Item 1. Business
McWhorter Technologies, Inc. ("McWhorter" or the "Company") is one of the leading manufacturers of surface coating resins in the United States and Europe and is a manufacturer of resins used in the reinforced fiberglass plastics industry. Surface coating resins are a primary component of paint and coatings which are used for a variety of protective and decorative purposes. Resins used for reinforced fiberglass plastics are a primary component for various fiberglass products. On August 1, 1997, the Company completed the acquisition of Syntech S.p.A. and its affiliated entities and subsidiaries (Syntech). Syntech, based in Italy, is one of Europe's largest liquid and powder resins companies. The acquisition of Syntech opens new markets for McWhorter and better enables the Company to serve its customers on a global basis.
All references to years are to fiscal years ended October 31 unless otherwise stated.
Products and Markets McWhorter's product line focuses on the requirements of customers in the paint and coatings and reinforced fiberglass plastics industries. Each of these industries is highly fragmented with a large number of competitors.
The paint and coatings industry is a mature market, growing at an estimated 2% per annum, or about the same rate as durable goods. Although a number of paint and coating manufacturers have captive resin manufacturing capabilities today, increased costs of product reformulation and updating of resin manufacturing processes to comply with environmental regulations are causing a shift from captive manufacturing to outsourcing. McWhorter believes this trend will increase its sales opportunities in future years.
McWhorter produces various products including alkyds, copolymers, polyurethanes, polyester resins, unsaturated polyesters, acrylic emulsions, polyvinyl acetate emulsions, solution acrylics, powder resins, powder curing agents and a number of small volume specialty resins. Various types of resins are required by customers due to differing application and product performance characteristics.
Alkyd Resins and Copolymers. Alkyd resins and copolymers are McWhorter's largest product category and are used in the manufacture of oil-based paints and coatings. Alkyd resins and copolymers can be used in consumer paints (e.g., house paint, deck stains, etc.), industrial coatings (e.g., decorative and protective coatings used on machinery, equipment, tools, etc.) and special purpose coatings (e.g., traffic-striping paints, automotive refinish coatings and industrial maintenance coatings).
Alkyd resins and copolymers are formulated and engineered according to customer specifications for various purposes and the same product can be used in different applications depending on the product's formulation. Alkyd resins and copolymers can also be modified with other raw materials to improve performance: silicone for longer-lasting products or high temperature applications, vinyl toluene for quicker-dry applications and acrylics for improved durability.
Polyurethane Resins. Oil-modified polyurethane resins are a form of an alkyd resin used primarily in varnishes and other clear wood coatings for application on wood floors, furniture, kitchen cabinets, etc. Oil-modified polyurethane resins are also used as additives to floor coatings and other products to improve a product's performance characteristics.
Polyester Resins. Polyester resins are used in industrial coatings requiring specific properties such as gloss and color retention, resistance to corrosion and excellent flexibility. Typical uses for polyesters are coil coated metal buildings, appliances and metal office furniture.
Unsaturated Polyester Resins. Unsaturated polyester resins are used for various applications in the reinforced fiberglass plastics industry. The largest uses are marine applications where unsaturated polyester resins are used in the manufacture of boats. Other applications include tub and shower enclosures, fiberglass tanks and cultured marble surfaces.
Acrylic and Polyvinyl Acetate Emulsion Resins. Acrylic and polyvinyl acetate emulsion resins are used primarily in consumer latex paints. Acrylic emulsion resins are used in trim paints and exterior applications where weathering, color and gloss retention are critical. Emulsions are also used in industrial and special purpose coatings. The major advantage of acrylic emulsion resins is their ability to meet or exceed environmental regulations because of their low solvent content.
Solution Acrylics. Solvent-borne acrylic resins are used in applications where resistance to weathering is required. Coatings produced from solvent-borne acrylic resins may be thermoplastic or may be combined with cross linkers to form high performance thermoset coatings. Typical applications include marine and maintenance paints, and automotive topcoats.
Powder Resins. Powder resins are used in the manufacture of industrial powder coatings. Powder coatings are dry coatings which provide an alternative to liquid coatings. The principal advantage of powder coatings are that they emit no solvents, have excellent application and performance characteristics and have a high degree of transfer efficiency. Powder coatings are the fastest growing segment of the industrial coatings industry.
Powder Curing Agents. Powder curing agents are used in conjunction with certain powder resins to impart durability and hardness. McWhorter produces urethane curing agents, the largest volume category for powder paint.
Sales and Distribution McWhorter sells its liquid and powder coating resin products primarily to customers in the paint and coatings industry through a direct sales force, with the balance sold through agents or distributors. The majority of McWhorter's sales of unsaturated polyester resins to the fiberglass resin products industry are sold through distributors. McWhorter's business has primarily been focused in North America. However, the acquisition of Italian-based Syntech and the acquisition of the equity interests of its joint venture partners in McWhorter Technologies Europe provides a strong base for McWhorter in Europe.
McWhorter's business is somewhat seasonal with sales volume being traditionally the highest during the third quarter of its fiscal year. This seasonality is largely due to the buying cycle of
the consumer paint and maintenance coatings businesses. Since orders are generally filled within a minimum lead time, McWhorter has no significant backlog.
Manufacturing and Research and Development McWhorter operates its manufacturing plants 24 hours a day on a five or seven day schedule, depending on local work practices, capacity utilization and customer requirements.
Solvent-based products are generally produced in high temperature reactors. Raw materials are fed into a reactor and heated to 400-500 degrees Fahrenheit for 10-30 hours, depending on the formulation. Once the desired properties are achieved, the product is transferred to a mixing vessel, where additional materials are added to complete the batch. Finally, the resin is filtered and pumped into drums or bulk storage tanks before shipment to customers.
Emulsions are processed differently from solvent-based resins. Emulsions are created by exothermic reactions in reactors designed to control the reaction by cooling the product. Once the reaction is complete, material is filtered and transferred to bulk storage tanks before shipment to customers.
McWhorter manufactures certain proprietary resins under tolling arrangements, which are common in the resin industry. Such arrangements are subject to confidentiality and secrecy agreements which safeguard the customer's technology.
McWhorter's research and development activities have emphasized emerging technologies in the paint and coatings industry, focusing on developing products designed to comply with environmental laws and maintain the integrity of a product's performance characteristics. In August, 1997, McWhorter broke ground for a new corporate research and development facility in Carpentersville, Illinois. This 42,000 square-foot facility is scheduled to open in the spring of 1998.
Raw Materials Materials used in the manufacturing of resins are procured primarily from domestic suppliers. Most of the raw materials are derived from either petroleum or vegetable oil. McWhorter has not experienced difficulty in recent years in obtaining an adequate supply of raw materials or other supplies needed in the manufacturing process. The majority of the materials purchased are subject to national supply contracts which generally average one to three years in length with pricing subject to periodic reviews and adjustment based on market conditions. Raw material prices move up and down due to market conditions in the petrochemical or vegetable oil markets.
Intellectual Property McWhorter's business is not materially dependent upon franchises, licenses or similar rights, or on any single patent or trademark or group of related patents or trademarks. The techniques and formulas used to produce solvent-based resins are mature and well known. The techniques and formulas used to produce acrylic emulsions, powder resins, curing agents and other specialty resins are in some instances not well known or are protected by patents or as trade secrets.
Competition McWhorter encounters competition from numerous other companies with respect to each of the products it produces. A significant number of resin producers are vertically integrated into
coatings manufacturers, providing a captive source of resin products for such manufacturers. Some of these captive producers also sell directly to third parties.
Consistent quality, responsive service, technology and price are the critical elements that customers use to select their resin suppliers. McWhorter believes that it competes favorably in each of these areas.
Employees McWhorter employs approximately 791 full- and part-time employees, of which approximately 52 are covered by collective bargaining agreements.
Item 2.
Item 2. Properties
McWhorter's corporate headquarters are located in Carpentersville, Illinois. The Company operates eight plants in the United States and two plants in Italy. All plant facilities are owned, well maintained, and being utilized for their intended purposes and have sufficient capacity to meet their reasonably anticipated needs. Total practical production capacity of McWhorter's plant facilities is approximately 761 million wet pounds per annum. McWhorter has no material encumbrances on its facilities. The following table provides certain additional information regarding McWhorter's properties:
Plant Location Approximate Square Footage Carpentersville, Illinois 224,277 Philadelphia, Pennsylvania 112,653 Forest Park, Georgia 83,875 Lynwood, California 52,899 Ennis, Texas 45,969 Chicago Heights, Illinois 35,510 Columbus, Georgia 30,325 Portland, Oregon 14,995 Cola Di Lazise, Italy 42,642 Sant Albano, Italy 102,640
The joint venture McWhorter Technologies Europe currently consists of three plants, one each located in Sweden, Finland and the United Kingdom.
McWhorter leases from Valspar approximately 30,000 square feet of office and laboratory space in Minneapolis, Minnesota.
Item 3.
Item 3. Legal Proceedings and Environmental Matters
McWhorter is involved in an administrative proceeding with the California Department of Toxic Substances Control ("DTSC"). McWhorter is appealing a Corrective Action Order issued by the DTSC. Because of the subjective nature of the Order's requirements and the pending ruling upon the Order's merits and validity, it is impossible to quantify any potential resulting impact to liabilities.
Other than above, McWhorter is not party to any legal or administrative proceedings, other than routine litigation incidental to the business or involving claims for immaterial amounts.
The operations of McWhorter, like those of other companies in its industry, involve the generation and disposal of substances regulated by the United States Environmental Protection Agency and certain state agencies under various federal and state environmental laws. As a result, McWhorter is involved in various claims relating to environmental and waste disposal matters. These claims generally allege that McWhorter, together with other parties, is responsible under federal and state environmental laws for the remediation of hazardous waste at a particular site. Several of these laws provide that potentially responsible parties may be held jointly and severally liable for investigation and remediation costs regardless of fault. Although McWhorter continually assesses its potential liability with respect to its past and present operations, any potential liability ultimately determined to be attributable to McWhorter is subject to a number of uncertainties, including, among others, the number of parties involved with respect to any given site, the volumetric contribution which may be attributed to McWhorter relative to that attributable to other parties, the nature and magnitude of the wastes involved, and the method and extent of remediation. McWhorter does not believe that any potential liability, either individually or in the aggregate, ultimately determined to be attributable to McWhorter will have a material adverse effect on its business or financial condition.
At October 31, 1997 the estimated amount of probable environmental liability of McWhorter is approximately $3,489,000. Cargill Incorporated (Cargill) has agreed to indemnify McWhorter, subject to certain limitations, for damages resulting from certain environmental matters relating to its former Resin Products Division that was acquired by the Company in 1994. As a result of the probable recovery of $2,289,000 from Cargill, McWhorter's net estimated environmental liability is approximately $1,200,000. There are a total of fifteen sites at which McWhorter believes it has probable environmental liability, including nine sites for which the estimated liability is less than $10,000 per site. The maximum estimated amount of environmental liability attributable to any individual site is approximately $907,000, of which a significant portion is expected to be reimbursed by Cargill. During 1997, McWhorter spent approximately $643,000 on remediation costs, of which $497,000 was spent on projects that were or shall be reimbursed by Cargill. During 1998, McWhorter expects to spend approximately $1,400,000 on remediation costs, of which $1,075,000 is expected to be reimbursed by Cargill. During 1997, McWhorter spent approximately $3,120,000 on capital expenditures to comply with environmental laws and regulations and during 1998 McWhorter expects to spend approximately $4,930,000 on such expenditures.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
There were no matters submitted to a vote of security holders during the fourth quarter of 1997.
PART II
Item 5.
Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters
McWhorter common stock is traded on the New York Stock Exchange under the trading symbol "MWT."
The following table sets forth the high and low bid and ask sales prices for the common stock for fiscal 1997 and 1996. The Company did not declare any cash dividends on its common stock in either fiscal year.
As of December 31, 1997, there were 1,355 holders of record of the common stock. There have been no sales of securities by the Company during the period covered by this report that were not registered under the Securities Act of 1933.
Item 6.
Item 6. Selected Financial Data
(a) Reflects the acquisition of Syntech S.p.A. since the August 1, 1997 acquisition date. (b) McWhorter Technologies, Inc. was formed as a result of the spin-off on April 29, 1994 by the Valspar Corporation of its wholly-owned subsidiary McWhorter Inc., including the Resin Products Division (RPD) of Cargill Incorporated that was acquired by McWhorter on February 18, 1994. The pro forma information does not necessarily reflect what the results for the Company would have been had it been an independent company or had the business of the Company and the RPD business been combined during the pro forma period. (c) Includes a charge of $2,472 pretax, $1,497 after taxes, or $.14 per share, to recognize the impairment in value of the Los Angeles resin facility. This facility was transferred to The Valspar Corporation during the second quarter at the time the Company acquired the Resin Products Division assets of Cargill Incorporated.
Item 7.
Item 7. Management's Discussion and Analysis of Results of Operations and Financial Condition
The following discussion and analysis provides information which management believes is relevant to an assessment and understanding of the consolidated results of operations and financial condition of McWhorter Technologies, Inc. (the "Company" or "McWhorter"). The discussion should be read in conjunction with the consolidated financial statements and notes thereto. Except for historical information contained herein, certain matters set forth in this Annual Report are forward looking statements that involve certain risks and uncertainties that could cause actual results to differ materially from those in the forward looking statements. All references to years are to fiscal years ended October 31 unless otherwise stated.
Overview On August 1, 1997, the Company completed the acquisition of Syntech S.p.A. and its affiliated entities and subsidiaries (Syntech) for $48.3 million in cash and approximately $17.1 million of assumed debt of Syntech. Syntech is an Italian-based resin company with two production facilities in Italy. The cash portion of the purchase consideration was made available from the Company's $150 million credit facility. The acquisition was accounted for under the purchase method and the results of Syntech since the date of acquisition have been included in the consolidated results of the Company. Refer to Note 2 of Notes to Consolidated Financial Statements for discussion on the acquisition of Syntech.
In February 1997, the Company announced plans to construct a 42,000 square foot laboratory facility in Carpentersville, Illinois. The projected cost of this new facility is $6,800,000. The facility is scheduled to open in the spring of 1998. As a result of this project, the Company will be closing the facility that is currently being leased in Minneapolis. Employees from the product development and technical support groups will be relocated to the new facility to serve
McWhorter's Liquid Coatings, Powder Coatings, and Composite Polymer businesses. Approximately 36 employees in Research and Development and Information Technology Services will be impacted by the closing. In total, the Company expects to incur approximately $1,300,000 of pretax charges to operating earnings, 7 cents per share after taxes, related to this move. In 1997, $615,000 has been charged to operations, 4 cents per share after taxes, primarily for costs associated with the estimated amount of termination benefits to be paid to certain employees. The remaining costs to be charged in 1998, primarily in the second quarter, are for costs to be incurred in connection with relocation of existing employees, hiring of new employees, and moving equipment from Minneapolis to Carpentersville.
The Company purchased the equity interest of its joint venture partners in McWhorter Technologies Europe (McWhorter Europe). The purchase occurred in separate transactions during November 1997 and January 1998 for $9,534,000. As a result, the Company increased its equity interest in McWhorter Europe from 33.3 percent to 100 percent.
Results of Operations 1997 vs. 1996 Net sales for 1997 were $331,465,000 compared to $315,925,000 in the prior year. The sales increase of 5 percent was made up of 4 percent from the acquisition of Syntech in August 1997 and a 3 percent volume increase offset by a 2 percent price decrease. Volume increases in the Company's large national customers were offset by loss of low margin industrial toll business and delayed timing of inventory replenishments by certain customers. The Company expects that the global consolidation of McWhorter and Syntech combined with other expansion efforts will result in improved performance in all of the Company's businesses in 1998.
The Company's gross profit margin was 16.3 percent in 1997 compared to 15.4 percent in 1996. The 1997 margins were favorably impacted by an increase of specialty products in the sales mix combined with the continuing focused efforts in the area of process improvements. The Company expects raw material costs to remain relatively stable for 1998 and internal process improvements in the U.S. to continue to favorably impact margins.
Operating expenses (research, selling, general and administrative) were 7.9 percent of sales in 1997 compared to 7.5 percent of sales in 1996. The higher expenses compared to 1996 reflect higher headcount levels and the amortization of costs related to the acquisition of Syntech.
Other expense in 1997 included charges totaling $811,000 (5 cents per share after taxes) for the estimated amount of termination benefits to be paid to employees related to the upcoming relocation of the Minneapolis research facility to Carpentersville in the spring of 1998 and the write-off of a tax-related receivable.
Net interest expense was $2,166,000 in 1997 compared to $1,653,000 last year. This comparison reflects higher debt levels due to the acquisition of Syntech. Excluding the acquisition, interest expense in 1997 was impacted by a reduction in debt of approximately $7,500,000.
The effective tax rate was 38.3 percent in 1997 and 40.5 percent in 1996. The 1997 tax rate reflects the tax benefit of an income tax audit of $591,000 (6 cents per share).
Net income in 1997 was $15,418,000, or $1.47 per share, compared to $13,833,000, or $1.32 per share last year. Excluding the acquisition of Syntech, net income for 1997 was $15,746,000 or $1.50 per share which represents a 14 percent increase over 1996 net income per share.
Results of Operations 1996 vs. 1995 Net sales for 1996 were $315,925,000 compared to $311,398,000 in 1995. Volume increases of 4 percent were partially offset by a 2 percent price decrease. The volume comparison is impacted by the September 1, 1995 acquisition of The Glidden Company's resin producing facility in Columbus, Georgia. On a comparable basis without the acquisition, volume was flat. Volume improved significantly during the second half of 1996. In the fourth quarter of 1996, volume in all businesses was strong. In 1996, the Company experienced a decline in raw material costs which resulted in the lowering of prices across businesses.
The Company's gross profit margin was 15.4 percent in 1996 compared to 13.5 percent in 1995. Declining raw material pricing and ongoing internal process improvements implemented in 1995 led to a significant improvement in gross margin percent in 1996. As a result of the raw material price decreases, the last-in, first-out (LIFO) inventory valuation method had the net effect of decreasing cost of sales by $1,358,000 pretax, $808,000 after taxes, or 8 cents per share, in 1996 compared to 1995 when raw material price increases had the net effect of increasing cost of sales by $1,090,000 pretax, $649,000 after taxes, or 6 cents per share. Such charges increased gross margin percent by .4 percent in 1996 and decreased gross margin percent by .4 percent in 1995.
Operating expenses were 7.5 percent of sales in 1996 compared to 6.8 percent in 1995. Higher expenses compared to 1995 primarily reflected higher costs associated with incentive plans tied to the Company's performance.
In September 1996, the Company completed the joint venture in McWhorter Technologies Europe. This investment is accounted for on the equity method with earnings reflected as a component of other expense (income), net in 1996. The investment did not have a material impact on earnings for 1996.
Net interest expense was $1,653,000 in 1996 compared to $2,310,000 in 1995. This comparison reflects reduced debt levels and lower average borrowing rates.
The effective tax rate was 40.5 percent in 1996 and 1995.
Net income in 1996 was $13,833,000, or $1.32 per share, compared to $11,070,000, or $1.02 per share in 1995. This comparison is impacted by the Company's share repurchase program which had a favorable impact of 5 cents per share in 1996.
Financial Condition In 1997 operations generated cash of $27,583,000 compared to $25,778,000 in 1996. The Company's current ratio was 1.3 at the end of 1997 including the impact of the Syntech acquisition compared to 1.5 at the end of 1996.
Investing activities used cash of $62,402,000 in 1997 compared to $12,417,000 in 1996. The increase primarily relates to the acquisition of Syntech in 1997. In January 1997, the Company made an equity investment of $2,343,000 for a 40 percent equity interest in the newly-formed joint venture, McWhorter Technologies Thailand. Capital expenditures were $11,203,000 in 1997 versus $6,991,000 in 1996. The 1997 capital expenditures were primarily for productivity improvements. Capital spending for 1998 is budgeted to be approximately $25,000,000. The increase from 1997 capital spending is from spending for two large projects, the new research and development facility and the implementation of Enterprise Resource Planning package totaling approximately $10,000,000, and spending for various productivity improvements in Company facilities in Europe of approximately $4,500,000.
Financing activities provided cash of $37,688,000 in 1997 compared to using cash of $14,205,000 in 1996. Total debt increased to $80,858,000 at October 31, 1997 from $23,140,000 a year ago. The increase was primarily due to borrowing to fund the Syntech acquisition, the equity investment in McWhorter Thailand, and the repurchase of 125,222 shares of common stock for treasury stock. Debt as a percentage of invested capital increased to 46.9 percent at October 31, 1997 as a result of the Syntech acquisition from 22.5 percent a year ago.
The Board of Directors of the Company adopted a resolution authorizing the repurchase by the Company of up to an aggregate of 500,000 shares of its common stock over a twelve-month period ending February 1998. As of October 31, 1997, the Company had acquired 139,522 shares at a total cost of $2,919,000. During 1996 and 1995, the Company completed the repurchase of 500,000 shares of its common stock from the 1995 authorization. The total cost of those shares repurchased was $7,194,000.
The Company has a $150,000,000 unsecured revolving credit facility that terminates on July 30, 2002. At October 31, 1997, $95,000,000 was available under this facility. The Company's Italian subsidiary has short-term lines of credit of $32,850,000 of which $18,604,000 is available for future use at October 31, 1997. Historically, while sales for McWhorter have been lowest in the first quarter, monthly fluctuations in working capital have been modest. The credit facility and internally generated funds are expected to be adequate to finance McWhorter's capital expenditures and other operating requirements. Refer to Note 8 of Notes to Consolidated Financial Statements for discussion on the Company's debt.
Refer to Item 3, Legal Proceedings and Environmental Matters and Note 11 of Notes to Consolidated Financial Statements for discussion on environmental liabilities.
Item 8.
Item 8. Financial Statements and Supplementary Data Page
Report of Independent Auditors. . . . . . . . . . . . . . 14
Consolidated Statements of Income for the Years Ended October 31, 1997, 1996 and 1995. . . . . . . . . . . . . 15
Consolidated Balance Sheets as of October 31, 1997 and 1996. . . . . . . . . . . . . . . . . . . . . . . . . 16
Consolidated Statements of Cash Flows for the Years Ended October 31, 1997, 1996 and 1995. . . . . . . . . . 17
Consolidated Statements of Changes in Shareholders' Equity for the Years Ended October 31, 1997, 1996 and 1995 . . . 18
Notes to Consolidated Financial Statements. . . . . .. . . . . 19
REPORT OF INDEPENDENT AUDITORS
To the Shareholders and Board of Directors of McWhorter Technologies, Inc.
We have audited the accompanying consolidated balance sheets of McWhorter Technologies, Inc. and subsidiaries as of October 31, 1997 and 1996, and the related consolidated statements of income, shareholders' equity and cash flows for each of the three years in the period ended October 31, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of McWhorter Technologies, Inc. And Subsidiaries at October 31, 1997 and 1996, and the consolidated results of their operations and their cash flows for each of the three years in the period ended October 31, 1997, in conformity with generally accepted accounting principles.
/s/ Ernst & Young LLP ERNST & YOUNG LLP
Chicago, Illinois November 17, 1997
See Notes to Consolidated Financial Statements
See Notes to Consolidated Financial Statements
The Company's 1995 acquisition spending involved the following:
Fair value of assets acquired $ 8,576 Note issued by seller (6,018)
See Notes to Consolidated Financial Statements
See Notes to Consolidated Financial Statements
See Notes to Consolidated Financial Statements
McWHORTER TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Description of business and basis of presentation The Company operates in one business segment, the manufacture and distribution of resin used in coatings and composite polymer industries, and sells primarily to customers located in North America and Western Europe.
The consolidated financial statements include the accounts of the parent company and its subsidiaries (refer to Note 2 - - Acquisition). Investments in 50 percent or less owned companies and joint ventures are carried on the equity basis with the Company's share of earnings reflected as a component of other expense (income), net. All significant intercompany accounts and transactions are eliminated in consolidation.
Use of estimates The preparation of the financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.
Inventories Inventories are stated at the lower of cost or market. At October 31, 1997, costs are recorded on the last-in, first-out (LIFO) method for approximately 76 percent of the inventories, and on a first-in, first-out (FIFO) method for the remainder. At October 31, 1996 costs are recorded on the LIFO method for all inventories.
Property, plant and equipment Property, plant and equipment are recorded at cost. Depreciation is based upon estimated useful lives of 10 to 40 years for buildings and 3 to 15 years for machinery and equipment, using primarily the straight-line method.
Intangible assets Intangible assets are recorded at cost. Amortization is recorded using the straight line method over 40 years for goodwill and over 15 years for other intangible assets.
Stock-based compensation The Company accounts for stock-based compensation plans under the provisions of Accounting Principles Board Opinion No. 25 (APB No. 25). Refer to Note 13 for disclosures required by Statement of Financial Accounting Standard (SFAS) No. 123, "Accounting for Stock-based Compensation".
Net income per share Net income per common share amounts were computed on the basis of the weighted average number of common and common equivalent shares outstanding. Such weighted average shares used in the computations were 10,492,875 in 1997; 10,484,279 in 1996; and 10,878,326 in 1995.
In February 1997, the Financial Accounting Standards Board issued SFAS No. 128, "Earnings Per Share". SFAS No. 128, which is effective for financial statements issued for periods ending after December 15, 1997, specifies the computation, presentation, and disclosure requirements for earnings
per share. The Company will adopt SFAS No. 128 in fiscal 1998. The difference between basic and diluted earnings per share, as defined by SFAS No. 128, would not be material for fiscal years 1997, 1996, and 1995.
Translation of foreign currencies Assets and liabilities of foreign subsidiaries are translated at the exchange rate in effect at the balance sheet date while the income and expenses are translated at the average exchange rates prevailing during the year. The related translation adjustments are reflected as a separate component of stockholder's equity. Gains and losses resulting from foreign currency transactions denominated in a currency other than the entity's functional currency are included in net income.
Long-lived assets In 1997, the Company adopted SFAS No. 121 "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets of be Disposed Of". Accordingly, when indicators of impairment are present, the Company evaluates the carrying value of property, plant & equipment and intangibles in relation to the future undiscounted cash flows of the underlying businesses. Adoption of the standard had no impact on the 1997 financial statements.
NOTE 2 - ACQUISITION
On August 1, 1997, the Company completed the acquisition of Syntech S.p.A. and its affiliated entities and subsidiaries (Syntech) for $48.3 million in cash and approximately $17.1 million of assumed debt of Syntech. Syntech is an Italian based resin company with two production facilities in Italy. The cash portion of the purchase consideration was made available from the Company's $150 million credit facility.
The acquisition was accounted for under the purchase method and the results of Syntech since the date of acquisition have been included in the consolidated results of the Company. The excess of purchase price over the net book value of assets was approximately $30.8 million, the largest component of which was allocated to goodwill. Since the acquisition was recently completed, finalization of the allocation of the purchase price is subject to completion.
The pro forma results below are unaudited and reflect the purchase price accounting adjustments assuming the acquisition occurred at the beginning of each year presented.
NOTE 3 - INVENTORIES
The major classes of inventories consist of the following:
Inventories stated at cost as determined by the LIFO method are approximately $2,276,000 and $2,151,000 lower at October 31, 1997 and 1996, respectively, than such costs determined under the FIFO method. In 1997, the LIFO valuation method had the net effect of decreasing pretax income as compared to the FIFO method by $125,000, $74,000 after taxes, or $.01 per share. In 1996, the LIFO valuation method had the net effect of increasing pretax income as compared to the FIFO method by $1,358,000, $808,000 after taxes, or $.08 per share. This was due to the impact of declining raw material costs in 1996 versus 1995. In 1995, the LIFO valuation method had the net effect of decreasing pretax income as compared to the FIFO method by $1,090,000, $649,000 after taxes, or $.06 per share. The pretax impact of raw material cost increases of $3,062,000 was partially offset by the $1,972,000 pretax effect of a partial inventory liquidation in 1995.
NOTE 4 - PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment classifications are as follows:
Depreciation expense for 1997, 1996, and 1995 was $9,962,000, $9,002,000, and $7,825,000, respectively.
NOTE 5 - INTANGIBLES
Intangibles, net include the following:
NOTE 6 - OTHER ASSETS
Other assets include the following:
NOTE 7 - ACCRUED LIABILITIES
Accrued liabilities include the following:
NOTE 8 - DEBT
Long-term debt consists of the following:
The Company has $150,000,000 available under a revolving credit facility that enables the Company to borrow funds on an unsecured basis. Under the terms of the agreement, interest rates are determined at the time of borrowing and are based on London Interbank Offered Rates (5.7% at October 31, 1997) plus an applicable margin up to .575% or other alternative rates. The weighted average interest rate at October 31, 1997 was 5.9%. This facility terminates on July 30, 2002. At October 31, 1997, borrowings totaling $55,000,000 were outstanding under this agreement all of which were classified with long-term debt as they are supported by the long-term credit facility and will continue to be refinanced beyond October 31, 1998. The 11% note payable was obtained under the Government of Italy's incentive program and is secured by a lien on the assets acquired with proceeds of the note. The mortgage loans are guaranteed by mortgages on certain property and equipment.
The aggregate payments of long-term debt outstanding for the next five years and thereafter, excluding revolving credit borrowings, are $4,060,000 in 1998, $1,016,000 in 1999, $359,000 in 2000, $298,000 in 2001, $204,000 in 2002, and $275,000 thereafter.
In addition, the Company had $5,400,000 outstanding at October 31, 1997, under an overnight credit facility with a weighted average interest rate of 6.1%. The Company's Italian subsidiary has short-term lines of credit that are cancellable at any time of $32,850,000, at weighted average interest of 6.5%, of which $14,246,000 is outstanding at October 31, 1997.
Interest paid during 1997, 1996, and 1995 was $2,146,000, $1,725,000 and $2,261,000, respectively.
At October 31, 1997 the Company had outstanding $3,977,000 in unissued letters of credit.
The carrying value of the Company's debt approximates fair value at October 31, 1997.
NOTE 9 - LEASE COMMITMENTS
The Company leases an industrial site (plant and equipment) in Italy under a capital lease agreement. The lease agreement provides the Company with a bargain purchase option at lease expiration in 1999 and the Company intends to exercise this option. Included in property, plant, and equipment as of October 31, 1997 are the following assets held under this capital lease:
Amortization of leased assets is included in depreciation and amortization and in accumulated depreciation. Total capital lease obligation at October 31, 1997, including current portion of $605,000, is $1,083,000. Total future minimum payments under the capital lease, including interest of $144,000, is $1,227,000, payable $726,000 in 1998 and $501,000 in 1999.
NOTE 10 - INCOME TAXES
The components of the provision for income taxes are as follows:
Income taxes paid during 1997, 1996 and 1995 were $8,416,000, $5,315,000, and $3,227,000, respectively.
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's deferred tax assets and liabilities are as follows:
The principal items comprising the difference between income tax expense computed at the Federal statutory rate and the actual provision for income taxes are as follows:
Income tax expense for 1997 was impacted by a tax benefit of $591,000 ($.06 per share) that resulted from the conclusion of an income tax audit for the period prior to the Company's spin-off from the Valspar Corporation.
NOTE 11 - ENVIRONMENTAL LIABILITIES
With respect to environmental liabilities, management reviews each individual site, taking into consideration the numerous factors that influence the costs that will likely be incurred. Based on these reviews, McWhorter accrues for potential environmental liabilities. Reserves are adjusted as additional information becomes available to better estimate the total remediation costs at individual
sites. While uncertainties exist with respect to the amounts and timing of McWhorter's ultimate environmental liabilities, management believes that such costs, individually and in the aggregate, will not have a material adverse effect on the Company's financial condition or results of operations.
Relating to Company plants located in Philadelphia, Pennsylvania; Portland, Oregon; and Carpentersville, Illinois; the Company has been named a potentially responsible party for the remediation of independently operated waste disposal sites previously used by these plants.
At October 31, 1997 the estimated amount of probable environmental liability of the Company is approximately $3,489,000. Cargill Incorporated has agreed to indemnify the Company, subject to certain limitations, for damages resulting from environmental matters relating to its former Resin Products Division that was acquired by the Company in 1994. As a result of the probable recovery of $2,289,000 from Cargill, the Company's net estimated environmental liability is approximately $1,200,000.
NOTE 12 - RETIREMENT BENEFIT PROGRAMS
In February 1994, McWhorter adopted an Employee Stock Ownership Plan (ESOP) and an Employee Savings Plan. These primary retirement benefit programs are defined contribution plans covering the majority of the employees. The total costs of the ESOP were $1,557,000, $1,556,000 and $570,000 in 1997, 1996, and 1995, respectively. The total costs of the Employee Savings Plan were $568,000, $515,000 and $457,000 in 1997, 1996, and 1995, respectively. Contributions are made to the ESOP at the rate of 4 percent of each participant's compensation and additional contributions can be made at the Company's discretion.
The Company also sponsors a defined benefit plan for certain hourly employees. The related pension costs and obligations are not material.
The Company also has a nonqualified deferred compensation plan which permits key employees to defer certain portions of their compensation. Such compensation is fully vested at the time of the contribution. The Company can also make discretionary contributions to the plan which vest upon the completion of 5 years employment. Deferred compensation liability at the end of 1997 was $532,000. The Company established an irrevocable rabbi trust in 1997 to fund this plan. The value of the assets in the trust at October 31, 1997 was $657,500.
The Company accrues for its Italian employees benefits in accordance with Italian statutes. Such benefits are based on length of service, employment category, and remuneration and are payable when an employee leaves the Company. The liability recorded in the balance sheet is the amount to which the employee is entitled for services rendered to date. Amounts charged to expense in 1997 were $52,000.
NOTE 13 - STOCK PLANS
The Company's two stock incentive plans adopted in 1994 and 1996 provide for the granting of options and the issuance of restricted stock, deferred stock and stock appreciation rights of up to 1,050,000 shares of common stock, of which 351,331 shares are available for future grants. Options
issued to date under these plans have a term of ten years and become fully vested over a period of up to five years. Outstanding options will expire over a period ending no later than August 20, 2007.
A summary of stock option activity for the 1994 and 1996 Stock Incentive Plans follows:
Under APB No. 25, because the exercise price of the Company's employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized. The impact on 1997 and 1996 net income and earnings per share under the fair value method required by SFAS No. 123 would have been immaterial based upon fair value at the date of grant for awards granted in 1997 and 1996. The fair value at the date of grant was determined using the assumptions below. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion the existing models do not provide a reliable single measure of the value of the employee stock options.
The exercise price for the options outstanding as of October 31, 1997 ranged from $13.78 to $24.69 with a weighted average remaining contractual life of 7.4 years segregated as follows:
Restricted stock performance awards have been granted to key officers under the 1994 plan. These restricted stock awards will vest only if the Company achieves certain financial goals over a five-year performance period. Restricted shares granted under the plan were 7,493 in 1997 at market value of $22.75 and 94,354 in 1995 at market value of $15.50. The awards were recorded at the market value of the shares at the time the shares were awarded. The total market value of the shares will be charged to compensation expense based on achievement of the related financial goals. After comparing the Company's performance to the financial goals, $250,000 was charged to expense in 1997 and in 1996 and no expense was recorded in 1995.
The Company also issued 1,500, 1,483, and 10,541 restricted and deferred shares in 1997, 1996 and 1995, respectively, with vesting periods of up to three years. Amounts charged to expense were $30,000 in 1997, $22,000 in 1996, and $159,000 in 1995.
In 1996 the Company also established the 1996 Nonemployee Director Stock Option and Award Plan (the "1996 Directors' Plan"). The 1996 Directors' Plan provides for the issuance of up to 50,000 shares of the Company's common stock of which 40,115 shares are available for future grants. Participation in the 1996 Directors' Plan is limited to members of the Board of Directors of the Company who are not salaried officers or employees of the Company or any of its direct or indirect subsidiaries. Deferred stock awards granted under this plan were 3,814 and 6,071 in 1997 and 1996, respectively, and amounts charged to expense were $93,000 and $110,000 in 1997 and 1996, respectively.
Each outstanding common share includes a right to purchase one one-hundredth share of Series A Junior Preferred Participating Stock (Preferred Stock) under certain circumstances. Until exercisable, the rights are not separable from the underlying common shares. The rights only become exercisable if a person or group (an "acquiring person") acquires, or makes an offer to acquire, 15 percent or more of the Company's common stock without the prior approval of the Company's Board of Directors. The exercise price of each right is $70. If someone becomes an acquiring person, the holder of each right (other than the acquiring person) will be entitled to purchase common stock of
the Company having a value of twice the exercise price of the right. In addition, if the Company is acquired in a transaction in which the Company's common stock is exchanged for cash or securities or more than 50 percent of its consolidated assets or earnings power are sold, each holder (other than the acquiring person) will have the right to purchase common stock of the acquiring company having a market value of twice the exercise price of the right. The rights may be redeemed by the Company at the price of $.01 per right at any time prior to anyone becoming an acquiring person. 150,000 shares of Preferred Stock are reserved for issuance upon exercise of the rights. The Preferred Stock is nonredeemable, with a $100 liquidation preference and 100 votes per share, and is entitled to 100 times the per share dividends on the common stock.
NOTE 14 - CONTINGENCIES
The Company is involved in various legal actions arising in the normal course of business. Management, after taking into consideration legal counsel's evaluation of such actions, is of the opinion that the outcome of these matters will not have a material adverse effect on the Company's financial position.
NOTE 15 - GEOGRAPHIC SEGMENTS INFORMATION
The Company's operations include foreign subsidiaries beginning in August 1997. Prior to that, all the Company's facilities were in the United States. Inter-geographic sales are not significant. In 1997, the Company operated facilities in the United States and Europe. Sales, operating income, and identifiable assets for the European operations in 1997 were 3 percent, 3 percent, and 35 percent of the respective totals.
NOTE 16 - OTHER EXPENSE
Other expense (income), net includes second quarter charges of $811,000 ($.05 per share after taxes) related to costs, primarily severance, pursuant to Company's decision to relocate its research facility from Minneapolis to Carpentersville and the write-off of a tax-related receivable.
NOTE 17 - QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
(a) See Note 16 of Notes to Consolidated Financial Statements (b) Reflects the acquisition of Syntech S.p.A. since the August 1, 1997 acquisition date
Item 9.
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
Inapplicable.
PART III
Item 10.
Item 10. Directors and Executive Officers of the Registrant
(a) Identification of Directors Incorporated by reference from pages 2-4 of the Proxy Statement section entitled "Election of Directors."
(b) Identification of Executive Officers Set forth below are the names, ages and titles of the persons who serve as executive officers of McWhorter:
Name Age Positions John R. Stevenson 55 Chairman and Chief Executive Officer Jeffrey M. Nodland 42 President and Chief Operating Officer Patrick T. Heffernan 48 Senior Vice President, Coatings Resins Kevin W. Brolsma 43 Vice President, Acquisitions Integration/ Environmental, Health and Safety Douglas B. Rahrig 46 Vice President, Technology Louise M. Tonozzi-Frederick 41 Vice President, Chief Financial Officer and Secretary
JOHN R. STEVENSON is Chairman and Chief Executive Officer of the Company. Prior to being named in January 1997 to his current position, Mr. Stevenson was President and Chief Executive Officer of the Company beginning in February 1994. Previously he held the position of Vice President, Special Products Group and Administration of Valspar beginning in August 1992 and Vice President, Administration of Valspar beginning in February 1991.
JEFFREY M. NODLAND is President and Chief Operating Officer of the Company. Prior to being named in January 1997 to his current position, Mr. Nodland was Executive Vice President, Chief Operating Officer, and Secretary of the Company beginning in May 1995. Previously he held the position of Senior Vice President, Chief Financial Officer, Secretary, and Treasurer of the Company beginning in February 1994, and President of McWhorter, Inc. beginning in June 1991.
PATRICK T. HEFFERNAN is Senior Vice President, Coatings Resins of the Company. Prior to being named in February 1994 to his current position, Mr. Heffernan was an Assistant Vice President and General Manager of the Midwest Region of the Resin Products Division of Cargill beginning in January 1986. Mr. Heffernan held various positions with Cargill since January 1968.
KEVIN W. BROLSMA is Vice President, Acquisitions Integration/Environment, Health and Safety of the Company. Prior to being named in August 1997 to his current position, Mr. Brolsma was Vice President, Powder of the Company beginning in May 1996 and Vice President, Operations of the Company beginning in February 1994. Previously he was the General Manager of the Southeast Region of the Resin Products Division of Cargill beginning in January 1990. From January 1988 to January 1990, Mr. Brolsma was the National Accounts Manager and General Sales Manager of the Resin Products Division.
DOUGLAS B. RAHRIG is Vice President, Technology of the Company. Prior to being named in February 1994 to his current position, Dr. Rahrig was Department Manager of the Technology Department of S.C. Johnson & Son, Inc. beginning in February 1993. Dr. Rahrig held various technical and management positions with S.C. Johnson & Son, Inc. since 1985.
LOUISE M. TONOZZI-FREDERICK is Vice President, Chief Financial Officer and Secretary of the Company. Prior to being named in September 1996 to her current position, Ms. Tonozzi-Frederick was Treasurer and Controller beginning in May 1995. Previously, she was Controller beginning in May 1994, and prior to then was associated with Mallinkrodt Group, Inc. for seven years in various financial positions, most recently as Assistant Controller.
Item 11.
Item 11. Executive Compensation
Incorporated by reference from pages 6-8 of the Proxy Statement section entitled "Executive Compensation."
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management
Incorporated by reference from pages 4-6 of the Proxy Statement section entitled "Security Ownership of Certain Beneficial Owners."
Item 13.
Item 13. Certain Relationships and Related Transactions
Incorporated by reference from pages 2-8 of the Proxy Statement sections entitled "Election of Directors," "Security Ownership of Certain Beneficial Owners" and "Executive Compensation."
PART IV
Item 14.
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a)(1) Financial Statements commence on page 13. (2) Financial Statement Schedules. All schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions or are inapplicable and therefore have been omitted. (3) Exhibits:
EXHIBIT 21.1 - Subsidiaries of the Registrant
McWhorter Holdings Ltd. (United Kingdom) McWhorter Technologies Sales Corporation ( Bermuda) McWhorter Technologies, S.p.A. (Italy) Syntech France S.a.r.l.
EXHIBIT 23.1 - Consent of Independent Auditors
We consent to the incorporation by reference in the Registration Statements (Form S-8 Nos. 33-78412 and 333-4540) pertaining to the McWhorter Technologies, Inc. 1994 Stock Incentive Plan, McWhorter Technologies, Inc. Employee 401(k) Savings Plan, McWhorter Technologies, Inc. 1996 Incentive Stock Plan and McWhorter Technologies, Inc. 1996 Nonemployee Director Stock Option and Award Plan of our report dated November 17, 1997, with respect to the consolidated financial statements of McWhorter Technologies, Inc. included in the Annual Report (Form 10-K) for the year ended October 31, 1997.
/s/ Ernst & Young ERNST & YOUNG
Chicago, Illinois January 27, 1998