growth Opportunities
SunSource believes that each of its three operating businesses is well
positioned to capture opportunities in the markets in which it participates.
SunSource Industrial Services Company's strategy is to capitalize on
the trends among industrial customers toward consolidation of suppliers,
outsourcing the procurement function for goods and outsourcing in-plant services
for which they lack expertise or sufficient resources.
STS believes that it can significantly increase its revenues by
expanding its relationships with large industrial customers to provide them with
the full range of available products and services which STS can provide. To this
end, STS is currently enhancing its sales organization to include industry
specialists to augment the effectiveness of individual sales representatives.
For example, a sales representative could call upon STS' technology specialists
to assist in solving a paper mill's production problem. A successful solution
would be communicated to STS' industry specialist, who would check for similar
opportunities at the customer's other mills and would ensure the information was
made available to all STS representatives who call on paper mills.
STS plans to continue its successful program of establishing service
centers for the repair and overhaul of hydraulic equipment in major industrial
markets around the country. In addition, STS intends to resume its acquisition
program later in 1998 when its restructuring project is closer to completion.
STS' acquisition strategy is to acquire technology-driven distributors on the
West Coast, New England, and Florida to solidify its geographic coverage in
those areas. STS' objective is also to acquire companies with complementary
services, such as vibration monitoring or preventive maintenance programs to
industrial facilities.
Hillman's strategy is to capitalize on the desire of its customers to
shift the burden of maintaining a complex, low value inventory as well as to
continually expand its product line. Hillman currently services approximately
8,000 retail hardware locations, an estimated 65% of the retail hardware outlets
that are large enough to benefit from the Hillman merchandising system.
Management believes that growth is most likely to come from: (i) further
penetration of the retail hardware outlet markets; (ii) an increase in the
average number of Hillman product lines sold to each retail hardware outlet;
(iii) expanded participation in the home center and regional lumber yard
businesses in the United States; and (iv) expansion in the Caribbean, Mexico and
Central America under a newly-hired Director of International Sales. Hillman
targets companies for acquisition that offer a significant extension of its
already broad product line, companies with substantial selling relationships
with very large outlets,
28
such as home centers and nationwide building supply operations, and companies
which offer management services which would be of value to Hillman's customer
base (such as companies that specialize in providing set up and layout design
services for new store locations).
Harding believes that it has an excellent opportunity to build its
network of retail glass shops through further acquisitions in the highly
fragmented retail glass industry that consists of more than 9,000 independent
and small regional glass shops.
Industrial Services (STS and SIMCO)
SunSource Industrial Services Company provides a single nationwide
source for a broad array of industrial products and supporting technical
services. SunSource Industrial Services Company is comprised of two sales and
marketing activities--STS and SIMCO. Their common strategy is to capitalize on
the increasing awareness of many industrial companies of their inefficiencies in
performing activities that are ancillary to their principal business. These
activities include repairing equipment, running preventive maintenance programs,
maintaining in-house engineering capabilities and inventory management. In most
instances, the only alternative available to many industrial companies for such
services has been small, local firms, many of which lack the resources necessary
to assure the quality of services that they provide. SunSource Industrial
Services Company's customers are located throughout the United States, Mexico
and Canada and include major industrial concerns, as well as small and
medium-size businesses.
SunSource Technology Services (STS)
STS, with sales of approximately $300 million in 1996, offers a full
range of technology-based products and services to its customers. Its product
lines include hydraulic, pneumatic, electronic and filtration parts and
equipment. Services include engineering design, equipment repair and product
upgrades.
STS seeks to build strong relationships with its customers by providing
technological/problem-solving capabilities along with quality products. STS
relies on its engineering and fabricating capabilities to provide customized
solutions for specific applications requiring product engineering, assembly or
fabrication. To help a customer better understand how it is performing relative
to best industry practices, STS can perform a technology review of the
customer's facilities covering areas such as electronic systems, hydraulics,
pneumatics, repair activities and inventory management. STS can demonstrate to
its customers those areas in which they meet best industry practices and, when
they do not, offer detailed, cost-efficient steps to improve their performance
to meet those standards. STS also conducts multiple-day training programs to
help customers stay current with evolving technologies relevant to their
operations.
STS has benefited from the trend for manufacturers to move towards
increased standardization of products. The result is that many such products
have to be modified and used in combination with other components in order to
meet customers' performance requirements. STS recognized this trend as an
opportunity to set up a formal system to customize standardized products to meet
the more specialized needs of its customers. One example of this type of
customized solution is a hydraulic integrated circuit ("HIC"), which is more
compact and less prone to leakage than a generic circuit. Customized solutions
like HICs make STS a more valuable resource to its customers, thereby allowing
STS greater pricing flexibility. Management believes that there is a growing
market for such customized solutions among medium and smaller original equipment
manufacturers ("OEM") who do not have the capabilities to develop such products.
Since 1991, STS has opened 26 repair centers throughout the United
States to provide customers with convenient and reliable sources for the repair
of worn-out hydraulic power equipment. Repair centers have been useful in
gaining market share as they have helped STS achieve an expanded relationship
with many of its customers. They also provide STS with an opportunity to win new
customers because many of the local distributors do not have the resources to
provide comparable repair services. STS plans to continue its successful program
of
29
establishing service centers for the repair and overhaul of hydraulic equipment
in major industrial markets around the country.
The six hydraulic and pneumatic distributors which today comprise STS
were acquired by the Company between 1976 and 1991. The acquired companies
typically enjoyed profitable market niches created either through exclusive
territories granted by their vendors or the unique services they offered. Until
recently, STS operated each of its divisions on a decentralized basis with each
division having its own president and vice president of sales. In early 1997,
STS initiated a three-year project to consolidate financial and administrative
activities in its Chicago headquarters. STS is in the first stage of installing
a new information system that should be fully operational in the first half of
1999. In addition, STS is in the process of consolidating 36 inventory stocking
locations into fewer than ten facilities which the Company believes will result
in significantly lower operating costs and better product availability.
Centralized purchasing and inventory management is expected to result in
improved fill rates for customers while at the same time reducing STS' inventory
investment, leveraging its purchasing power with many suppliers and reducing
suppliers' operating costs. As an important part of this restructuring, the
focus of the sales organization will increasingly be on specific technologies
and market segments instead of geography.
Products and Suppliers. STS believes that it carries the most diverse
selection of fluid power products of any distributor in the United States,
totaling an estimated 100,000 items in five major product categories. Typically,
hydraulic systems are employed for dealing with heavy loads in applications such
as mining, manufacturing, construction or agriculture. An example of a hydraulic
application is the system that controls the positioning of the scraping blade of
a road grader - an integrated system of motors, pumps, valves, tubing, sensors
and electronic controls. Pneumatic systems are similar to hydraulic systems
except that air or some other gas is substituted for hydraulic fluid. Pneumatic
systems are preferred for lighter weight applications such as light
manufacturing and packaging lines. Hydraulic and pneumatic products represented
approximately 60% and 21%, respectively, of STS' 1996 sales.
STS distributes products in five major product categories. A
representative list of products by category is shown below:
30
STS has a broad supply base which includes almost all major
manufacturers of fluid power products in the United States. STS' top ten
suppliers account for less than 30% of its 1996 sales. Because of the fragmented
nature of the industry, manufacturers of fluid power equipment historically have
awarded their franchises on a limited geographical basis. STS has secured
exclusive franchises within certain geographic areas from significant suppliers
such as Vickers, Hydroline, Trabon, Versa, SMC, Denison, Norgren, Mosier and
Hansen. Two of STS' larger suppliers are Sunstrand and Commercial, whose
products are distributed in most of STS' territories.
In recent years there has been considerable consolidation among
suppliers, a trend which management believes will continue. STS, as a leading
fluid power distributor, is likely to benefit from this trend. In addition, STS
seeks to provide valuable market and product information that enhances its
relationships with its key suppliers by helping them improve their product
offering in response to changing market demands.
Markets and Customers. STS currently serves over 35,000 customers, the
top ten of which accounted for approximately 11% of its 1996 sales.
Approximately 60% of sales are to OEM customers who incorporate the equipment or
system purchased from STS into their final products. An example of an OEM
customer is a manufacturer of back-hoes who incorporates a STS hydraulic system
to operate the hoe. The remaining 40% of sales are to maintenance, repair and
operation ("MRO") customers who use STS products as part of their production
process. An example of an MRO customer is an automobile manufacturer whose heavy
metal presses are powered by large hydraulic systems designed and installed by
STS.
Within the MRO and OEM markets, STS sells to construction and mining
equipment manufacturers, industrial wholesale distributors, metalworking
equipment manufacturers, farm and garden equipment manufacturers, industrial
specialized machinery manufacturers and automobile and auto parts manufacturers.
Sales and Marketing. STS markets its products nationwide, principally
through a network of outside sales representatives supported by inside sales
representatives and a telemarketing operation. In order to become more
responsive to the increasing demands of customers, STS has devoted substantial
resources to make its sales force more specialized both in terms of technical
training and industry knowledge.
STS employs approximately 315 outside sales representatives. Each
customer has a primary sales representative who might be assisted by technology
specialists or industry specialists. Technology specialists are available in the
fields of hydraulics, pneumatics, mobile equipment, lubrication, filtration,
automation and other specialties while industry specialists bring particular
expertise in industries such as pulp and paper, construction equipment,
injection molding or heavy metal working. STS is in the process of adding
additional industry specialists to its sales organization.
To support the outside sales representatives, STS employs approximately
235 inside sales representatives who collectively function as a customer service
department, taking orders from customers on the telephone, answering questions
and solving problems. STS also employs approximately 20 people in its
telemarketing group which is responsible for customers with sales potential not
large enough to justify the cost of service by an outside
31
sales representative. STS has established an electronic data interchange ("EDI")
capability for use with selected customers and vendors and is in the early
stages of establishing a presence on the Internet.
Competition. The great majority of STS' competitors are relatively
small companies with sales of less than $10 million from one or two facilities.
Many of these companies offer considerable depth in certain product lines,
together with related technical support. STS competes with these companies on
price, the strength of its product offering and an extensive range of ancillary
technical services. The largest national competitor is Motion Industries which
competes on the basis of price and product availability. Another national
competitor is Applied Industrial Technologies, Inc., formerly known as Bearings,
Inc.
Sun Inventory Management Company (SIMCO)
SIMCO provides inventory management services resulting in the delivery
of required material to the customer's point of use at the lowest total cost.
SIMCO's customers range from small machine shops with two or three employees to
major manufacturing facilities with thousands of employees.
SIMCO serves its small and medium-size accounts through its "expediter"
activity. The expediter activity, with sales of $121 million in 1996, offers
personalized, small parts inventory management service to the low volume
customer. The expediter sales force relieves the customer of the inconvenience
and expense of purchasing numerous, small, inexpensive maintenance parts and
provides assurance against the expense and inconvenience of stock outs. Sales in
this market segment tend to be of relatively small dollar value items with
limited technology content but high service demands. The Company believes that
SIMCO has a competitive advantage in this market segment due to its large sales
force, a broad inventory of parts for diverse applications, a reputation for
high-quality products, a responsive physical distribution system and a
computerized material management system which permits 98% of all orders to be
shipped within 24 hours. In 1996, the expediter activity of SIMCO sold more than
25,000 products to over 50,000 customers in the United States and Canada.
SIMCO's "integrated supply" activity, with sales of $35 million in
1996, is focused on major industrial manufacturing customers. In some instances,
SIMCO will take over complete responsibility for a customer's purchases of
maintenance, repair and operating supplies. In those cases, SIMCO places the
purchase orders, receives the material and dispenses it to the customer's
employees from the customer's tool cribs. The advantage to the customer is
substantial reduction in the total cost of procuring and handling the thousands
of items which are routinely used by a large facility, while at the same time
improving the availability of these materials.
Products and Suppliers. SIMCO's expediter activity packages and
inventories over 25,000 items in nine major product categories. The largest
category is fasteners, which accounted for approximately 30% of SIMCO's 1996
expediter sales. A representative list of products of SIMCO's expediter activity
by category is shown below:
32
SIMCO purchases the parts it needs for its expediter activity from over
600 regular vendors, none of which account for greater than 2% of SIMCO's annual
purchases. SIMCO has long-standing relationships with a majority of its
suppliers and continually seeks to upgrade vendor performance by measuring it
and educating vendors on SIMCO's quality and service standards. A majority of
the products sold by SIMCO's expediter activity are packaged by vendors under
SIMCO's private brand labels.
To maintain its reputation for leading product lines and "one-stop
shopping," SIMCO's expediter activity emphasizes new product innovation and is
an active participant in trade shows and trade publications. SIMCO works with
its vendors to introduce more than 500 new products per year.
The products and suppliers used by SIMCO's integrated supply activity
vary considerably depending on the nature of the customer's manufacturing
activity. SIMCO seeks to maximize its purchasing power by aggregating purchases
of common items used by multiple SIMCO customers and also by purchasing through
the other SunSource businesses. SIMCO often obtains lower prices and provides
improved availability for many products without changing the customer's vendors.
Markets and Customers. Customers of the expediter activity tend to be
smaller companies that make frequent small purchases. A typical expediter
customer purchases less than $2,400 per year from SIMCO and includes truck fleet
operators, construction and mining operations, industrial plants, paper plants,
welding shops, hospitals, schools, government facilities and automobile
dealerships.
SIMCO's integrated supply customers tend to be large industrial
facilities which purchase in excess of $1 million per year from SIMCO. SIMCO's
major industrial customers include Colgate Palmolive, Mercedes Benz and Marley
Cooling Tower.
Sales and Marketing. SIMCO's expediter sales representatives serve
their customers by providing merchandising systems, helping control inventory
and physically stocking and organizing products. For example, a sales
representative might maintain an inventory of 100 to 150 small items for an
automobile repair center. Items typically include nuts, bolts, small cutting
tools, lubricants and related items. The service provided to the customer is to
insure that all of these small consumables remain in stock, thereby enabling the
customer to avoid the expense of maintaining inventories, placing purchase
orders and receiving materials. Even more importantly, the customer's highly
trained technicians do not have to waste time and money tracking down missing
parts of nominal dollar value. Larger accounts are offered programmed inventory
maintenance service ("PIMS") to ensure that inventory is maintained at
appropriate levels. PIMS sales account for approximately 20% of total expediter
sales. SIMCO also offers customized product literature which is targeted to
selected niche markets.
SIMCO's expediter sales force consists of approximately 750 sales
representatives, each of whom sells the entire product line and serves an
average of 65 customer accounts. Ten to twelve sales representatives in a
geographical area report to a district manager, who in turn reports to one of
ten regional vice presidents. Sales management support includes training on new
product applications and technical information to assist customers in
33
solving operational and maintenance problems. The marketing department provides
support in the form of product line management, promotional programs, catalogs
and related materials. Logistics support is provided by seven strategically
located distribution centers and a computerized material management system which
assures fast, accurate and complete shipments.
SIMCO approaches its larger integrated supply customers by offering to
perform a survey of their existing procurement practices. The goal of the study
is to determine whether the customer's total costs can be reduced by utilizing
the outsourcing services offered by SIMCO. Typically, savings occur in the
customer's purchasing department, in its tool cribs or other dispensing
locations within its facility and in lower inventory carrying costs. The net
result of a decision to outsource to SIMCO is typically lower total costs,
substantial reduction in inventory investment and improved product availability.
Competition. SIMCO's expediter activity competes primarily with other
national expediters that similarly provide a high level of service, and to a
lesser extent with more narrowly focused regional or small local distributors
competing mainly on the basis of low price with minimal service. The four
largest national expediters are Premier Industrial, Bowman Products, Curtis
Industries and Lawson Products, none of which has a significant market share.
SIMCO's expediter business serves all segments of the highly fragmented MRO
market and has less than 1% market share. The Company believes that SIMCO can
capture additional market share by increasing the number of its qualified sales
representatives and has recently undertaken a program to improve the quality and
training of its sales representatives.
The competition for SIMCO's integrated supply activity comes from a
large number of companies following a variety of strategies. Some competitors
seek to be perceived as an integrated supplier by continually increasing the
number of product lines offered. Other competitors provide staff to dispense
product in a customer's plant. SIMCO also competes with "strategic alliances"
among established distributors of traditional product lines.
Hardware Merchandising Services (Hillman)
The Company believes that Hillman, with sales of $103 million in 1996,
is the leading supplier of merchandising services, fasteners and related small
hardware repair items to retail outlets in the United States. Through its sales
and service force, Hillman provides hardware retailers in all 50 states and in
Mexico, Central and South America with an extensive line of fasteners and other
small hardware items. More importantly, Hillman complements its extensive
product selection with value-added services for the retailer.
Fasteners and other small hardware items typically account for
approximately 25% of a hardware store's traffic, but less than 5% of its
revenues. A typical hardware store maintains in inventory thousands of different
items, many of which generate only small profits. It is difficult for a retailer
to monitor economically all stock levels and to reorder the products from
multiple vendors. The problem is compounded by the necessity of receiving small
shipments of inventory at different times and having to stock the goods.
However, failure to have these small items consistently available will have an
adverse effect on store traffic, thereby denying the retailer the opportunity to
sell items that generate higher profits.
Hillman's sales representatives regularly visit retail outlets to
review stock levels and to reorder those items in need of replacement. Thousands
of items can thus be actively managed with the retailer experiencing a
substantial reduction in paperwork and labor costs. Hillman's sales
representatives also assist in organizing the products in a user-friendly
manner. Hillman complements its broad range of products with value-added
merchandising services such as free displays, product identification stickers,
retail price stickers, store rack and drawer systems, assistance in rack
positioning and store layout and inventory and restocking services. Hillman
periodically introduces new package designs and color-coding for ease of
shopping by hardware store customers, and also modifies rack designs to improve
attractiveness of individual store displays. Furthermore, Hillman provides the
retailer with inventory management software that ties to the retailer's
point-of-sale system. In effect, Hillman functions as a merchandising manager
for the hardware store. Hillman supports these services with high
34
order fill rates and rapid delivery from its nine distribution centers across
the United States. Orders are shipped within 24 hours with a 96% order fill
rate.
Products and Suppliers. Hillman buys its products from approximately
500 vendors, the largest of which accounted for 14.6% of Hillman's 1996
purchases and the top ten of which accounted for less than 45% of Hillman's 1996
total purchases. Hillman's wide variety of products includes standard and
specialty nuts, bolts, screws, washers and anchors, plus brass, stainless steel,
plastic and miscellaneous fasteners. Management believes that Hillman's
selection of over 20,000 fastener items is the largest in the industry.
Non-fastener products include locks, keys, letters, numbers, signs, rope and
chain accessories and an extensive list of special-purpose items having a
relatively limited product line such as corks, electrical connectors, flashlight
bulbs, specialty fuses, and picture hangers.
Hillman buys approximately half of its purchases directly from foreign
suppliers and coordinates its overseas purchasing with SIMCO. The balance of
purchases are made from domestic manufacturers and master distributors. To
assure quality from its vendors, Hillman conducts annual on-site evaluations and
random sampling of products and communicates the results to vendors. Hillman
also tracks the performance of its vendors based on delivery time and accuracy
of shipments.
Markets and Customers. Hillman services approximately 8,000 full
service retail outlets. Hillman historically has serviced individual dealers of
some of the larger cooperatives, such as Cotter (Tru-Serve), Ace and HWI.
Hillman sells directly to the cooperative's retail locations and also supplies
many fastener items to the cooperative's central warehouses. These central
warehouses continue to distribute to their smaller members that do not have the
purchase volume to justify direct service from Hillman. These arrangements with
the cooperatives reduce credit risk and logistics for Hillman and reduce central
warehouse inventory and delivery costs for the cooperatives.
Hillman is also increasing its focus on regional and national lumber
yards and home centers, particularly companies with three to fifteen locations.
Management believes that the dynamics which make its services attractive to
hardware retailers are present with these larger customers as well. At the
present time, Hillman sells approximately $15 million to this market segment.
Management has established a special sales and service force to further
penetrate this market segment.
Hillman also sells to approximately 6,000 smaller hardware outlets who
are not large enough to qualify for Hillman's full service program, and has four
sales representatives dedicated to serving industrial customers in the greater
Cincinnati area. Hillman can offer such industrial customers very attractive
prices because of Hillman's purchasing power and low freight costs.
Sales and Marketing. Hillman believes that it is more responsive to
customers' needs than its competitors because it operates the largest direct
national sales force selling fasteners and small hardware repair items and
providing related value-added services to hardware stores. The sales force is
comprised of a vice president of sales, two regional managers, 20 field sales
managers and approximately 175 sales representatives. Each sales representative
is responsible for approximately 50 full service accounts, each of which is
generally called on an average of every three weeks. Several specialists call on
cooperative warehouses and others focus on home centers and regional lumber
yards. The sales effort to home centers and lumber yards is supported by a 60
person service organization that is devoted to maintaining the customers'
inventory levels and ensuring that the Hillman displays are properly maintained.
Hillman has an EDI system which is used by a number of larger customers.
Hillman's sales force is supported by a five person customer support staff which
is responsible for quoting special items and bulk quantity orders, expediting
orders, issuing credits and providing sales representatives with customer
feedback.
Competition. The principal competitors for Hillman's core business are
Midwest Fasteners, Servalite, Elco and Sharon Bolt & Screw, the latter two of
which carry only fastener products. Hillman competes primarily on the strength
of the merchandising services it provides, as well as product availability,
price and breadth of product line.
35
Management estimates that Hillman sells to approximately 65% of the full service
retail outlets that comprise its core market. The smaller hardware outlets who
purchase products but not services from Hillman also purchase products from
local and regional distributors and cooperatives. Competition in this segment is
primarily on the basis of price and availability.
The principal competitors in the home center, regional and national
lumberyard markets are Crown Fastener with an estimated 50% market share and
Elco and Newell Industries. Hillman estimates its share in this market to be
less than 10%. Competition is based primarily on in-store service and price.
Other competitors are local and regional distributors.
Glass Merchandising (Harding)
Harding, with sales of approximately $90 million in 1996, is one of the
largest regional networks of full service retail glass shops in the United
States. Harding operates in the following businesses: retail automotive and flat
glass, insulating glass, small contract glazing and the wholesale distribution
of automotive and flat glass.
Harding provides retail glass products and related services through a
network of approximately 85 retail locations throughout the Southwestern United
States and, to a lesser degree, along the East Coast. Customers include
individuals, insurance companies and commercial accounts. The retail glass
market is highly fragmented within the U.S. market, consisting primarily of
small, privately owned companies with one or two locations. The industry is in
the early stages of consolidation and Harding believes that it is well
positioned to capitalize on this opportunity due to its substantial purchasing
power and its comprehensive management information systems.
As a result of emphasizing the higher margin retail business and
deemphasizing lower margin businesses, such as glass tempering and large
contract glazing, Harding has increased its overall gross margins from 34.9% in
1994 to 40.8% in the nine-month period ended September 30, 1997. Harding is
positioned as a full-service glass retailer offering one of the broadest product
lines in the retail glass industry as well as installation services for
automotive glass, windows and commercial store fronts. The role of the
fabrication and wholesale activities is to ensure that the full service shops
receive the products they require at the lowest total cost.
Harding's new management information system links all of its formerly
independent locations and improves its ability to manage operations. The system
also allows Harding to centralize its purchasing function, thereby enabling it
to take advantage of its significant purchasing power. Another important benefit
is that acquired businesses can immediately begin following Harding's
standardized business practices. The Company believes that this will allow
Harding to integrate acquisitions substantially faster than previously and
reduce the dependence on key employees at any location.
Products and Suppliers. Harding maintains in inventory over 8,000 items
and many more products can be fabricated to meet customer requirements. The
following are major products carried by Harding:
Adhesives/Sealants Commercial Glass Store Fronts Storm Doors
Automotive Glass Mirrors/Mirrored Walls Fire Resistant Glass
Beveled Mirror Strips Wardrobe Doors Patio Doors
Shower/Bath Enclosures Glass Blocks Wire Glass
Framed Mirrors Replacement Insulating Glass
Glass Units Solariums
Harding purchases both automotive and flat glass from four leading
national manufacturers, as well as from regional glass companies and local
distributors. These four manufacturers account for approximately 25% of
Harding's purchases. In addition to flat and automotive glass, Harding purchases
a number of other items, including sheet mirror, framed mirror, shower door
frames and accessories from a variety of manufacturers and distributors.
Harding has in inventory over 90% of the products ordered by its customers.
36
Markets and Customers. Approximately 37% of retail autoglass sales are
attributable to insurance companies while the remaining sales are divided among
individuals, autobody shops, rental car agencies and car dealerships. Retail
flat glass sales are split fairly evenly between individual consumers and small
contract jobs under $5,000. Wholesale autoglass sales are primarily to glass
shops, while wholesale flat glass sales are divided among independent retail
glass shops, window manufacturers and large contract glaziers. Harding's top ten
customers accounted for approximately 10% of 1996 sales.
Sales and Marketing. The majority of Harding's retail customers are
located within ten miles of a store and typically order in person or via phone.
The retail marketing effort relies on the strategic location of the stores as
well as advertising in the local media. Harding's retail organization also
maintains a 24 person sales force of whom 19 sell both flat and automotive glass
and five focus exclusively on flat glass.
The retail sales force calls on replacement automotive glass users such
as auto body shops, rental car agencies, automotive dealerships and insurance
agents who direct insured claims to approved suppliers. Sales management calls
on regional and national fleet accounts, insurance companies and network
providers in order to become an approved or preferred supplier. Network
providers are companies that handle the entire glass replacement process for
many insurance companies.
Harding's wholesale operation has a nine person sales force, all of
whom sell both flat and automotive glass. Sales representatives call on flat
glass customers such as window manufacturers, glass shops, and other large users
of glass such as contract glaziers.
Competition. Because of the diversity of markets and geographic
locations it serves, Harding has numerous competitors at the retail level.
Harding's retail competitors can be categorized as follows: national automotive
chains, large regional glass retailers and local independent glass shops.
Harding, with its broad offering of both automotive and flat glass, has
positioned itself as the largest comprehensive glass retailer in its region. At
the wholesale level, Harding faces competition from national, regional and local
competitors. In addition, in recent years, the major manufacturers of automotive
and flat glass have been taking steps to integrate vertically into wholesale
distribution, thereby assuring themselves of greater control over the sale of
their products. As a result, many of these smaller, independent glass businesses
are now inclined to look favorably upon the sale of their businesses to a larger
competitor.
The Company believes that Harding is currently the largest full service
retail glass shop business in the United States with approximately 85 retail
locations. Although a number of chains are larger than Harding, they deal
primarily in auto glass replacement and are not full service shops. Competition
for Harding's full service shops comes mainly from single location operations or
small chains. Harding's purchasing power and recently installed comprehensive
information system give it significant advantages over these competitors.
Insurance Arrangements
Under the Company's current insurance programs, commercial umbrella
coverage is obtained for catastrophic exposure and aggregate losses in excess of
expected claims. Since October 1991, the Company has retained the exposure on
certain expected losses related to worker's compensation, general liability and
automobile. The Company also retains the exposure on expected losses related to
health benefits of certain employees. The Company believes that its present
insurance is adequate for its businesses. See Note 14 of Notes to Consolidated
Financial Statements of the Partnership as of and for the three years ended
December 31, 1996.
37
Employees
As of September 30, 1997, the Company had approximately 4,000
employees, of which approximately 1,700 are sales personnel, approximately 1,300
are employed as warehouse and delivery personnel and approximately 1,000 hold
administrative positions. The Company has collective bargaining agreements with
five unions representing a total of approximately 80 employees. In the opinion
of management, employee relations are good.
Backlog
The Company's sales backlog excluding divested operations was
$59,531,000 as of December 31, 1996, and $54,935,000 as of December 31, 1995. On
average, the Company's backlog is less than one month's sales.
Properties
The Company currently has approximately 200 warehouse and stocking
facilities located throughout the United States, Canada and Mexico. Most of
these include sales offices. Approximately 32% of these facilities are owned and
the remainder are leased. The Company's principal properties are the following
warehouse facilities:
Business Location Description
-------- -------- -----------
Hillman Cincinnati, Ohio 190,000 sq. ft. (leased)
Harding Denver, Colorado 184,000 sq. ft. (owned)
SIMCO Itasca, Illinois 80,000 sq. ft. (owned)
In the opinion of management, the Company's existing facilities are in
good condition.
Legal Proceedings
Litigation originally instituted on February 27, 1996 is pending in the
Court of Common Pleas of Montgomery County, Pennsylvania in which Dorman
Products of America, Ltd. ("Dorman"), and its parent, R&B, Inc. ("R&B"), allege
that misrepresentations of certain facts were made by the Company's subsidiary
operating partnership, upon which R&B allegedly based its offer to purchase the
assets of the Dorman Products division of such subsidiary operating partnership.
Dorman and R&B seek damages of approximately $21 million. In the opinion of
management, the ultimate resolution of this matter will not have a material
effect on the consolidated financial position, operations or cash flows of the
Company.
38
MANAGEMENT
The following table sets forth certain information regarding the
Company's directors and executive officers.
Donald T. Marshall has been the Chairman and Chief Executive Officer
since December 1988 and a director since February 1987. Mr. Marshall served as
President and Chief Executive Officer from February 1987 to December 1988. Mr.
Marshall started with the Company in 1977 as Vice President-Operations.
John P. McDonnell has been the President and Chief Operating Officer
since December 1994 and a director since May 1995. Mr. McDonnell served as Group
Vice President from December 1987 to December 1994 and President of the Walter
Norris division from December 1981 to December 1987.
Norman V. Edmonson has been the Executive Vice President since December
1994 and a director since February 1987. Mr. Edmonson served as Group Vice
President from May 1, 1977 to December 1994. Mr. Edmonson plans to retire as an
executive officer in May 1998 but will continue after that time as a director
and consultant to the Company.
Joseph M. Corvino has been Vice President-Finance, Chief Financial
Officer, Treasurer and Secretary since December 1995. Mr. Corvino served as Vice
President and Controller from May 1993 to December 1995 and as Controller from
December 1985 to May 1993. Mr. Corvino started with the Company as Assistant
Controller in June 1980.
39
Max W. Hillman, Jr. has been the Chief Executive Officer of Hillman
since December 1996. Mr. Hillman served as Group Vice President from December
1991 to December 1996. Mr. Hillman started with the Company in operations in
1982.
Harold J. Cornelius has been the Chief Executive Officer of Harding
since December 1996. Mr. Cornelius served as Group Vice President from December
1988 to December 1996. Mr. Cornelius started with the Company in the sales
organization in 1979.
O. Gordon Brewer, Jr. has been a director of the Company since February
1987. Mr. Brewer has served as Vice President-Finance of Ikon Office Solutions
(formerly Alco Standard Corporation) for more than the past five years. Mr.
Brewer serves as a director of Corporate Insurance and Reinsurance Limited.
Eliot M. Fried has been a director of the Company since December 1994.
Mr. Fried has been a Managing Director of Lehman Brothers Inc. since 1987. Mr.
Fried serves as a director of Axsys Technologies, Inc., Bridgeport Machines,
Inc., EVI, Inc., L3 Communications, Inc. and Walter Industries.
Arnold S. Hoffman has been a director of the Company since February
1987. Mr. Hoffman has been a Senior Managing Director in Corporate Finance at
Legg Mason Wood Walker, Incorporated since April 1995 and a Managing Director at
Legg Mason Wood Walker, Incorporated prior thereto. Mr. Hoffman serves as a
director of Intelligent Electronics Incorporated.
Robert E. Keith, Jr. has been a director of the Company since December
10, 1997. Mr. Keith has been the Managing Director and Chief Executive Officer
of TL Ventures (a venture capital firm) for more than the past five years. Mr.
Keith serves as a director of Cambridge Technology Partners, National Media
Corporation, Navigator, Safeguard Scientifics, Inc. and Wave Technologies
International.
Ernest L. Ransome, III has been a director of the Company since
February 1987. Mr. Ransome has been the Chairman of Giles & Ransome, Inc. (a
distributor of construction equipment) for more than the past five years.
Donald A. Scott has been a director of the Company since February 1987.
Mr. Scott has been a partner of Morgan, Lewis & Bockius LLP from July 1964 to
present. Mr. Scott serves as a director of Provident Mutual Life Insurance
Company.
Henri I. Talerman has been a director of the Company since March 1995.
Mr. Talerman has been a Managing Director of Lehman Brothers Inc. from June 1992
to present and Senior Vice President of Lehman Brothers Inc. prior to 1992. Mr.
Talerman serves as a director of McBride plc. and Financier Gerflor SA and as an
advisory director of Europe Capital Partners.
All directors will hold office until the next annual meeting of
stockholders and until their successors are duly elected and qualified. All
executive officers hold office at the pleasure of the Board of Directors.
40
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS, MANAGEMENT AND
SELLING STOCKHOLDERS
Except for the 500,000 shares being offered by the Company, all of the
Common Shares being offered hereby are being sold by the Selling Stockholders
named below.
The following table shows for (i) each director, (ii) each executive
officer, (iii) certain persons known to the Company to own beneficially more
than 5% of the outstanding interests, (iv) the Selling Stockholders and (v) all
officers and directors as a group, the beneficial ownership of Common Shares
before and after the Offering. Percentage amounts represent less than 1% of the
outstanding Common Shares unless otherwise indicated.
- ---------------
(1) Mr. Edmonson intends to sell 20,000 Common Shares after completion of
the Offering.
(2) Does not include any Common Shares owned by the Selling Stockholders.
Messrs. Hoffman and Fried, as limited partners of Lehman Brothers
Capital Partners I, together derive economic benefit of approximately
1% from interests held by Lehman Brothers Capital Partners I. An
affiliate of Lehman Brothers Inc., of which Messrs. Fried and Talerman
are officers, also owns all of the capital stock of Lehman Ltd. I,
Inc. and Lehman/SDI, Inc.
(3) 750 of these Common Shares are owned by Hoffman Investment Co., of
which Mr. Hoffman is Managing Partner. In addition, Mr. Hoffman's
children own 1,000 Common Shares with respect to which he disclaims
beneficial ownership.
(4) 625 of these Common Shares are held in a trust, of which Mr. Ransome
is a trustee.
41
The address of Lehman LTD I, Inc., Lehman Brothers Capital Partners I
and Lehman/SDI is 3 World Financial Center, New York, NY 10285.
See "Description of Capital Stock - Stockholders Agreement" for a
description of certain restrictions with respect to voting and sale of Common
Shares held by affiliates of Lehman Brothers and certain officers of the
Company.
In connection with the Conversion, the Company entered into a
Registration Rights Agreement with affiliates of Lehman Brothers (collectively
referred to as "Lehman Brothers") and Messrs. Marshall, McDonnell and Edmonson.
The agreement provides that at any time after the Conversion Lehman Brothers may
require the Company to file a registration statement with the Securities and
Exchange Commission for the sale of Common Shares held by them. Messrs.
Marshall, McDonnell and Edmonson are entitled to include up to 20% of the Common
Shares held by them in the registration statement. The registration statement of
which this Prospectus is a part has been filed pursuant to that demand. The
parties have agreed that they will not sell any Common Shares (other than
pursuant to the Offering) during such period prior to and after the effective
date of the registration statement as may be reasonably requested by the
managing underwriters. The Company has also agreed not to sell any Common Shares
(other than pursuant to the Offering) prior to the earlier of the closing of
this Offering and nine months following the Conversion, except for the issuance
of Common Shares in connection with acquisitions where the person receiving the
Common Shares agrees to abide by this restriction.
The Company has agreed to pay all expenses incident to the Company's
compliance with the Registration Rights Agreement, including registration and
filing fees, blue sky expenses, printing expenses and fees and expenses of
Company counsel and accountants. The parties have agreed to indemnify each other
for certain liabilities including liabilities under the Securities Act of 1933,
as amended.
DESCRIPTION OF CAPITAL STOCK
Preferred Stock
The Certificate of Incorporation of the Company authorizes the issuance
of 1,000,000 shares of Preferred Stock, par value $.01 per share, by the Board
of Directors in one or more classes or series and with such voting powers,
designations, preferences and relative participating, optional or other special
rights and such qualifications, limitations, or restrictions thereof as shall be
set forth in the resolutions of the Board of Directors authorizing such
issuance. There are no shares of Preferred Stock outstanding. There are reserved
for issuance 64,189 shares of Series A Junior Participating Preferred Shares
pursuant to the Company's Stockholder Rights Plan. See "--Stockholder Rights
Plan."
Common Stock
The Certificate of Incorporation of the Company authorizes the issuance
of 20,000,000 Common Shares, of which 6,418,936 Common Shares are outstanding.
Holders of Common Shares are entitled to one vote per share on all
matters to be voted upon by the stockholders. There are no cumulative voting
rights with respect to the election of directors. Subject to preferences that
may be applicable to any outstanding Preferred Stock, holders of Common Shares
are entitled to receive ratably such dividends, if any, as may be declared from
time to time by the Board of Directors out of funds legally available therefor.
In the event of liquidation, dissolution or winding up of the Company, the
holders of Common Shares are entitled to share ratably in all assets after
satisfaction of liabilities, subject to prior distribution rights of Preferred
Stock, if any, then outstanding. Common Shares have no preemptive, conversion or
other subscription rights and there are no redemption or sinking fund provisions
applicable to the Common Shares.
42
Stockholders Agreement
The Company and certain stockholders have entered into a Stockholders
Agreement dated as of July 31, 1997 (the "Stockholders Agreement"), that
contains certain restrictions with respect to voting and sale of Common Shares.
The Stockholders Agreement provides that Lehman Brothers and each of the
following members of management, Donald T. Marshall, John P. McDonnell, Norman
V. Edmonson, Harold J. Cornelius, Max W. Hillman and Joseph M. Corvino (the
"Senior Executives"), agree with the Company not to sell any Common Shares that
they beneficially own, in a single transaction or series of related
transactions, to any third person(s) which, to the knowledge of Lehman Brothers
and the Senior Executives, after reasonable inquiry, would beneficially own
after such transactions more than 10% of the outstanding Common Shares (or more
than 15% of the outstanding Common Shares if such third person(s) are eligible
to report the acquisition of such shares on Schedule 13G pursuant to clauses
(i), (ii) and (iii) of Rule 13d-1(b)(1) under the Securities Exchange Act of
1934, as amended (the "Exchange Act"), as such rule is currently in effect.) The
Stockholders Agreement also contains provisions that restrict the respective
voting power of Lehman Brothers and the Senior Executives. Under the terms of
such restriction, such persons agree to vote, in the same proportion as the
"Unaffiliated Shares" that are voted on any such matter, that percentage of
Excess Voting Shares held by them at such time that equals the percentage of
outstanding Unaffiliated Shares that are voted on such matter. "Excess Voting
Shares" means the Common Shares beneficially owned by Lehman Brothers and its
affiliates and the Senior Executives, at any time, that represents voting power
in excess of the respective voting powers immediately prior to the Conversion
that they would have had in a vote of the holders of A Interests and B Interests
of the Partnership voting together as a single class. See also "-- Anti-takeover
Provisions - Bylaw Provisions" below.
The Stockholders Agreement contains a provision regarding nomination of
the Board of Directors of the Company. The Board of Directors of the Company
will consist of up to nine members, of whom three will be nominated by
management, four will be independent and either one or two will be appointed by
Lehman Brothers, depending upon the percentage of Common Shares held by Lehman
Brothers.
Anti-takeover Provisions
Certain provisions of the Company's Bylaws and the Stockholder Rights
Plan could have an anti-takeover effect. These provisions are intended to
enhance the likelihood of continuity and stability in the composition of the
Company's Board of Directors and management and in the policies formulated by
the Board of Directors and to discourage an unsolicited takeover of the Company
if the Board of Directors determines that the takeover is not in the best
interests of the Company and its stockholders. However, these provisions could
have the effect of discouraging certain attempts to acquire the Company or
remove incumbent management even if some or a majority of stockholders deemed
such an attempt to be in their best interests.
Bylaws Provisions. The Bylaws provide that stockholders are permitted
to call a special meeting or to require that the Board of Directors call a
special meeting of stockholders if such meeting is called by holders of at least
25% of outstanding Common Stock. In addition, the stockholders may act by
written consent in lieu of a meeting with a number of votes sufficient for such
action.
The Bylaws establish an advance notice procedure for the nomination of
candidates for election as directors, other than by or at the direction of the
Board of Directors, as well as for other stockholder proposals to be considered
at annual meetings of stockholders. In general, notice of intent to nominate a
director or raise business at such meetings must be received at least 60 days
prior to any annual meeting and must contain certain specified information
concerning the persons to be nominated or the matters to be brought before the
meeting and concerning the stockholder submitting the proposal.
Pursuant to the terms of the Stockholders Agreement, the Bylaws provide
that prior to the third anniversary of the date of the Conversion, the approval
of at least a majority of the Company's Independent Directors is required to
approve and authorize (i) amendments to the Company's Certificate of
Incorporation or Bylaws or any
43
stockholder rights plan of the Company (including the redemption of the rights
thereunder or waiver of any provision thereof) or any waiver of, or "opt-out"
from, the benefit or effect of any anti-takeover statute or other provision
applicable to the Company or (ii) any agreement binding the Company in respect
of the sale, in a single transaction or a series of related transactions, of all
or a substantial part of the Company. In addition, the approval of at least a
majority of the Company's Independent Directors is required to approve and
authorize (i) any transaction or series of related transactions between the
Company or any of its subsidiaries, on the one hand, and SDI Partners I, L.P.,
Lehman Brothers Capital Partners I, L.P., Lehman Ltd. I, Inc., LB I Group, Inc.,
Lehman/SDI, Lehman Brothers Holdings Inc. or any affiliate of these entities on
the other, so long as any of such entities and its affiliates own, in the
aggregate, at least 10% of the outstanding Common Shares, (ii) any amendment to,
or waiver of, any provision of the Stockholders Agreement, or (iii) any
amendment to the Certificate of Incorporation or Bylaws that would amend these
restrictive provisions.
Stockholder Rights Plan. The Company has adopted a Stockholder Rights
Plan pursuant to a Rights Agreement between the Company and Registrar and
Transfer Company. The Plan is designed to insure that all stockholders of the
Company receive fair value for their Common Shares in the event of any proposed
takeover of the Company and to guard against the use of partial tender offers or
other coercive tactics to gain control of the Company without offering fair
value to the Company's stockholders. Under the Rights Plan, each Common Share
has attached thereto a Right. Each Right entitles the registered holder to
purchase from the Company one one-hundredth of a share of Series A Junior
Participating Preferred Stock, par value $.01 per share, of the Company (the
"Preferred Shares"), or a combination of securities and assets of equivalent
value, at a Purchase Price of $75, subject to adjustment. The Purchase Price may
be paid, at the option of the holder, in cash or Common Shares having a value at
the time of exercise equal to the Purchase Price.
Until the Distribution Date, ownership of the Rights will be evidenced
by and will be transferred with and only with the certificates representing the
Common Shares, and no separate Rights Certificates will be distributed. The
Distribution Date will occur upon the earlier of (i) ten days following a public
announcement that a person or group has acquired, or obtained the right to
acquire, beneficial ownership of 20% or more of the outstanding Common Shares,
or (ii) the close of business on a date fixed by the Board of Directors
following the commencement of a tender offer or exchange offer that would result
in a person or group beneficially owning 20% or more of the outstanding Common
Shares. The Rights are not exercisable until the Distribution Date and will
expire at the close of business on September 30, 2007, unless earlier redeemed
by the Corporation as described below. The percentage ownership of Common Shares
held by Lehman Brothers after the Conversion will not cause a Distribution Date
to occur.
Except in the circumstances described below, after the Distribution
Date each Right will be exercisable for one-hundredth of a Preferred Share (a
"Preferred Share Fraction"). Each Preferred Share Fraction carries voting and
dividend rights that are intended to produce the equivalent of one Common Share.
Each Preferred Share Fraction will entitle the holder to receive dividends each
calendar quarter in an amount equal to the aggregate per share amount in cash of
all dividends or other distributions (other than dividends payable in Common
Shares) declared on the Common Shares during the preceding quarter. Each
Preferred Share Fraction will entitle the holder to one vote on all matters
submitted to a vote of the stockholders of the Company. Each Preferred Share
Fraction will have a liquidation preference equal to the greater of $1.00 per
share, plus accrued dividends, or an amount per share equal to the aggregate
amount to be distributed per share to holders of Common Shares. The Preferred
Share Fractions are not redeemable.
It is unlikely that a holder of a Right will ever exercise the Right to
receive Preferred Shares. The Rights may be exercised if a "Flip-in" or
"Flip-over" event occurs.
If a "Flip-in" event occurs and the Distribution Date has passed, the
holder of each Right, with the exception of the Acquiror, is entitled to
purchase $75 worth of Common Shares for $37.50. The Rights will no longer be
exercisable into Preferred Shares at that time. A "Flip-in" event takes place if
one of the following happens:
44
o A person or group acquires 20% or more of the outstanding Common
Shares.
o A 20% stockholder merges with or acquires the Company and an
equity security of the Company remains outstanding.
o A 20% stockholder engages in "self-dealing" transactions with the
Company, defined as (i) the receipt of securities from the
Company; (ii) the sale of assets by the 20% stockholder to, from
or with the Company having a value of more than $5,000,000 or on
terms and conditions less favorable to the Company than the
Company would be able to obtain in an arm's length negotiation
with an unaffiliated third party; (iii) the receipt by the 20%
stockholder of compensation other than for full time employment
at regular rates; and (iv) the receipt by the 20% stockholder of
the benefit of any loans, guarantees or other financial
assistance or tax credits from the Company. The Board of
Directors of the Company has the power to administer and
interpret the Plan.
If a "Flip-over" event occurs, the holder of Rights is entitled to
purchase $75 worth of the Acquiror's stock for $37.50 for each Right held. A
"Flip-over" event occurs if the Company is acquired or merged and no outstanding
shares remain or if 50% of the Company's assets or earning power is sold or
transferred. The Rights Plan prohibits the Company from entering into this sort
of transaction unless the Acquiror agrees to comply with the "Flip-over"
provisions of the Plan.
The Rights can be redeemed by the Company for $.005 per right until up
to ten days after the public announcement that someone has acquired 20% or more
of the Company's Common Shares or the Board can extend the redemption period for
as long as it determines appropriate. If the Rights are not redeemed or
substituted by the Company, they will expire on September 30, 2007.
Limitation of Liability
As permitted by the Delaware General Corporation Law (the "DGCL"), the
Company's Certificate of Incorporation provides that directors of the Company
shall not be personally liable to the Company or its stockholders for monetary
damages for breach of fiduciary duty as a director, except for liability (i) for
any breach of the director's duty of loyalty to the Company or its stockholders,
(ii) for acts or omissions not in good faith or which involve intentional
misconduct or a knowing violation of law, (iii) under Section 174 of the DGCL,
relating to prohibited dividends or distributions or the repurchase or
redemption of stock or (iv) for any transaction from which the director derives
an improper personal benefit.
Transfer Agent and Registrar
The transfer agent and registrar for the Common Shares is Registrar and
Transfer Company.
45
UNDERWRITING
Under the terms of, and subject to the conditions contained in, the
Underwriting Agreement, the form of which is filed as an exhibit to the
Registration Statement of which the Prospectus forms a part, each of the
Underwriters named below, for whom Lehman Brothers Inc., Robert W. Baird & Co.
Incorporated, Furman Selz LLC and Legg Mason Wood Walker, Incorporated are
acting as representatives (the "Representatives"), has severally agreed to
purchase from the Company and the Selling Stockholders, and the Company and the
Selling Stockholders have agreed to sell to each Underwriter, the aggregate
number of Common Shares set forth opposite the name of each such Underwriter
below:
Underwriters Number of Shares
------------ ----------------
Lehman Brothers Inc..................................
Robert W. Baird & Co. Incorporated...................
Furman Selz LLC......................................
Legg Mason Wood Walker, Incorporated.................
Total.......................................... 2,512,169
=========
The Company and the Selling Stockholders have been advised by the
Representatives that the Underwriters propose to offer the Common Shares
directly to the public at the public offering price set forth on the cover page
of this Prospectus and to certain selected dealers (who may include the
Underwriters) at such public offering price less a concession not in excess of $
per share. The selected dealers may reallow a concession not in excess of $
per share to certain other brokers and dealers. After commencement of the
public offering, the offering price and other selling terms may be changed by
the Representatives.
The Underwriting Agreement provides that the obligations of the several
Underwriters to pay for and accept delivery of the Common Shares are subject to
certain conditions precedent, including the conditions that no stop order
suspending the effectiveness of the Registration Statement is in effect and no
proceedings for such purpose are pending before or threatened by the Commission,
and that there has been no material adverse change in the condition of the
Company. The Underwriters will be obligated to purchase all of the Common Shares
if any are purchased.
The Company and the Selling Stockholders have agreed to indemnify the
Underwriters against certain liabilities, including liabilities under the
Securities Act or to contribute to payments that may be required to be made in
respect thereof.
The Company has granted the Underwriters an option to purchase up to an
aggregate of 375,000 additional Common Shares at the public offering price less
the underwriting discounts and commissions set forth on the cover page of this
Prospectus. Such option may be exercised at any time until 30 days after the
date of the Underwriting Agreement. To the extent that the Underwriters exercise
such option, each of the Underwriters will have a firm commitment, subject to
certain conditions, to purchase a number of the additional Common Shares
proportionate to such Underwriter's initial commitment as indicated in the
preceding table. The Company will be obligated, pursuant to such option, to sell
such shares to the Underwriters to the extent such option is exercised. The
Underwriters may exercise such option only to cover over-allotments made in
connection with the sale of Common Shares offered hereby.
46
Prior to the Offering, Lehman Ltd. I, Inc., Lehman Brothers Capital
Partners I and Lehman/SDI, Inc., each an affiliate of Lehman Brothers Inc.,
beneficially own, in the aggregate, approximately 2,012,169 of the outstanding
Common Shares. Because Lehman Brothers Inc. is a member of the National
Association of Securities Dealers, Inc. ("NASD") and will act as an underwriter
in the Offering, the Offering is subject to the provisions of Section 2720 of
the Conduct Rules of the NASD (formerly Schedule E to the Bylaws of the NASD)
("Section 2720"). Although not required by Section 2720 in this instance, it has
been determined that Robert W. Baird & Co. Incorporated will serve as a
"qualified independent underwriter" and will recommend the public price in
compliance with the standard requirements of Section 2720. Robert W. Baird & Co.
Incorporated, in its role as qualified independent underwriter, is assuming the
responsibilities of acting as a qualified independent underwriter and has
performed due diligence investigation and participated in the preparation of
this Prospectus and the Registration Statement of which this Prospectus is a
part. In addition, in accordance with Section 2720, the Underwriters will not
make sales of Common Shares offered hereby to customer's discretionary accounts
without the prior specific written approval of such customer.
Until the distribution of the Common Shares is completed, rules of the
Commission may limit the ability of the Underwriters and certain selling group
members to bid for and purchase Common Shares. As an exception to these rules,
the Representatives are permitted to engage in certain transactions that
stabilize the price of the Common Shares. Such transactions may consist of bids
or purchases for the purposes of pegging, fixing or maintaining the price of the
Common Shares.
In addition, if the Representatives over-allot (i.e., if they sell more
Common Shares than are set forth on the cover page of this Prospectus), and
thereby create a short position in the Common Shares in connection with the
Offering, the Representatives may reduce that short position by purchasing
Common Shares in the open market. The Representatives also may elect to reduce
any short position by exercising all or part of the over-allotment option
described herein.
In general, purchases of a security for the purpose of stabilization or
to reduce a syndicate short position could cause the price of the security to be
higher than it might otherwise be in the absence of such purchase.
Neither the Company nor any of the Underwriters make any representation
or prediction as to the direction or magnitude of any effect that the
transactions described above may have on the price of the Common Shares. In
addition, neither the Company nor any of the Underwriters make any
representation that the Representatives will engage in such transactions or that
such transactions, once commenced, will not be discontinued without notice.
The Company, its officers and directors and certain of its stockholders
have agreed that they will not, subject to certain exceptions, for a period of
90 days from the date of this Prospectus, directly or indirectly, offer, sell or
otherwise dispose of any Common Shares or any securities convertible into or
exchangeable or exercisable for any such Common Shares, without the prior
written consent of Lehman Brothers Inc.
Affiliates of Lehman Brothers Inc. will receive a substantial portion
of the proceeds from the Offering. In addition, two of the ten members of the
Company's Board of Directors are presently employed by Lehman Brothers Inc. and
a third is employed by Legg Mason Wood Walker, Incorporated. Lehman Brothers
Inc. and Legg Mason Wood Walker, Incorporated have from time to time provided
investment banking, financial advisory and other services to the Company, for
which services they have received fees.
47
LEGAL MATTERS
The validity of the securities offered hereby will be passed upon for
the Company by Morgan, Lewis & Bockius LLP, Philadelphia, Pennsylvania. Donald
A. Scott, a partner in Morgan, Lewis & Bockius LLP, is a director of the
Company. Certain legal matters in connection with this offering will be passed
upon for the Underwriters by Simpson Thacher & Bartlett (a partnership which
includes professional corporations), New York, New York.
EXPERTS
The consolidated balance sheets of the Partnership at December 31, 1996
and 1995 and the consolidated statements of income, changes in partners' capital
and cash flows for the three years in the period ended December 31, 1996
included and incorporated by reference in this Prospectus and the balance sheet
of SunSource Inc. at December 31, 1996 included in this Prospectus, have been
included and incorporated herein in reliance on the reports of Coopers & Lybrand
L.L.P., independent accountants, given on the authority of that firm as experts
in accounting and auditing.
AVAILABLE INFORMATION
The Company is subject to the informational requirements of the
Securities Exchange Act of 1934, as amended (the "Exchange Act"), and in
accordance therewith files reports and other information with the Commission.
Such reports and other information may be inspected and copied at the public
reference facilities maintained by the Commission, 450 Fifth Street, N.W.,
Washington, D.C. 20549, and at the Commission's Regional Offices at Seven World
Trade Center, New York, New York 10048, and at Citicorp Center, 500 West Madison
Street, Suite 1400, Chicago, Illinois 60661-2511. Copies of this material should
also be available on-line through EDGAR and may be obtained at the prescribed
rates from the Public Reference Section of the Commission at its principal
office in Washington, D.C. The Commission also maintains a Web site
(http://www.sec.gov) that contains reports and other information regarding the
Company. Such reports and other information concerning the Company can also be
inspected at the office of the New York Stock Exchange, 20 Broad Street, New
York, New York 10005, the exchange on which the Common Shares are listed.
This Prospectus constitutes a part of a Registration Statement on Form
S-2 (the "Registration Statement") filed by the Company with the Commission
under the Securities Act. This Prospectus omits certain of the information
contained in the Registration Statement in accordance with the rules and
regulations of the Commission. Reference is hereby made to the Registration
Statement and related exhibits for further information with respect to the
Company and the securities offered hereby. Any statements contained herein
concerning the provisions of any document are not necessarily complete, and, in
such instance, reference is made to the copy of such document filed as an
exhibit to the Registration Statement or otherwise filed with the Commission.
Each such statement is qualified in its entirety by such reference.
INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE
This Prospectus incorporates documents by reference which are not
presented herewith. These documents (without exhibits, unless such exhibits are
specifically incorporated by reference herein) are available without charge to
each person to whom a copy of this Prospectus is delivered, upon written or oral
request addressed to SunSource Inc., 3000 One Logan Square, Philadelphia,
Pennsylvania 19103, Attention: Joseph M. Corvino, Secretary, telephone number
(215) 282-1290.
The following documents of the Partnership (Commission file no.
1-09375) and the Company (Commission file no. 1-13293) have been filed with the
Commission and are incorporated herein by reference:
48
(a) Annual Report on Form 10-K for the Partnership for the fiscal
year ended December 31, 1996;
(b) Quarterly Reports on Form 10-Q for the Partnership for the
quarterly periods ended March 31 and June 30, 1997; and
(c) Quarterly Report on Form 10-Q for the Company for the quarterly
period ended September 30, 1997.
49
INDEX TO FINANCIAL STATEMENTS
F-1
SunSource Inc. and Subsidiaries
Pro Forma Consolidated Financial Statements (Unaudited)
The following unaudited pro forma consolidated financial statements of
SunSource Inc. ("the Company"), give effect to the closing of this offering of
common shares of the Company, (the "Offering"), the conversion of its
predecessor, SunSource L.P. ("the Partnership") to corporate form, including
the elimination of non-recurring charges and credits ("the Conversion") and the
refinancing of debt in conjunction with the Conversion (the "Refinancing"). The
pro forma financial statements include the accounts of the Company and its
indirect wholly-owned subsidiary partnership, SDI Operating Partners, L.P. (the
"Operating Partnership"). Refer to the unaudited historical financial
statements and notes thereto filed by the Company on Form 10-Q for the period
ending September 30, 1997 and included elsewhere herein for further information
regarding the Conversion.
The pro forma consolidated statements of income assume the Offering and
the Refinancing closed and the Conversion occurred at the beginning of the
periods presented. The pro forma consolidated income statements are not
necessarily indicative of operating results that would have been achieved had
the Offering, the Conversion, and the Refinancing occurred on the dates
indicated and should not be construed as representative of future operating
results.
These pro forma financial statements should be read in conjunction with
the unaudited historical financial statements and notes thereto as filed by the
Company and the Partnership on Form 10-Q for the nine months ended September
30, 1997 and 1996 and the audited financial statements filed by the Partnership
on Form 10-K for the twelve months ended December 31, 1996, and included
elsewhere herein.
F-2
SUNSOURCE INC. AND SUBSIDIARIES
PRO FORMA CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(dollars in thousands, except for per unit data)
*SEE ACCOMPANYING NOTES TO PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS
F-3
SUNSOURCE INC. AND SUBSIDIARIES
PRO FORMA CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(dollars in thousands, except for per unit data)
*SEE ACCOMPANYING NOTES TO PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS
F-4
SUNSOURCE INC. AND SUBSIDIARIES
PRO FORMA CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(dollars in thousands, except for per unit data)
*SEE ACCOMPANYING NOTES TO PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS
F-5
SUNSOURCE INC. AND SUBSIDIARIES
NOTES TO PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(dollars in thousands)
1. Pro Forma Adjustments to Consolidated Statements of Income:
A. To eliminate, in consolidation, the management fee paid to SDI Partners I,
L.P., the "General Partner" or "GP" of the Operating Partnership.
B. To record amortization of goodwill associated with the exchange of the GP's
Minority Interest in the Operating Partnership, using the Partnership's
current estimated useful life of goodwill.
C. To eliminate restructuring charges due to their non-recurring nature.
D. To eliminate transaction and other costs related entirely to the Conversion
which have been recorded by the Company for each period presented.
E. To adjust interest expense, utilizing for each period presented, (i) an
interest rate of 6.98% (equal to current LIBOR rates of 5.73% plus 125
basis points, which reflects interest rates under the new revolving credit
facility), and (ii) net proceeds from the offering of $10,604.
F. Eliminate minority interest expense as a result of the Conversion.
G. Record an expense for the monthly distributions on Trust Preferred
Securities; the annual yield is 11.6% on the liquidation amount of the
securities of $105,446, resulting in an approximate charge of $1,019 per
month.
H. Adjust the partnership basis state and foreign provision or benefit for
income taxes to reflect a total provision for federal, state and foreign
income taxes under corporate form.
I. Eliminate extraordinary loss from early extinguishment of debt as a
non-recurring charge.
F-6
SUNSOURCE INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(dollars in thousands, except for per share amounts)
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
F-7
SUNSOURCE INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
FOR THE NINE MONTHS ENDED
(dollars in thousands, except for per unit amounts)
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
F-8
SUNSOURCE INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
FOR THE NINE MONTHS ENDED
(dollars in thousands)
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
F-9
SUNSOURCE INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN PARTNERS' CAPITAL/STOCKHOLDERS' DEFICIT
(UNAUDITED)
FOR THE PERIOD ENDED SEPTEMBER 30, 1997
(dollars in thousands)
(RESTUBBED TABLE)
- --------
(a) Minority interest included as other liabilities by the Partnership.
(b) Each Class A limited partnership interest was exchanged for $1.30 in cash
plus .38 share of Trust Preferred Securities recorded at fair value based
on the price of the Class A interests upon close of trading on the New
York Stock Exchange on September 30, 1997 of $11.75. This fair value of
$115,991 is recorded by the Corporation as Guaranteed Preferred Beneficial
Interests in the Corporation's Junior Subordinated Debentures.
(c) Goodwill related to the exchange of the GP minority interest (See Note 1).
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
F-10
SUNSOURCE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(dollars in thousands)
1. Basis of Presentation:
The accompanying financial statements include the consolidated accounts of
SunSource Inc. (the "Corporation"), its predecessor, SunSource L.P. (the
"Partnership"), and its wholly-owned subsidiaries including SDI Operating
Partners, L.P. (the "Company") and SunSource Capital Trust (the "Trust"). All
significant intercompany balances and transactions have been eliminated. The
Company is one of the largest wholesale distributors of industrial products and
related services in the United States. The Company's three business segments
are Industrial Services, Hardware Merchandising and Glass Merchandising.
On September 25, 1997, the limited partners of the Partnership approved
the conversion of the Partnership to a taxable C corporation (the "Conversion")
effective at the close of business on September 30, 1997. As a result of the
Conversion, each Class A limited partnership interest in the Partnership was
converted into $1.30 of cash and .38 share of 11.6% Guaranteed Preferred
Beneficial Interests in the Corporation's Junior Subordinated Debentures (the
"Trust Preferred Securities"), each Class B limited partnership interest in the
Partnership was converted into .25 share of common stock of the Corporation and
the general and limited partnership interests in the GP were exchanged with the
Corporation for 1,000,000 shares of its common stock (the "GP Exchange"). In
connection with the Conversion, the Company also refinanced all of its
outstanding senior notes and bank revolving credit.
The exchange represented by the GP's 1% interest in the Company (the
"Minority Interest") is subject to purchase accounting in accordance with
Accounting Principles Bulletin ("APB") No. 16. Accordingly, the excess of fair
value of the consideration received for the Minority Interest over its book
value has been recorded by the Corporation as goodwill at September 30, 1997,
calculated as follows:
Fair value of Minority Interest (i) ...................... $21,841
Less book value of the GP Minority Interest (ii) ......... 1,082
-------
Excess over book value recorded as Goodwill ........... $20,759
(i) Represents 92.9% of the GP Exchange (the portion allocable to the
Minority Interest) valued at $23,500 in the aggregate for 1,000,000
shares of common stock, based on the closing price of the Class B
interest on the New York Stock Exchange at September 30, 1997 of
$5.875.
(ii) As reported on the pre-conversion balance sheet of the Partnership at
September 30, 1997.
The Trust was organized in connection with the Conversion for the purpose
of (a) issuing (i) its Trust Preferred Securities to the Corporation in
consideration of the deposit by the Corporation of Junior Subordinated
Debentures in the Trust as trust assets, and (ii) its Trust Common Securities
to the Corporation in exchange for cash and investing the proceeds thereof in
an equivalent amount of Junior Subordinated Debentures and (b) engaging in such
other activities as are necessary or incidental thereto. The Trust had no
operating history prior to the issuance of the Trust Preferred Securities. The
terms of the Junior Subordinated Debentures include those stated in the
Indenture (the "Indenture") between the Corporation and the indenture trustee,
the form of which was filed as an exhibit to Registration Statement No.
33319077 of the Corporation and the Trust, as amended (the "Registration
Statement") and those made part of the Indenture by the Trust Indenture Act.
The Corporation has guaranteed on a subordinated basis the payment of
distributions on the Trust Preferred Securities and payments on liquidation of
the Trust and redemption of Trust Preferred Securities (the "Preferred
Securities Guarantee"). The sole assets of the Trust are the Junior
Subordinated Debentures and the obligations of the Corporation under the
Indenture, the Preferred Securities Guarantee and the Junior Subordinated
Debentures in the aggregate constitute a full and unconditional guarantee by
the Corporation of the Trust's obligations under the Trust Preferred
Securities.
The accompanying consolidated financial statements and related notes are
unaudited; however, in management's opinion all adjustments (consisting of
normal recurring accruals) considered necessary for the fair presentation of
financial position, income and cash flows for the periods shown have been
reflected. Results for the interim period are not necessarily indicative of
those to be expected for the full year.
F-11
SUNSOURCE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (Continued)
(dollars in thousands)
1. Basis of Presentation: -- (Continued)
Certain information in note disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
has been condensed or omitted pursuant to Form 10-Q requirements although the
Corporation believes that disclosures are adequate to make the information
presented not misleading. It is suggested that these financial statements be
read in conjunction with the consolidated financial statements and notes
thereto included in the Partnership's report on Form 10-K for the year ended
December 31, 1996, and the Registration Statement.
2. Pro Forma Corporate Basis Financial Information:
As a result of the Conversion, historical net income of the Partnership is
not meaningful in the comparison to net income as recorded by the Corporation.
In order to present financial information for the current reporting periods
that will be comparable prospectively to corporate basis financial information,
the table below reconciles the partnership historical basis net income reported
on the Statements of Income included herein with corporate pro forma basis net
income which assumes the Conversion occurred at the beginning of the year for
each period presented and excludes non-recurring charges and credits related
solely to the Conversion.
Conversion of Class B Limited Partnership Interests to Common Stock:
F-12
SUNSOURCE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (Continued)
(dollars in thousands)
2. Pro Forma Corporate Basis Financial Information: -- (Continued)
Reconciliation of historical net income to pro forma basis net income:
3. Lines of Credit and Long-Term Debt:
On September 30, 1997, the Company entered into two new financing
commitments which together aggregate $150,000 from lenders. The new financing
commitments consist of a $60,000 five-year fixed rate senior note at 7.66% and
a $90,000 five-year bank revolver with terms and conditions more favorable than
the Corporation's previous senior notes and bank credit lines including less
restrictive covenants and an effective interest rate reduction of approximately
1.00%. The Company utilized this debt capacity to fund transaction costs and
other payments related to the Conversion, refinance its current outstanding
senior notes of $63,934 as of September 30, 1997, including interest thereon
and related make-whole amount of approximately $4,343, and outstanding bank
revolver borrowings of $17,000 as of September 30, 1997.
The new credit facilities provide working capital for reinvestment in the
Company's businesses and acquisition capital for future growth. As of September
30, 1997, the Company had $70,818 available under its new bank credit
facilities. The $79,182 outstanding balance consisted of Senior Notes totaling
$60,000, bank borrowings totaling $17,000, and Letter of Credit Commitments
aggregating $2,182.
F-13
SUNSOURCE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) -- (Continued)
(dollars in thousands)
3. Lines of Credit and Long-Term Debt: -- (Continued)
The Company has another credit facility available in the amount of $500
for letter of credit commitments only, of which no amount was outstanding as of
September 30, 1997. In addition, an indirect, wholly-owned Canadian subsidiary
of the Company has a $2,500 Canadian dollar line of credit for working capital
purposes of which no amount was outstanding at September 30, 1997.
4. Contingencies:
On February 27, 1996, a lawsuit was filed against the Company by the buyer
of its Dorman Products division for alleged misrepresentation of certain facts
by the Company upon which the buyer allegedly based its offer to purchase
Dorman. The complaint seeks damages of approximately $21,000.
On January 16, 1997, a holder of B Interests filed a purported class
action alleging that the terms of the Conversion unfairly transfer substantial
equity to the GP to the detriment of the B Interests and constitute a breach of
fiduciary duty. A second complaint containing substantially identical
allegations was filed by a limited partner on February 11, 1997. The cases were
consolidated and an amended complaint was filed on April 16, 1997, which added
claims for breach of contract and breach of covenant of good faith and fair
dealing. The Corporation and its co-defendants have reached an agreement in
principle to settle the class action.
Certain other legal proceedings are pending which are either in the
ordinary course of business or incidental to the Company's business. Those
legal proceedings incidental to the business of the Company are generally not
covered by insurance or other indemnity.
In the opinion of management, the ultimate resolution of these matters
will not have a material effect on the consolidated financial position,
operations or cashflows of the Company.
F-14
Report of Independent Accountants
To the Board of Directors
SunSource Inc.
We have audited the accompanying balance sheet of SunSource Inc. as of December
31, 1996. This financial statement is the responsibility of the Company's
management. Our responsibility is to express an opinion on this financial
statement based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the balance sheet is free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the balance sheet. An audit also includes
assessing the accounting principles used and the significant estimates made by
management, as well as evaluating the overall balance sheet presentation. We
believe that our audit of the balance sheet provides a reasonable basis for our
opinion.
In our opinion, the balance sheet referred to above presents fairly, in all
material aspects, the financial position of SunSource Inc. as of December 31,
1996 in conformity with generally accepted accounting principles.
/s/ Coopers & Lybrand L.L.P.
- ----------------------------
2400 Eleven Penn Center
Philadelphia, Pennsylvania
May 1, 1997
F-15
SUNSOURCE INC.
BALANCE SHEET
as of DECEMBER 31, 1996
SEE ACCOMPANYING NOTES TO BALANCE SHEET
F-16
SUNSOURCE INC.
NOTES TO BALANCE SHEET
as of DECEMBER 31, 1996
1. Organization and Operation:
SunSource Inc. (the "Corporation") is a Delaware corporation which was
formed in December 1996 to accomplish the conversion of SunSource L.P. (the
"Partnership") to corporate form (the "Conversion"). On December 11, 1996, the
Partnership announced the terms of a plan to convert from its current limited
partnership structure to a taxable C corporation.
The outstanding shares of the Corporation are presently owned by the
Partnership. In the Conversion, the Partnership and a subsidiary of the
Partnership will merge with and into the Corporation (the "Merger"). In the
Merger, the Class A limited partnership interests in the Partnership will be
exchanged for Trust Preferred Securities of SunSource Capital Trust, a newly
formed Delaware statutory business trust (the "Trust"), affiliated with the
Corporation, and the Class B limited partnership interests in the Partnership
will be exchanged for common stock of the Corporation. As a result of the
Merger, the interests of the general and limited partners of the General
Partner in the Partnership and the Operating Partnership will be indirectly
exchanged for common stock of the Corporation.
As a result of the Conversion, subsidiaries of the Corporation will own
all of the partnership interests in the Operating Partnership and the General
Partner. The Corporation will own, through its wholly-owned subsidiaries, 100%
of the equity in the business and operations owned by the Operating
Partnership, which will remain in partnership form after the Conversion. The
employees of the Operating Partnership will continue as employees after the
Conversion.
The Corporation's only asset at December 31, 1996 is a receivable from the
Partnership (see Note 3). The Corporation has not conducted any operations and
all activities related to the Conversion and the Merger have been conducted by
the Partnership and its General Partner.
2. Summary of Significant Accounting Policies:
Income Taxes:
Statement of Financial Accounting Standards ("SFAS") No. 109, "Accounting
for Income Taxes", requires the Corporation to recognize deferred tax assets
and liabilities for expected future tax consequences of events that have been
recognized in the financial statements or tax returns. Under this method,
deferred tax assets and liabilities are determined based on the difference
between the financial statement and tax bases of assets and liabilities using
enacted tax rates in effect for the year in which the temporary differences are
expected to reverse. The Corporation currently has no deferred taxes.
Use of Estimates:
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the reported
periods. Actual results could differ from those estimates; however, management
does not believe these differences would have a material effect on operating
results.
3. Related Party Transactions:
On December 30, 1996, the Corporation recorded a receivable from the
Partnership for the capital contribution to establish the Corporation. On March
11, 1997 the Partnership paid $1,000 to the Corporation to satisfy the
receivable due from the Partnership.
F-17
SUNSOURCE INC.
NOTES TO BALANCE SHEET
as of DECEMBER 31, 1996 -- (Continued)
4. Commitments and Contingencies:
On January 16, 1997, a holder of Class B Interests in the Partnership,
filed a purported class action which alleged that the terms of the Conversion
unfairly transfer substantial equity to the General Partner of the Partnership
to the detriment of the B Interests and constitute a breach of fiduciary duty.
A second complaint containing substantially identical allegations was filed by
a limited partner on February 11, 1997. The cases have been consolidated and an
amended complaint was filed on April 16, 1997 which added claims for breach of
contract and breach of a covenant of good faith and fair dealing. The
Corporation was named as a defendant in these actions.
In the opinion of management, the ultimate resolution of this matter will
not have a material effect on the consolidated financial position, operations
or cash flows of the Partnership or the Corporation.
F-18
Report of Independent Accountants
The Board of Directors
Lehman/SDI, Inc.
We have audited the accompanying consolidated balance sheets of SunSource
L.P. and subsidiary as of December 31, 1996 and 1995, and the related
consolidated statements of income, changes in partners' capital and cash flows
for each of the three years in the period ended December 31, 1996. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and the 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 SunSource L.P.
and subsidiary as of December 31, 1996 and 1995, and the consolidated results
of their operations and their cash flows for each of the three years in the
period ended December 31, 1996, in conformity with generally accepted
accounting principles.
/s/ Coopers & Lybrand L.L.P.
- --------------------------------------------------------
2400 Eleven Penn Center Philadelphia, Pennsylvania
January 29, 1997, except for Note 9 as to which the date
is March 21, 1997 and Note 19 as to which the date
is March 4, 1997
F-19
SUNSOURCE L.P. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(dollars in thousands)
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
F-20
SUNSOURCE L.P. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
(dollars in thousands, except for partnership interest amounts)
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
F-21
SUNSOURCE L.P. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in thousands)
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
F-22
SUNSOURCE L.P. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN PARTNERS' CAPITAL
FOR THE YEARS ENDED
(dollars in thousands)
PARTNERS' CAPITAL
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
F-23
SUNSOURCE L.P. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands)
1. Basis of Presentation:
The accompanying financial statements include the consolidated accounts of
SunSource L.P. (the "Partnership") and its subsidiary partnership, SDI
Operating Partners, L.P. (the "Operating Partnership"). All significant
inter-company balances and transactions have been eliminated.
Nature of Operations:
The Partnership is one of the largest wholesale distributors of industrial
products and related services in the United States. The Partnership's three
segments are: (1) industrial products and services, primarily maintenance and
fluid power products and inventory management services sold to industrial
customers for machine and plant maintenance and for manufacturing of original
equipment; (2) retail merchandising products and services, primarily fasteners
and related products sold to retail hardware stores; and (3) retail glass
products and services sold to construction and retail markets. Based on net
sales of existing divisions for the year ended December 31, 1996, the
Industrial Services Segment provides approximately 70% of the Partnership's
sales through its Sun Technology Services divisions (46% of net sales) and the
Sun Inventory Management Company ("SIMCO") divisions (24% of net sales). The
Hardware Merchandising and Glass Merchandising segments provide approximately
16% and 14%, respectively, of the Partnership's net sales.
Although its sales are primarily industrially-based, the Partnership has
over 180,000 customers, the largest of which accounted for less than 5% of net
sales for the year ended December 31, 1996. The Partnership's products and
services are sold throughout all 50 states as well as in Canada and Mexico.
Foreign sales account for less than 5% of total revenues. The average single
sale during the year ended December 31, 1996 was less than three hundred
dollars. Sales performance is tied closely to the overall performance of the
non-defense-goods producing sector of Gross Domestic Product in the United
States.
Restructuring Charges:
On December 11, 1996 (the "commitment date"), the Board of Directors of
Lehman/SDI, Inc. ("Lehman/SDI"), the general partner of the Partnership's
General Partner, approved the Partnership's plan to restructure its Technology
Services divisions and its Glass Merchandising business. The Partnership
recorded a provision for these charges on the commitment date in the amount of
$5,950, of which $4,400 related to Technology Services and $1,550 to Glass
Merchandising. The following disclosures are made in accordance with the
provisions of Emerging Issues Task Force ("EITF") Abstract No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit
an Activity."
The following is a summary of the balance sheet classification of the
accrued restructuring charges in the accompanying balance sheet at December 31,
1996:
Termination Other
Balance Sheet Classification Benefits Exit Costs Total
- ----------------------------------- ------------- ------------ ---------
Current -- other accrued expenses . $ 829 $896 $1,725
Long-term -- other liabilities .... $2,014 $573 $2,587
Restructuring Charges -- Technology Services Divisions
The restructuring charges for the Technology Services Divisions include
termination benefits of $2,955 covering 175 employees, including sales (40),
warehouse (27), purchasing (16), branch operations (56) and accounting (36).
Other exit costs for Technology Services include legal and consulting costs of
$525 to develop severance agreements and to conduct employee meetings and lease
termination and related costs of $920 to close ten leased warehouse and office
facilities. The Board's approval on the commitment date provided the
Partnership's management with the authority to involuntarily terminate
employees. The Partnership has established the levels of benefits that the
terminated employees would receive and informed the employees of their
termination benefits prior to December 31, 1996.
F-24
SUNSOURCE L.P. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(dollars in thousands)
1. Basis of Presentation: -- (Continued)
The following table summarizes the restructuring costs charged, the
balance sheet classification, and payments or adjustments between the
commitment date and December 31, 1996:
Termination Other
Balance Sheet Classification Benefits Exit Costs Total
- ---------------------------------------------------- ------------ ---------
Opening Balance at December 11, 1996:
Current -- other accrued expense ..... $ 941 $ 872 $ 1,813
Long-term -- other liabilities ....... $ 2,014 $ 573 $ 2,587
Payments during period:
Current -- other accrued expense* .... $ (112) $ (55) $ (167)
Ending Balance at December 31, 1996:
Current -- other accrued expense ..... $ 829 $ 817 $ 1,646
Long-term -- other liabilities ....... $ 2,014 $ 573 $ 2,587
- ------------
* Termination benefits paid to 9 employees; other exit costs for legal and
consulting charges paid.
Restructuring Charges -- Glass Merchandising Divisions
The restructuring charges for the Glass Merchandising division represent
primarily costs to withdraw from certain geographic markets as part of the
Partnership's restructuring plan. The largest component of these charges is the
write-off of unamortized goodwill from purchase business combinations in the
amount of $1,321, which is not recoverable. The remaining charges represent the
excess of undepreciated fixed assets over their fair value, in the amount of
$150, with fair value determined using the estimated prices of similar assets.
The Partnership applied the provisions of SFAS No. 121, "Accounting for
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of",
in connection with the determination of these charges. The decision to withdraw
from these markets was primarily strategic based on an overall review of the
operations of the Glass Merchandising segment; in the Partnership's view, any
recognition of asset impairment prior to the commitment date would not have
been appropriate under SFAS No. 121., since the specific locations to be closed
were decided upon only in the process of finalizing the restructuring plan.
These amounts are included as restructuring charges since they were recognized
at the commitment date as part of the overall plan of restructuring. Also
included are $79 of lease termination costs recognized in accordance with EITF
No. 94-3 as exit costs.
The following table summarizes other exit costs charged, the balance sheet
classification, and payments or adjustments between the commitment date and
December 31, 1996:
Balance Sheet Classification Total
- ----------------------------- ----
Opening Balance at December 11, 1996
- ------------------------------------
Unamortized Goodwill ......................... $ 1,321
Excess of undepreciated fixed assets ......... $ 150
Current -- other accrued expenses ............ $ 79
Charges during period:
- ---------------------
Unamortized Goodwill ......................... $ (1,321)
Excess of undepreciated fixed assets ......... $ (150)
Ending Balance at December 31, 1996:
- -----------------------------------
Current -- other accrued expenses ............ $ 79
F-25
SUNSOURCE L.P. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(dollars in thousands)
1. Basis of Presentation: -- (Continued)
Transaction Costs:
On December 11, 1996, the Partnership announced the terms of a plan to
convert from its current limited partnership structure to a taxable C
corporation, which must be approved by a majority of the holders of the Class A
and Class B interests unaffiliated with SDI Partners I, L.P., the General
Partner, each voting separately as a class.
In connection with the proposed conversion, the Partnership has incurred
certain costs related to the transaction which are included as a separate
component of income from operations, due to the infrequent nature of the
conversion transaction.
2. Summary of Significant Accounting Policies:
Cash Equivalents:
Cash equivalents consist of commercial paper, U.S. Treasury obligations
and other liquid securities purchased with initial maturities less than 90 days
and are stated at cost which approximates market value.
Inventories:
Inventories, which consist of products purchased for resale, are valued at
the lower of cost or market, cost being determined principally on the first-in,
first-out method.
Property and Equipment:
Property and equipment, including assets acquired under capital leases, is
carried at cost and includes expenditures for new facilities and major
renewals. Maintenance and repairs are charged to expense as incurred. When
assets are sold, or otherwise disposed of, the cost and related accumulated
depreciation are removed from their respective accounts, and the resulting gain
or loss is reflected in current operations.
Depreciation:
For financial accounting purposes, depreciation, including that related to
plant and equipment acquired under capital leases, is computed on the
straight-line method over the estimated useful lives of the assets, generally
three to twenty-five years, or, if shorter, over the terms of the related
leases.
Goodwill and Other Intangible Assets:
Goodwill related to the excess of acquisition cost over the fair value of
net assets acquired is amortized on a straight-line basis over forty years.
Other intangible assets arising principally from acquisitions by the Operating
Partnership are amortized on a straight-line basis over periods ranging from
three to ten years.
Income Taxes:
As a partnership, taxable income and losses are included on the federal
tax returns of the partners; accordingly, the Partnership incurs no liability
for U.S. federal income taxes. Accordingly, no current provision for federal
income taxes is reflected in the accompanying consolidated financial
statements. However, the Partnership does incur certain state and local income
taxes on its domestic operations and foreign income taxes on its Canadian and
Mexican operations. Therefore, a current provision for state, local and foreign
income taxes is reflected in the accompanying consolidated financial
statements.
The Revenue Act of 1987 provides that certain "existing publicly traded
partnerships", such as the Partnership, generally will not be treated as
corporations for federal income tax purposes until after December 31, 1997,
provided that such partnerships do not add any substantial new line of business
before the effective date.
F-26
SUNSOURCE L.P. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(dollars in thousands)
2. Summary of Significant Accounting Policies: -- (Continued)
Statement of Financial Accounting Standards ("SFAS") No. 109 requires the
Partnership to recognize deferred tax assets and liabilities for expected
future tax consequences of events that have been recognized in the consolidated
financial statements or tax returns. Under this method, deferred tax assets and
liabilities are determined based on the difference between the financial
statement and tax bases of assets and liabilities using enacted tax rates in
effect for the year in which the temporary differences are expected to reverse.
The Partnership's deferred taxes are determined from temporary differences
expected to reverse after December 31, 1997, or the date of conversion, if
earlier, when the Partnership will be taxed as a corporation. Therefore, a
deferred provision or benefit for state and federal income taxes is reflected
in the accompanying consolidated statements of income.
Retirement Benefits:
Certain employees are covered under profit-sharing retirement plans
("defined contribution plans") for which contributions are determined on an
annual basis in accordance with the requirements of each plan.
Defined benefit plan contributions covering certain employees are funded,
at a minimum, in accordance with the requirements of the Employee Retirement
Income Security Act of 1974, as amended.
In accordance with collective bargaining agreements, annual contributions
to multi-employer pension plans are made. These contributions, which are based
on fixed contributions per month for each hour worked, are charged to income as
incurred.
Certain employees are covered under post-retirement benefit plans for
which benefits are determined in accordance with the requirements of each plan.
The Partnership has elected to amortize the accumulated post-retirement benefit
liability (transition obligation) resulting in delayed recognition. The impact
of the adoption on the Partnership's financial position and results of
operations is immaterial.
Fair Value of Financial Instruments:
Cash, accounts receivable, short-term borrowings, accounts payable,
accrued liabilities and bank revolving credit are reflected in the consolidated
financial statements at fair value because of the short-term maturity or
revolving nature of these instruments. The fair values of the Partnership's
debt instruments are disclosed in Note 9.
Translation of Foreign Currencies:
The translation of applicable foreign-currency-based financial statements
into U.S. dollars is performed for balance sheet accounts using exchange rates
in effect at the balance sheet date and for revenue and expense accounts using
an average exchange rate during the period. The changes in the cumulative
foreign translation adjustment for each period relate to translation
adjustments in their entirety.
Exchange adjustments resulting from foreign currency transactions are
recognized in net income and were immaterial for the three years ending
December 31, 1996.
Use of Estimates in the Preparation of Financial Statements:
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amount of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
3. Ownership Structure:
The General Partner of the Partnership and the Operating Partnership is
SDI Partners I, L.P. (the "GP"), a Delaware limited partnership whose sole
general partner is Lehman/SDI, formerly known as Shearson/SDI, Inc., an
indirect, wholly-owned subsidiary of Lehman Brothers Holdings, Inc. ("Lehman
Holdings"), formerly known as Shearson Lehman Brothers Holdings, Inc.
F-27
SUNSOURCE L.P. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(dollars in thousands)
3. Ownership Structure: -- (Continued)
The Partnership's Class A and Class B limited partnership interests
outstanding, as of December 31, 1996, are held as follows:
- ------------
(a) Executive officers of the Partnership and the Operating Partnership and
Directors of Lehman/SDI, including beneficial ownership.
(b) Net of 523,400 Class B interests held in the Partnership's treasury as of
December 31, 1996.
Except as expressly limited by the partnership agreement, the GP has
complete and exclusive discretion in the management and control of the affairs
and business of the Partnership and its subsidiary partnership. The holders of
Class A and Class B interests have certain limited voting rights under the
partnership agreement generally regarding the removal of the GP and the sale of
all or substantially all of the assets of the Partnership or the Operating
Partnership or dissolution of the Partnership.
Holders of Class A interests are entitled to receive, to the extent cash
is available, $1.10 annually (the "priority return") per Class A interest,
which is currently paid monthly. On December 19, 1996, the Partnership declared
a priority return distribution for the month of January 1997 in the amount of
$1,038 or $.091666 per Class A interest payable January 31, 1997, to holders of
record December 31, 1996. The Class A capital account as of December 31, 1996
and 1995, was $10.00 per Class A interest.
All items of income and loss and cash distributions of the Operating
Partnership are allocated 99% to the Partnership and l% to the GP. The GP is
allocated l% of the Partnership's share of income or loss and cash
distributions, with the remaining 99% allocated to the limited partners.
Income for federal income tax purposes is allocated to the holders of
Class A interests, until the Class A capital account of each holder is equal to
the sum of their initial capital investment ($10.00 per Class A interest), plus
any unpaid priority return. For years 1996, 1995, and 1994, federal taxable
income per Class A interest amounted to $1.10 per year, all of which
represented ordinary income. Any remaining income after the Class A allocation
is allocated to the holders of Class B interests. The holders of Class B
interests receive an allocable share of loss until the Class B capital account
(as defined in the partnership agreement) of each holder is reduced to zero.
Thereafter, any unallocated loss is allocated to the holders of Class A
interests.
For 1996, 1995 and 1994, federal taxable income amounted to $.70, $1.6923
and $1.1146 per Class B interest, respectively. In 1996, federal taxable income
consisted of ordinary income only. Federal taxable income in 1995 consisted of
ordinary income of $.5326 per Class B interest and a combined capital gain of
$1.1597 per Class B interest related to the sale of the Dorman Products and
Downey Glass divisions (see Note 5, Acquisitions/Divestitures). Federal taxable
income in 1994 consisted of ordinary income of $.7069 per Class B interest and
a capital gain of $.4077 per Class B interest related to the sale of the
Electrical Products Group divisions. The Class B capital account as of December
31, 1996 and 1995, was approximately $2.89 and $2.54 per Class B interest,
respectively.
Holders of Class B interests are entitled to receive annual cash
distributions sufficient to cover their tax liabilities on taxable income
allocated to the Class B interests (the "Class B Tax Distribution"). For 1996,
the
F-28
SUNSOURCE L.P. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(dollars in thousands)
3. Ownership Structure: -- (Continued)
Class B Tax Distribution amounted to $7,663 or $.3465 per Class B interest
which was partially paid in the amount of $.02 per Class B interest per month
for the period January through April 1996 and $.03 for the period May through
December 1996. On March 31, 1997, the Partnership intends to distribute the
balance of the tax distribution due of $.0265 per Class B interest to holders
of record for the entire year.
For 1995, the Class B Tax Distribution amounted to $14,807 or $.6695 per
Class B interest which was partially paid in the amount of $.02 per Class B
interest per month for the period January through December 1995 and a partial
distribution of $.15 paid on April 10, 1995 to holders of record on December
30, 1994, related to the taxable gain on the sale of the Dorman Products
division on January 3, 1995. On March 29, 1996, the Partnership distributed the
balance of the tax distribution of $.2795 per Class B interest, as follows:
approximately $.1745 to holders of record on December 30, 1994 for the balance
due on the taxable gain on the sale of Dorman Products; $.00197 per month to
holders of record of Class B interests on the first day of the month during
January through December 1995 for the balance due on ordinary income; and
$.0814 to holders of record on September 29, 1995 related to the taxable gain
on the sale of the Downey Glass division (see Note 5,
Acquisitions/Divestitures).
For 1994, the Class B Tax Distribution amounted to $10,895 or $.492619 per
Class B interest which was partially paid in the amount of $.009352 per Class B
interest per month for the period January through March 1994 and $.02 per Class
B interest per month during the period April through December 1994. The monthly
tax distributions were paid to holders of record on the first day of each month
during 1994 and aggregated $.208056 per Class B interest for the full year
1994. On March 31, 1995, the Partnership paid the balance of the tax
distribution due of $.284563 per Class B interest, as follows: approximately
$.01981 per month to holders of record of Class B interests on the first day of
the month during January through March 1994, $.00916 per month for April
through November 1994, and $.15185 for December 1994 which includes $.14269
related to the capital gain on the sale of the Electrical Products Group
divisions. (See Note 5, Acquisitions/Divestitures.)
On December 19, 1996, the Partnership in anticipation of its conversion to
corporate form, suspended payment of the monthly tax-related distributions to
Class B interest holders effective January 1, 1997, through March 31, 1997. Due
to the delay in completion of the proposed corporate conversion, the
Partnership intends to resume payment of monthly advance Class B tax
distributions in April 1997 in the amount of $.03 per B Interest. On March 20,
1997, the Partnership declared a B tax distribution in the amount of $.03 per B
Interest payable April 30, 1997, to holders of record April 1, 1997. The
Partnership intends to pay this monthly rate to Class B holders until the
effective date of the conversion since it expects to allocate sufficient Class
B taxable income in the shortened tax year from January 1, 1997, through the
effective date to require the B tax distribution payment. The balance of the
required 1997 Class B tax distribution, if any will be paid on or before March
31, 1998.
4. Extraordinary Loss:
In 1995, the Partnership recorded an extraordinary loss of $629 or
approximately $.03 per Class B limited partnership interest, due to early
extinguishment of a portion of the Operating Partnership's Series A 9.08% and
Series B 8.44% Senior Notes (See Note 9, Long-Term Debt).
5. Acquisitions/Divestitures:
On April 11, 1996, the Partnership's Industrial Services segment, through
its Warren Fluid Power division purchased certain assets of Hydraulic Depot,
Inc., of Reno, Nevada, for an aggregate purchase price of $700. Annual sales of
Hydraulic Depot, Inc., are approximately $2,500.
F-29
SUNSOURCE L.P. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(dollars in thousands)
5. Acquisitions/Divestitures: -- (Continued)
In November 1995, the Partnership's Hillman Fastener division purchased
certain assets of the Retail division of Curtis Industries of Eastlake, Ohio,
for an aggregate purchase price of $8,011 and the assumption of certain
liabilities. The aggregate purchase price includes goodwill of $3,442. The
purchase price and goodwill amounts include post-closing adjustments recorded
in 1996. This acquisition has been accounted for as a purchase and,
accordingly, the results of operations have been included in the accompanying
consolidated financial statements from the date of acquisition.
On October 27, 1995, the Operating Partnership sold certain assets of its
Downey Glass division for a cash consideration, net of expenses, of
approximately $6,237 (subject to certain post-closing adjustments) and the
assumption of certain liabilities. The Operating Partnership recorded a gain on
the sale in the amount of $4,144 or $.19 per Class B interest included in the
1995 consolidated statement of income. The aggregate assets sold, net of
liabilities, in connection with the sale of the Downey Glass division was
approximately $2,093.
On January 3, 1995, the Operating Partnership sold certain assets of its
Dorman Products division for a cash consideration, net of expenses, of
approximately $36,600 (subject to certain post-closing adjustments) and the
assumption of certain liabilities. The Operating Partnership recorded a gain on
the sale in the amount of $16,500 or $.75 per Class B interest included in the
1995 consolidated statement of income. The aggregate assets sold, net of
liabilities, in connection with the sale of Dorman Products was approximately
$20,100.
On December 5, 1994, the Operating Partnership sold certain assets of its
Electrical Products Group divisions for a cash consideration, net of expenses,
of approximately $27,800 (subject to certain post-closing adjustments) and the
assumption of certain liabilities. The Operating Partnership recorded a gain on
the sale in the amount of $3,523 or $.16 per Class B interest included in the
1994 consolidated statement of income. The aggregate assets sold, net of
liabilities, in connection with the sale of the Electrical Products Group
divisions was approximately $24,300.
6. Related Party Transactions:
The GP earns a management fee annually from the Operating Partnership
equal to 3% of the aggregate initial Capital Investment of the holders of Class
A interests ($110,996). The management fee will be paid only after cumulative
outstanding priority returns and additional required cash distributions are
paid. In addition, the management fee can be paid only if the Partnership
complies with covenants required by the credit agreements (see Note 8, Lines of
Credit, and Note 9, Long-Term Debt). Management fees earned but not paid
accumulate until paid. Management fees earned in each of years 1996, 1995 and
1994 were $3,330. The management fees for the years 1995 and 1994 were paid in
full in March 1996 and 1995, respectively. Management expects to pay in full
the 1996 management fee due March 31, 1997.
7. Property and Equipment:
Property and equipment consist of the following at December 31, 1996 and
1995:
1996 1995
---------- ----------
Land .......................................... $ 3,289 $ 3,319
Buildings and leasehold improvements .......... 18,642 18,048
Machinery and equipment ....................... 18,680 16,290
Furniture and fixtures ........................ 10,368 9,208
------- -------
50,979 46,865
Less accumulated depreciation ................. 29,570 26,684
------- -------
$21,409 $20,181
======= =======
F-30
SUNSOURCE L.P. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(dollars in thousands)
8. Lines of Credit:
On December 22, 1992, the Operating Partnership entered into a $50,000
bank credit agreement with three lenders. This agreement provides borrowings on
a revolving credit basis at interest rates based on the London Interbank
Offered Rate ("LIBOR") plus 1 and 3/4% and prime. Letters of credit commitments
are issued at varying rates. The bank credit agreement's original termination
date of December 22, 1995 has been extended to December 31, 1997. The credit
facility requires a commitment fee of 1/2 of 1% per year on the average daily
unused portion of the commitment and an annual agent's fee. There is no
compensating balance requirement under this facility. As of December 31, 1996,
the Operating Partnership had $33,152 available under this Credit Agreement.
The $16,848 outstanding consists of bank borrowings amounting to $11,000 as
reflected on the Partnership's consolidated balance sheet at December 31, 1996,
and letter of credit commitments aggregating $5,848.
The bank credit agreement contains covenants restricting distributions
from the Operating Partnership to the Partnership and the GP. Amounts available
for distribution in accordance with the bank credit agreement at December 31,
1996, were $4,164. The agreement also requires the maintenance of specific
coverage ratios and levels of financial position and restricts incurrence of
additional debt and the sale of assets. The bank credit agreement did not
permit the Partnership to consummate acquisitions in 1994. Amendments to the
agreement were negotiated in March and December of 1994 to ease certain
coverage ratios and other financial requirements in 1994 and future years. The
December 1994 amendment allows for acquisition spending in 1995 and future
years up to $15,000 in any calendar year, absent a default or event of default
as defined in the bank credit agreement.
In connection with the sale of operating divisions (see note 5,
Acquisitions/ Divestitures), the Operating Partnership was required to reduce
permanently the bank revolver commitment under the bank credit agreement by
approximately $13,000. However, the banks waived this permanent reduction and
maintained the existing bank credit commitment of $50,000. For 1995 and future
years, the lenders have agreed to revise certain covenant tests to exclude the
impact of cash distributions to holders of Class B interests related solely to
tax gains on divisions sold.
The Operating Partnership has another credit facility available in the
amount of $500 for letters of credit of which no amount was outstanding at
December 31, 1996. The letters of credit commitments are issued at varying
rates. This facility, renewable annually, is not subject to compensating
balance requirements or unused commitment fees.
An indirect, wholly-owned Canadian subsidiary of the Operating Partnership
has a $2,500 Canadian dollar line of credit with a local lender for working
capital purposes of which $557 USD was outstanding at December 31, 1996. This
facility, which is renewable annually, provides bank borrowings at an interest
rate of prime plus 1/4 of 1%. There are no compensating balance requirements or
commitment fees associated with this facility.
Notes payable consisted of the following at December 31, 1996 and 1995:
F-31
SUNSOURCE L.P. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(dollars in thousands)
8. Lines of Credit: -- (Continued)
The weighted average interest rate on the outstanding notes payable
borrowings at December 31, 1996 and 1995 was 3.05% and 3.01%, respectively.
9. Long-Term Debt:
On December 22, 1992, the Operating Partnership issued $95,000 of senior
notes with a final maturity of December 1, 2002, through a private placement
with several institutional investors.
The new senior notes were issued in two series, as follows: $65,000 Series
A notes at 9.08% and $30,000 Series B notes at 8.44%. Interest is required to
be paid semiannually on June 1 and December 1 on the outstanding principal of
the senior notes. The Operating Partnership repaid $4,375, $3,282 and $3,900 in
Series A notes, and $2,020, $1,514 and $1,800 in Series B notes in 1996, 1995
and 1994, respectively. Principal repayments required on the senior notes
during each of the five years subsequent to December 31, 1996, are as follows:
Series A Series B
---------- ---------
December 1, 1997 .......... $4,375 $2,020
December 1, 1998 .......... 5,468 2,522
December 1, 1999 .......... 6,562 3,030
December 1, 2000 .......... 8,201 3,786
December 1, 2001 .......... 9,297 4,290
Optional prepayments, in multiples of $100, may be made at anytime, as a
whole or in part, with accrued interest thereon plus a penalty ("make-whole
amount"), if any, as defined in the note agreement.
If the Partnership sells a significant amount of assets as defined in the
note agreement, it must make an offer of prepayment of note principal to the
senior noteholders determined on an applicable share basis with the bank credit
agreement. The prepayment offer also must include accrued interest thereon plus
a make-whole amount, if any, as defined in the note agreement. Related to the
sale of operating divisions in December 1994 and January 1995 (see Note 5,
Acquisition/Divestitures), the Operating Partnership was required to offer the
noteholders prepayment of senior notes in the amount of $14,175. The
noteholders accepted the prepayment offer which the Operating Partnership paid
on March 14, 1995, including accrued interest thereon of $360 and a prepayment
penalty of $629 (see Note 4, Extraordinary Loss).
The senior note agreement contains covenants restricting distributions
from the Operating Partnership to the Partnership and the GP. Additionally, the
note agreement restricts the incurrence of additional debt and the sale of
assets and requires the maintenance of specific coverage ratios and levels of
financial position. Also, the senior note agreement did not permit the
Partnership to consummate acquisitions in 1994. For 1994 and future years, the
senior noteholders have agreed to ease certain coverage ratios and other
financial requirements.
Provisions made during the year for restructuring charges and transaction
costs (Note 7) rendered the Operating Partnership unable to comply with certain
financial covenants of the bank credit agreement and the senior note agreement.
On March 21, 1997, the Partnership received the final consent in which the
banks and senior note holders agreed to a modification of these covenants
effective for the fiscal quarters ending December 31, 1996 through: (i) June
30, 1997 for the bank credit agreement; and (ii) September 30, 1997 for the
senior note agreement. The Partnership is in compliance with the modified
covenants.
As of December 31, 1996, the fair value estimate of the Partnership's
senior notes is approximately $65,000 as determined in accordance with SFAS No.
107. The Partnership discounted the future cash flows of its senior notes based
on borrowing rates for debt with similar terms and remaining maturities. The
fair value estimate is made at a specific point in time and is subjective in
nature and involves uncertainties and matters of significant judgment and
therefore cannot be determined with precision. Changes in assumptions could
significantly affect the estimate.
F-32
SUNSOURCE L.P. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(dollars in thousands)
10. Leases:
Certain warehouse and office space and equipment are leased under capital
and operating leases with terms in excess of one year. Future minimum lease
payments under noncancellable leases consisted of the following at December 31,
1996:
Capital Operating
Leases Leases
--------- ----------
1997 .......................................... $ 151 $ 9,210
1998 .......................................... 151 7,696
1999 .......................................... 151 5,475
2000 .......................................... 151 4,204
2001 .......................................... 134 2,875
Later years ................................... -- 10,692
------ -------
Total minimum lease payments ......... .... $ 738 $40,152
=======
Less amounts representing interest ............ (127)
------
Present value of Net Minimum Lease payments
(including $107 currently payable) ......... $ 611
======
Total rental expenses for all operating leases amounted to $15,239 in
1996, $14,232 in 1995, and $15,153 in 1994.
11. Deferred Compensation Plans:
Certain officers and employees earn performance-based compensation,
payment of which is deferred until future periods.
The Partnership adopted a new deferred compensation plan for its officers
effective January 1, 1994. Under this plan, awards are earned based on
operating performance over a five-year period which vest and are paid in cash
only at the end of the fifth year. At the end of any year within the five-year
program, the cumulative award is subject to reduction or forfeiture if
performance goals are not achieved. Upon a change in control of the Operating
Partnership, participants are entitled to payment of awards earned through
completion of the most recent plan year. The amounts charged to income under
this plan were $378 in 1996, $1,186 in 1995 and $850 in 1994. The portion of
the Operating Partnership's deferred compensation liability attributable to
this plan is $2,414 as of December 31, 1996.
For a plan adopted in 1987 and amended thereafter, certain employees
earned awards which vest at the rate of 20% per year over the 5-year period
following the year in which the award was earned. The awards will be paid at
age 60, if elected by the employee, or upon death, disability or retirement and
accrue investment earnings until paid. Upon a change in control of the
Operating Partnership, participants are entitled to payment of all vested and
non-vested amounts including accrued interest. The full award is charged to
operations in the year earned. The amounts charged to income under the plan
were $677, $1,135 and $2,295 in 1996, 1995 and 1994, respectively. During the
three years ended December 31, 1996, distributions from the plan amounted to
$1,160 in 1996, $1,422 in 1995, and $240 in 1994. The deferred compensation
liability attributable to the plan amounted to $5,998 at December 31, 1996 of
which $564 is included in other accrued expenses.
Under a former plan, effective through December 31, 1986, certain
employees and officers earned deferred compensation amounts which
unconditionally vested at the rate of 20% per year over the 5-year period
following the year in which the award was earned. Participants of the former
plan have elected to defer all outstanding awards until retirement. Upon a
change in control of the Operating Partnership, participants are entitled to
F-33
SUNSOURCE L.P. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(dollars in thousands)
11. Deferred Compensation Plans: -- (Continued)
payment of their total account balance including accrued interest. Amounts
charged to income and distributions related to the former plan for the three
years ended December 31, 1996 were immaterial. The portion of the Operating
Partnership's deferred compensation liability attributable to this plan is $796
at December 31, 1996.
In December 1995, the Operating Partnership established a Rabbi trust to
assist in funding the liabilities of the Deferred Compensation plans described
above. This trust purchased insurance policies on the lives of certain
participants in the Deferred Compensation plans. The Operating Partnership is
the sole beneficiary of these insurance policies. The cash surrender value of
these insurance policies was $4,566 at December 31, 1996.
The change of control provision in the deferred compensation plans is
triggered upon a sale of all of the Operating Partnership's business, a change
in the GP including its reorganization or a change, other than due to death or
retirement, in a majority of the directors of Lehman/SDI during any one-year
period.
The Partnership adopted a new deferred compensation plan effective
December 1, 1996, to offer key employees an opportunity to defer a portion of
their compensation including bonuses and any amounts credited to the accounts
of such employees which otherwise may become payable to such employees under
other incentive compensation programs maintained by the Partnership. This new
plan would allow participants eligible for accelerated payments under the
change in control provision of the Partnership's deferred compensation plans an
election to continue to defer their balances.
Net periodic pension cost (income) in 1996, 1995, and 1994 for
non-contributory defined benefit plans consists of:
Significant assumptions used in determining pension cost (income) include:
F-34
SUNSOURCE L.P. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(dollars in thousands)
11. Deferred Compensation Plans: -- (Continued)
The following table sets forth the defined benefit plans' funded status
and amounts recognized in the Partnership's balance sheets at December 31, 1996
and 1995:
The discount rate assumptions used in determining actuarial present value
of benefit obligations at December 31, 1996 and 1995 was 7.25%.
Certain employees of the Partnership's Kar Products, J.N. Fauver Co., and
its divested Dorman Products and American Electric Co. divisions are covered by
these defined benefit retirement plans. Assets of the defined benefit plans
consist of insurance contracts and assets managed under a commingled trust
agreement. The trust assets are invested primarily in equity and fixed income
holdings.
Costs charged to operations under all retirement benefit plans are as
follows:
1996 1995 1994
--------- --------- ---------
Defined contribution plans ............ $1,327 $2,693 $3,498
Multi-employer pension plans .......... 189 374 362
Defined benefit plans ................. 20 259 266
------ ------ ------
Total .............................. $1,536 $3,326 $4,126
====== ====== ======
Management estimates that its share of unfunded vested liabilities under
multi-employer pension plans is not material.
For the years ended December 31, 1996, 1995 and 1994, the costs of
post-retirement benefits charged to income were $87, $81 and $115,
respectively. The 1996 and 1995 charges were determined in accordance with SFAS
No. 106 on an accrual basis with costs recognized in prior years upon payment
of the post-retirement obligations. The Partnership's unrecognized accumulated
post-retirement benefit liability as of December 31, 1996, 1995 and 1994 was
$477, $516 and $744, respectively.
F-35
SUNSOURCE L.P. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(dollars in thousands)
13. Income Taxes:
Deferred tax assets are comprised of the following at December 31, 1996
and 1995:
1996 1995
--------- --------
Gross deferred tax assets:
Deferred compensation .............................. $3,292 $2,936
Deferred restructuring changes ..................... 1,034 --
Casualty Loss Insurance Program .................... 548 --
Prepayment penalties related to early extinguishment
of debt .......................................... 304 299
------ ------
5,178 3,235
Valuation allowance for deferred tax assets ........... (171) (391)
------ ------
Net deferred tax asset ................................ $5,007 $2,844
====== ======
Management has determined, based on the Partnership's history of prior
operating earnings and its expectations for the future, that operating income
of the Partnership will more likely than not be sufficient to recognize fully
these net deferred tax assets. The Partnership has no deferred tax liability at
December 31, 1996 or December 31, 1995.
As of December 31, 1996, the Partnership's tax basis of its assets and
liabilities was greater than its financial statement basis by approximately
$77,000.
The provision (benefit) for income taxes consists of the following:
1996 1995 1994
----------- -------- --------
Current income taxes
State and local ......... $ 605 $ 608 $ 276
Foreign ................. 418 629 558
-------- ------ ------
1,023 1,237 834
-------- ------ ------
Deferred income taxes
Federal ................. (1,897) (627) (657)
State and local ......... (266) (73) (77)
-------- ------ ------
(2,163) (700) (734)
-------- ------ ------
Total income taxes ......... $ (1,140) $ 537 $ 100
======== ====== ======
14. Commitments and Contingencies:
Performance and bid bonds are issued on the Partnership's behalf during
the ordinary course of business through surety bonding companies as required by
certain contractors. As of December 31, 1996, the Partnership had outstanding
performance and bid bonds aggregating $234. As required by sureties, the
Partnership has standby letters of credit outstanding in the amount of $650 as
of December 31, 1996.
Letters of credit are issued by the Partnership during the ordinary course
of business through major domestic banks as required by certain vendor
contracts, legal proceedings and acquisition activities. As of December 31,
1996, the Partnership had outstanding letters of credit in the aggregate amount
of $1,872 related to these activities.
As of December 31, 1996 the Partnership has guaranteed approximately
$1,181 worth of lease obligations, principally relating to businesses
previously divested. The Partnership is not currently aware of any existing
conditions which would cause a financial loss related to these guarantees.
F-36
SUNSOURCE L.P. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(dollars in thousands)
14. Commitments and Contingencies: -- (Continued)
Under the Partnership's insurance programs, commercial umbrella coverage
is obtained for catastrophic exposure and aggregate losses in excess of normal
claims. Beginning in 1991, the Partnership has retained risk on certain
expected losses from both asserted and unasserted claims related to workman's
compensation, general liability and automobile as well as the health benefits
of certain employees. Provisions for losses expected under these programs are
recorded based on an analysis of historical insurance claim data and certain
actuarial assumptions. As of December 31, 1996, the Partnership has provided
insurers letters of credit aggregating $3,326 related to certain insurance
programs.
On February 27, 1996, a lawsuit was filed against the Operating
Partnership by the buyer of its Dorman Products division for alleged
misrepresentation of certain facts by the Partnership upon which the buyer
allegedly based its offer to purchase Dorman. The complaint seeks damages of
approximately $21,000.
On January 16, 1997, a holder of B Interests filed a purported class
action alleging that the terms of the Conversion unfairly transfer substantial
equity to the General Partner to the detriment of the B Interests and
constitute a breach of fiduciary duty. A second complaint containing
substantially identical allegations was filed by a limited partner on February
11, 1997.
In the opinion of management, the ultimate resolution of these matters
will not have a material effect on the consolidated financial position,
operations or cash flows of the Partnership.
Certain other legal proceedings are pending which are either in the
ordinary course of business or incidental to the Partnership's business. Those
legal proceedings incidental to the business of the Partnership are generally
not covered by insurance or other indemnity. In the opinion of management, the
ultimate resolution of these matters will not have a material effect on the
consolidated financial position, operations or cash flows of the Partnership.
15. Statements of Cash Flows:
Supplemental disclosures of cash flow information are presented below:
F-37
SUNSOURCE L.P. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(dollars in thousands)
16. Quarterly Data (unaudited):
- ------------
* Includes non-recurring restructuring charges and transaction costs of $5,950
and $2,150, respectively.
- ------------
** Includes gain on sale of Dorman Products divison of $16,500.
*** Includes gain on sale of Downey Glass division of $4,144.
17. Concentration of Credit Risk:
Financial instruments which potentially subject the Partnership to
concentration of credit risk consist principally of cash and cash equivalents
and trade receivables. The Partnership places its cash and cash equivalents
with high credit quality financial institutions. Concentrations of credit risk
with respect to sales and trade receivables are limited due to the large number
of customers comprising the Partnership's customer base, and their dispersion
across many different industries and geographies. The Partnership performs
periodic credit evaluations of its customers' financial condition and generally
does not require collateral.
F-38
SUNSOURCE L.P. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(dollars in thousands)
18. Segment Information:
The following are the segment disclosures required under SFAS No. 14,
"Financial Reporting for Segments of a Business Enterprise," with respect to
the Partnership's reportable segments as identified in Note 1, "Basis of
Presentation" under "Nature of Operations":
* Includes non-recurring restructuring charges and transaction costs of $5,950
and $2,150, respectively.
19. Subsequent Event:
On March 4, 1997, the Operating Partnership received the last of two
financing commitments which together aggregate $150,000 from lenders. These
commitments are available to the Partnership until May 30, 1997. The
Partnership intends to utilize the debt capacity to fund transaction costs and
other payments related to its conversion to corporate form, refinance its
current outstanding senior notes of $63,934 as of December 31, 1996, including
interest thereon and related make-whole amount of approximately $5,000, and
outstanding bank
F-39
SUNSOURCE L.P. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(dollars in thousands)
19. Subsequent Event: -- (Continued)
revolver borrowings of $11,000 as of December 31, 1996. Also, the new credit
facilities will provide working capital for reinvestment in its businsses and
acquisition capital for future growth. The new financing commitments consist of
a $60,000 five-year fixed rate note at 7.66% and a $90,000 five-year bank
revolver with terms and conditions more favorable than the Partnership's
existing senior notes and bank credit lines including less restrictive
covenants and an effective interest rate reduction of approximately 1.00%.
Consummation of the refinancing with the new credit facilities is
contingent upon approval of the Partnership's conversion into corporate form
and certain other terms and conditions of closing being satisfied in a manner
acceptable to the lenders.
F-40
[Photograph of STS technician servicing equipment]
[Photograph of SIMCO's operations]
[Photograph of Hillman display racks]
[Photograph of Harding glass operations]
================================================================================
No dealer, salesperson, or any other individual has been authorized to give
any information or to make any representation not contained in this Prospectus
and, if given or made, such information or representations must not be relied
upon as having been authorized by the Company, the Selling Stockholders or any
of the Underwriters. This Prospectus does not constitute an offer of any
securities other than those to which it relates or an offer to sell, or a
solicitation of an offer to buy, to any person in any jurisdiction where such
offer or solicitation would be unlawful. Neither the delivery of this Prospectus
nor any sale made hereunder shall, under any circumstances, create any
implication that the information contained herein is correct as of any time
subsequent to the date hereof.
---------------------------
TABLE OF CONTENTS
Page
----
Prospectus Summary................................... 1
Risk Factors......................................... 8
The Company.......................................... 11
Use of Proceeds...................................... 11
Dividend Policy...................................... 11
Capitalization....................................... 12
Price Range of Common Shares......................... 13
Selected Historical and Pro Forma Financial
Information........................................ 14
Managements' Discussion and Analysis of Financial
Condition and Results of Operations................ 16
Business............................................. 25
Management........................................... 39
Security Ownership of Certain Beneficial Owners,
Management and Selling Stockholders................ 41
Description of Capital Stock......................... 42
Underwriting......................................... 46
Legal Matters........................................ 48
Experts.............................................. 48
Available Information................................ 48
Incorporation of Certain Documents by Reference...... 48
Index to Financial Statements........................ F-1
================================================================================
================================================================================
2,512,169 Shares
[LOGO]
Common Shares
---------------------------
PROSPECTUS
, 1998
---------------------------
LEHMAN BROTHERS
ROBERT W. BAIRD & CO.
INCORPORATED
FURMAN SELZ
LEGG MASON WOOD WALKER
INCORPORATED
================================================================================
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 14. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
The following table sets forth the costs and expenses of the issuance
and distribution of the securities being registered hereby, all of which are
being borne by the Company. All costs and expenses, other than the SEC
registration fee, the New York Stock Exchange Listing Fee and the NASD filing
fee, are estimated.
SEC Registration Fee................................ $19,962
NASD Filing Fee..................................... *
Legal Fees and Expenses............................. *
Accounting Fees and Expenses........................ *
Blue Sky Fees and Expenses.......................... *
Printing Expenses................................... *
Transfer Agent's Fees............................... *
New York Stock Exchange Listing Fee................. *
Miscellaneous Expenses.............................. *
--------
Total............................................... $ *
========
- ---------------
* To be completed by amendment.
ITEM 15. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
The Company's By-laws contain provisions permitted by the Delaware
General Corporation Law (under which the Company is organized) that provide that
directors and officers will be indemnified by the Company to the fullest extent
permitted by law for all losses that may be incurred by them in connection with
any action, suit or proceeding in which they may become involved by reason of
their service as a director or officer of the Company. In addition, the
Company's Certificate of Incorporation contains provisions permitted by the
Delaware General Corporation Law that limit the monetary liability of directors
of the Company for certain breaches of their fiduciary duty, and its By-laws
provide for the advancement by the Company to directors and officers of expenses
incurred by them in connection with a proceeding of a type to which the duty of
indemnification applies. The Company maintains directors' and officers'
liability insurance to insure its directors and officers against certain
liabilities incurred in their capacity as such, including claims based on
breaches of duty, negligence, error and other wrongful acts. Insofar as
indemnification for liabilities arising under the Securities Act of 1933, as
amended, may be permitted to directors, officers, or persons controlling the
Company pursuant to the foregoing provisions, the Company has been informed that
in the opinion of the Securities and Exchange Commission such indemnification is
against public policy as expressed in that Act and is therefore unenforceable.
Reference is also made to the indemnification provisions of the
Underwriting Agreement to be filed as Exhibit 1 and to the first undertaking
contained in Item 17 of this Registration Statement.
ITEM 16. EXHIBITS.
EXHIBIT NO. DESCRIPTION
- ----------- -----------
1 Form of Underwriting Agreement*
4 Rights Agreement between the Company and the Registrar
and Transfer Company***
5 Opinion of Morgan, Lewis & Bockius LLP regarding
legality of securities being registered*
10.1 Amended and Restated Credit Agreement dated September
30, 1997, among CoreStates Bank, N.A., for itself and
as agent, The Bank of Nova Scotia, for itself and as
documentation agent, and SDI Operating Partners, L.P.,
SDI Partners I, L.P., SunSource Inc., SunSub A Inc. and
SunSub B Inc. **
10.2 Note Purchase Agreement dated September 30, 1997
between Teachers Insurance and Annuity Association and
SDI Operating Partners, L.P., SDI Partners I, L.P.,
SunSource Inc., SunSub A Inc. and SunSub B Inc.**
23.1 Consent of Coopers & Lybrand L.L.P.**
23.2 Consent of Morgan, Lewis & Bockius LLP (contained in
its opinion to be filed as Exhibit 5)*
24 Powers of Attorney (included in signature page)**
27 Financial Data Schedule **
- ---------------
*To be filed by amendment.
**Filed herewith.
***Incorporated by reference to Exhibit 10.5 to the Company's
Registration Statement on Form S-4 (No. 333-19077).
ITEM 17. UNDERTAKINGS.
Insofar as indemnification for liabilities arising under the Securities
Act may be permitted to directors, officers and controlling persons of the
Company pursuant to the foregoing provisions, or otherwise, the Company has been
advised that in the opinion of the Securities and Exchange Commission such
indemnification is against public policy as expressed in the Act and is,
therefore, unenforceable. In the event that a claim for indemnification against
such liabilities (other than the payment by the registrant of expenses incurred
or paid by a director, officer or controlling person of the Company in the
successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the registrant will, unless in the opinion of its counsel the matter
has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the Securities Act and will be governed by the final
adjudication of such issue.
The undersigned Company hereby undertakes that:
(1) For purposes of determining any liability under the Securities Act,
the information omitted from the form of prospectus filed as part of this
Registration Statement in reliance upon Rule 430A and contained in a form of
prospectus filed by the Company pursuant to Rule 424(b)(1) or (4) or 497(h)
under the Securities Act shall be deemed to be part of this Registration
Statement as of the time it was declared effective.
(2) For the purpose of determining any liability under the Securities
Act, each post-effective amendment that contains a form of prospectus shall be
deemed to be a new Registration Statement relating to the securities offered
therein, and the offering of such securities at that time shall be deemed to be
the initial bona fide offering thereof.
SIGNATURES
Pursuant to the requirements of the Securities Act, the registrant
certifies that it has reasonable grounds to believe that it meets all of the
requirements for filing on Form S-2 and has duly caused this Registration
Statement to be signed on its behalf by the undersigned, thereunto duly
authorized, in Philadelphia, Pennsylvania on January 22, 1998.
SUNSOURCE INC.
BY: /s/ Joseph M. Corvino
--------------------------------
Name: Joseph M. Corvino
Title: Vice President - Finance,
Chief Financial Officer,
Treasurer and Secretary
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS that the undersigned does hereby
constitute and appoint Norman V. Edmonson and Joseph M. Corvino, or either of
them acting alone, his true and lawful attorney-in-fact and agent, with full
power of substitution and revocation for him and in his name, place and stead,
in any and all capacities, to sign this Registration Statement on Form S-2 of
SunSource Inc. (and any Registration Statement filed pursuant to Rule 462(b)
under the Securities Act), relating to the offer and sale of its Common Shares
and any and all amendments (including post-effective amendments) to the
Registration Statement and to file the same with all exhibits thereto, and other
documents in connection therewith, with the Securities and Exchange Commission,
granting unto said attorneys-in-fact and agents full power and authority to do
and perform each and every act and thing requisite and necessary to be done as
fully to all intents and purposes as he might or could do in person, hereby
ratifying and confirming all that said attorneys-in-fact and agents, or his or
their substitute or substitutes, may lawfully do or cause to be done by virtue
hereof.
Pursuant to the requirements of the Securities Act, this Registration
Statement has been signed by the following persons, in the capacities indicated,
on January 22, 1998.
INDEX TO EXHIBITS
EXHIBIT NO. DESCRIPTION
- ----------- -----------
1 Form of Underwriting Agreement*
4 Rights Agreement between the Company and the Registrar
and Transfer Company***
5 Opinion of Morgan, Lewis & Bockius LLP regarding
legality of securities being registered*
10.1 Amended and Restated Credit Agreement dated September
30, 1997, among CoreStates Bank, N.A., for itself and
as agent, The Bank of Nova Scotia, for itself and as
documentation agent, and SDI Operating Partners, L.P.,
SDI Partners I, L.P., SunSource Inc., SunSub A Inc. and
SunSub B Inc. **
10.2 Note Purchase Agreement dated September 30, 1997
between Teachers Insurance and Annuity Association and
SDI Operating Partners, L.P., SDI Partners I, L.P.,
SunSource Inc., SunSub A Inc. and SunSub B Inc.**
23.1 Consent of Coopers & Lybrand L.L.P.**
23.2 Consent of Morgan, Lewis & Bockius LLP (contained in
its opinion to be filed as Exhibit 5)*
24 Powers of Attorney (included in signature page)**
27 Financial Data Schedule **
- ---------------
*To be filed by amendment.
**Filed herewith.
***Incorporated by reference to Exhibit 10.5 to the Company's
Registration Statement on Form S-4 (No. 333-19077).