-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, GIhIMgIbXPaXs7WFKcJ4VH96r5Uz/z8YZQFsIYc/+BsAwW0h+LZfuQmocBUtlkLl LhESn8N+2pG9ePmUYNMwzA== 0000950132-99-000501.txt : 19990513 0000950132-99-000501.hdr.sgml : 19990513 ACCESSION NUMBER: 0000950132-99-000501 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19990328 FILED AS OF DATE: 19990512 FILER: COMPANY DATA: COMPANY CONFORMED NAME: PALEX INC CENTRAL INDEX KEY: 0001029448 STANDARD INDUSTRIAL CLASSIFICATION: MILLWOOD, VENEER, PLYWOOD & STRUCTURAL WOOD MEMBERS [2430] IRS NUMBER: 760520673 STATE OF INCORPORATION: DE FISCAL YEAR END: 1130 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-22237 FILM NUMBER: 99618208 BUSINESS ADDRESS: STREET 1: 1360 POST OAK BLVD STE 800 CITY: HOUSTON STATE: TX ZIP: 77056 BUSINESS PHONE: 7133506030 FORMER COMPANY: FORMER CONFORMED NAME: PAL EX INC DATE OF NAME CHANGE: 19961220 10-Q 1 FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDING MARCH 28, 1999 OR [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ________ TO________ COMMISSION FILE NUMBER: 000-22237 PALEX, INC. (Exact name of Registrant as specified in its charter) DELAWARE 76-0520673 (STATE OF OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NO.) INCORPORATION) OR ORGANIZATION) 6829 FLINTLOCK ROAD HOUSTON, TEXAS 77040 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: 713-332-6145 Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to filed such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [_] The number of shares of Common Stock of the Registrant, par value $.01 per share, outstanding at May 5, 1999 was 19,578,609. 1 PALEX, INC. FORM 10-Q FOR THE QUARTERLY PERIOD ENDED MARCH 28, 1999 INDEX PART I -- FINANCIAL INFORMATION ITEM 1 -- FINANCIAL STATEMENTS General Information................................................................................... 3 Consolidated Balance Sheets -- PalEx, Inc. and Subsidiaries as of December 27, 1998 and March 28, 1999.................................................................................. 4 Consolidated Statements of Income -- PalEx, Inc. and Subsidiaries for the Three Month Periods Ended March 29, 1998 and March 28, 1999.................................................................... 5 Consolidated Statements of Comprehensive Income -- PalEx, Inc. and Subsidiaries for the Three Month Periods Ended March 29, 1998 and March 28, 1999...................................................... 6 Consolidated Statement of Changes in Stockholders' Equity -- PalEx, Inc. and Subsidiaries for the Three Month Period Ended March 28, 1999.............................................................. 7 Consolidated Statements of Cash Flows -- PalEx, Inc. and Subsidiaries for the Three Month Periods Ended March 29, 1998 and March 28, 1999.............................................................. 8 Notes to the Consolidated Financial Statements........................................................ 9 Item 2 -- Management's Discussion and Analysis of Financial Condition and Results of Operations............................................................................ 16 Part II -- Other Information Item 1 -- Legal Proceedings........................................................................... 21 Item 2 -- Recent Sales of Unregistered Securities..................................................... 23 Item 6 -- Exhibits and Reports on Form 8-K............................................................ 23 Signature............................................................................................. 24
2 PALEX, INC. PART I -- FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS GENERAL INFORMATION PalEx, Inc. ("PalEx" or the "Company") was founded in January 1996 to create a national provider of pallet products and related services. On March 25, 1997, concurrently with the closing of the initial public offering (the "Offering") of its Common Stock, par value $.01 per share (the "Common Stock"), PalEx acquired the following three businesses in separate transactions (the "Acquisitions"): Fraser Industries, Inc. ("Fraser"), Ridge Pallets, Inc. ("Ridge") and Interstate Pallet Co., Inc. ("Interstate" and, together with Fraser and Ridge, collectively referred to as the "Founding Companies"). The consideration for the Acquisitions of the Founding Companies consisted of a combination of cash and Common Stock. Fraser has been identified as the accounting acquiror for financial statement presentation purposes. The acquisitions of Ridge and Interstate were accounted for using the purchase method of accounting. Subsequent to the acquisition of the Founding Companies and the Offering and during fiscal 1997, PalEx acquired five additional companies. Sheffield Lumber & Pallet Company, Inc. ("Sheffield"), Sonoma Pacific Company ("Sonoma"), Bay Area Pallet Company ("Bay Area") and New London Pallet, Inc. ("New London") were accounted for as poolings-of-interests (the "Pooled Companies"). The fifth acquisition, Summers Pallet Manufacturing, Inc. ("Summers"), was accounted for as a purchase. During fiscal 1998, the Company acquired 19 additional companies, four of which, Acme Barrel Company, Inc. ("Acme"), Drum Service Co. of Florida ("DSF"), Consolidated Container Corporation ("CCC") and Western Container, LLC ("Western") were accounted for as poolings-of-interests (the "1998 Pooled Companies"). The other fifteen companies, Consolidated Drum Reconditioning, Inc. ("CDR"), American Pallet Recyclers ("APR"), Capital Pallet Company ("Capital"), Pallet Outlet Company, Inc. ("POC"), Southern Pallet Company ("Southern"), Shipshewana Pallet Co., Inc. ("Shipshewana"), Gilbert Lumber, Inc. ("Gilbert"), Valley Pallets, Inc. ("Valley"), Duckert Pallet Co., Inc. ("Duckert"), Continental Pallet Company ("Continental"), Isaacson Lumber Company ("Isaacson"), McCook Drum & Barrel Co., Inc. ("McCook"), Superior Management Group Corporation ("SMG"), Charlotte Steel Drum Corporation ("CSD") and Atlas Container Company, Inc. ("Atlas") were accounted for as purchases (the "1998 Purchased Companies" and, together with Summers, the "Purchased Companies"). Eight of the 19 companies acquired after fiscal 1997 are engaged in the reconditioning and rebuilding of industrial steel containers. SMG is engaged in the rental, sale, repair and retrieval of pallets in Canada. The Company made no acquisitions during the three month period ended March 28, 1999. Unless the context otherwise requires, all references herein to the Company include PalEx, the Founding Companies, the Pooled Companies, the 1998 Pooled Companies and the Purchased Companies. Operating results for interim periods are not necessarily indicative of the results for full years. The financial statements included herein should be read in conjunction with the related notes thereto and management's discussion and analysis and the Consolidated Financial Statements of PalEx, Inc. and Subsidiaries as of December 27, 1998 and related notes thereto as filed with the Securities and Exchange Commission with the Company's Form 10-K on March 29, 1999. 3 PALEX, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE DATA)
DECEMBER 27, MARCH 28, 1998 1999 ------------ ------------ (UNAUDITED) ASSETS CURRENT ASSETS: Cash and cash equivalents................................................ $ 4,157 $ 5,623 Accounts receivable, net of allowance of $1,616 and $1,301............... 44,543 50,533 Inventories.............................................................. 29,986 28,550 Deferred income taxes.................................................... 2,105 1,826 Prepaid expenses and other current assets................................ 4,427 6,089 -------- -------- Total current assets................................................... 85,218 92,621 PROPERTY, PLANT AND EQUIPMENT, net....................................... 75,724 76,087 GOODWILL, net of accumulated amortization of $3,570 and $4,655........... 127,234 126,830 OTHER ASSETS............................................................. 4,262 4,334 -------- -------- Total assets........................................................... $292,438 $299,872 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Current maturities of long-term debt..................................... $ 1,960 $145,460 Current maturities of convertible notes payable to related parties....... - 7,224 Bank overdraft........................................................... 8,407 7,852 Accounts payable......................................................... 9,004 10,850 Accrued expenses......................................................... 10,646 11,391 Income taxes payable..................................................... 529 1,462 -------- -------- Total current liabilities.............................................. 30,546 184,239 LONG-TERM DEBT, net of current maturities................................ 143,902 2,345 CONVERTIBLE NOTES PAYABLE TO RELATED PARTIES, net of current maturities.. 9,910 2,788 DEFERRED INCOME TAXES.................................................... 5,350 5,127 FOREIGN DEFERRED INCOME TAXES............................................ 3,957 3,957 OTHER LONG-TERM LIABILITIES.............................................. 3,493 3,345 COMMITMENTS AND CONTINGENCIES............................................ STOCKHOLDERS' EQUITY: Preferred stock $.01 par value, 5,000,000 shares authorized, no shares issued.................................................................. - - Common stock, $.01 par value, 30,000,000 shares authorized, 20,289,091 and 20,299,341 outstanding.............................................. 203 203 Additional paid-in capital............................................... 79,030 79,107 Unearned compensation.................................................... (1,770) (1,770) Accumulated other comprehensive (loss) income: Foreign currency translation adjustment.............................. (623) 98 Retained earnings........................................................ 18,440 20,433 -------- -------- 95,280 98,071 -------- -------- Total liabilities and stockholders' equity............................. $292,438 $299,872 ======== ========
The accompanying notes are an integral part of these consolidated financial statements. 4 PALEX, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) (UNAUDITED)
THREE MONTH PERIOD ENDED ------------------------------- MARCH 29, 1998 MARCH 28, 1999 -------------- --------------- REVENUES................................................................... $ 68,970 $ 96,388 COST OF GOODS SOLD......................................................... 56,370 77,392 ----------- ----------- Gross profit............................................................. 12,600 18,996 SELLING, GENERAL AND ADMINISTRATIVE EXPENSES............................... 6,580 10,482 GOODWILL AMORTIZATION...................................................... 342 1,085 POOLING EXPENSES........................................................... 1,651 - COMPENSATION DIFFERENTIAL.................................................. 1,062 - ----------- ----------- Income from operations................................................... 2,965 7,429 INTEREST EXPENSE........................................................... (937) (3,540) OTHER INCOME (EXPENSE), NET................................................ 7 (191) ----------- ----------- INCOME BEFORE INCOME TAXES................................................. 2,035 3,698 PROVISION FOR INCOME TAXES................................................. 875 1,705 ----------- ----------- NET INCOME................................................................. $ 1,160 $ 1,993 =========== =========== NET INCOME PER SHARE-BASIC................................................. $ .06 $ .10 NET INCOME PER SHARE-DILUTED............................................... $ .06 $ .10 Shares used in computing net income per share - basic...................... 17,920,864 20,291,619 Shares used in computing net income per share - diluted.................... 18,376,703 20,349,341
The accompanying notes are an integral part of these consolidated financial statements. 5 PALEX, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (IN THOUSANDS) (UNAUDITED)
THREE MONTH PERIOD ENDED ------------------------------ MARCH 29, 1998 MARCH 28, 1999 -------------- -------------- Net income................................ $1,160 $1,993 Other comprehensive income: Foreign currency translation adjustment... - 721 ------ ------ Comprehensive income $1,160 $2,714 ====== ======
The accompanying notes are an integral part of these consolidated financial statements. 6 PALEX, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (IN THOUSANDS) (UNAUDITED)
ACCUMULATED COMMON STOCK CAPITAL IN OTHER TOTAL EXCESS OF UNEARNED RETAINED COMPREHENSIVE STOCKHOLDERS' SHARES AMOUNT PAR VALUE COMPENSATION EARNINGS (LOSS) INCOME EQUITY ------------ ---------- --------- ------------- -------- -------------- ------------- BALANCE, December 27, 1998......... 20,289 $203 $79,030 $(1,770) $18,440 $(623) $95,280 Exercise of stock options.......... 10 - 77 - - - 77 Foreign currency translation adjustment........................ - - - - - 721 721 Net income......................... - - - - 1,993 - 1,993 ------ ---- ------- ------- ------- ----- ------- BALANCE, March 28, 1999............ 20,299 $203 $79,107 $(1,770) $20,433 $ 98 $98,071 ====== ==== ======= ======= ======= ===== =======
The accompanying notes are an integral part of these consolidated financial statements. 7 PALEX, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS) (UNAUDITED)
THREE MONTH PERIOD ENDED ---------------------------------- MARCH 29, 1998 MARCH 28, 1999 ---------------- ---------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income................................................................. $ 1,160 $ 1,993 Adjustment to conform fiscal year-end of Pooled Companies.................. (470) - Adjustments to reconcile net income to net cash provided by (used in) operating activities -- Depreciation and amortization............................................. 2,012 3,689 Deferred income taxes..................................................... 108 56 (Gain) loss on sale of assets............................................. (22) 14 Changes in operating assets and liabilities -- Accounts receivable.................................................... (3,594) (5,777) Inventories............................................................ (2,883) 1,509 Other current assets................................................... 95 (1,657) Accounts payable and accrued expenses.................................. 2,159 2,897 Other assets and liabilities........................................... 345 (308) -------- -------- Net cash (used in) provided by operating activities....................... (1,090) 2,416 -------- -------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of property, plant and equipment................................. (2,194) (2,986) Proceeds from sale of equipment............................................ 105 52 Payments for adjustments to purchase price of certain Purchased Companies.. - (126) Cash paid for business acquisitions, net of cash acquired.................. (51,753) - -------- -------- Net cash used in investing activities..................................... (53,842) (3,060) -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES: Net repayments on line of credit........................................... (1,150) - Proceeds from long-term debt............................................... 72,950 12,052 Payments on long-term debt................................................. (21,015) (10,007) Net proceeds from exercise of stock options................................ - 77 Purchase of minority interest in pooled company............................ (480) - -------- -------- Net cash provided by financing activities................................. 50,305 2,122 -------- -------- EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS................ - (12) -------- -------- NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS........................ (4,627) 1,466 CASH AND CASH EQUIVALENTS -- beginning of period............................ 7,448 4,157 -------- -------- CASH AND CASH EQUIVALENTS -- end of period.................................. $ 2,821 $ 5,623 ======== ======== SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid for -- Interest.................................................................. $ 611 $ 2,833 Income taxes.............................................................. $ 274 $ 776
The accompanying notes are an integral part of these consolidated financial statements. 8 PALEX, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 28, 1999 (UNAUDITED) 1. BASIS OF PRESENTATION PalEx, Inc. ("PalEx" or the "Company") was founded in January 1996 to create a nationwide provider of pallet products and related services. On March 25, 1997, concurrently with the closing of PalEx's initial public offering (the "Offering") of its common stock, par value $.01 per share (the "Common Stock"), PalEx and separate wholly owned subsidiaries of PalEx acquired, in separate transactions (the "Acquisitions"), the following three businesses: Fraser Industries, Inc. ("Fraser"), Ridge Pallets, Inc. ("Ridge"), and Interstate Pallet Co., Inc. ("Interstate"), collectively referred to as the "Founding Companies." The consideration for the acquisitions of the Founding Companies consisted of a combination of cash and Common Stock. Subsequent to the acquisition of the Founding Companies and the Offering and during fiscal 1997, PalEx acquired five additional companies, four of which were accounted for as poolings-of-interests (the "Pooled Companies"). The fifth acquisition, Summers Pallet Manufacturing, Inc. ("Summers"), was accounted for as a purchase. During fiscal 1998, the Company acquired 19 additional companies, four of which, Acme Barrel Company, Inc. ("Acme"), Drum Service Co. of Florida ("DSF"), Consolidated Container Corporation ("CCC") and Western Container, LLC ("Western") were accounted for as poolings-of-interests (the "1998 Pooled Companies"). The remainder were accounted for as purchase accounting transactions (the "1998 Purchased Companies"). Eight of the 19 companies are engaged in the reconditioning and rebuilding of industrial steel containers. One is engaged in the rental of pallets in Canada. The Company's headquarters are in Houston, Texas, with significant manufacturing operations located in Arkansas, California, Florida, Georgia, Illinois, North Carolina, Ohio, Pennsylvania, Texas and Wisconsin and pallet leasing operations in seven Canadian provinces. Sales are made throughout the United States and Canada with significant concentrations in the southeastern, midwestern and western regions of the United States. The Company primarily serves agricultural and industrial customers. Revenues related to the agricultural customers are highly seasonal, occurring primarily during the harvesting season. Fraser has been identified as the accounting acquiror for financial statement presentation purposes. The acquisitions of Ridge, Interstate and Summers, and the 1998 Purchased Companies were accounted for using the purchase method of accounting. The purchase prices have been allocated based upon the estimated fair value of the assets and liabilities acquired. The Company evaluates on a regular basis whether events and circumstances have occurred that would warrant changes in those estimates. The accompanying consolidated financial statements present Fraser combined with the Pooled Companies and the 1998 Pooled Companies for the periods presented, and those companies accounted for as purchases from their respective dates of acquisition. All significant intercompany transactions and balances have been eliminated in consolidation. The accompanying unaudited consolidated financial statements are prepared pursuant to the rules and regulations for reporting on Form 10-Q. Accordingly, certain information and footnotes required by generally accepted accounting principles for complete financial statements are not included herein. The Company believes all adjustments necessary for a fair presentation of these interim statements have been included and are of a normal and recurring nature. The interim statements should be read in conjunction with the Consolidated Financial Statements of PalEx, Inc. and Subsidiaries as of December 27, 1998 and 9 related notes thereto as filed with the Securities and Exchange Commission on the Company's Form 10-K on March 29, 1999. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The Company maintains its accounting records using a 52/53-week year ending on the last Sunday in December. Each quarter contains 13 weeks, unless otherwise noted. There has been no significant change in the accounting policies of the Company during the periods presented. For a description of these policies, refer to Note 2 of Notes to Consolidated Financial Statements of PalEx, Inc. and Subsidiaries as filed with the Company's Form 10-K on March 29, 1999. 3. LONG TERM DEBT Amended Credit Facility On March 25, 1997, the Company entered into a credit agreement with Bank One, Texas, N.A., which was amended on January 29, 1998, September 3, 1998, November 10, 1998, December 28, 1998 and May 10, 1999 (collectively, the "Amended Credit Facility"). The Amended Credit Facility provides the Company with a revolving line of credit of up to $150.0 million, which may be used for general corporate purposes, including acquisitions, the repayment or refinancing of indebtedness of all acquisitions including future acquisitions, capital expenditures, letters of credit and working capital. The Amended Credit Facility will terminate and all amounts outstanding thereunder, if any, will be due and payable on the earlier of September 30, 1999 or a change of control. Amounts outstanding under the Amended Credit Facility at March 28, 1999 are classified as current liabilities in the accompanying balance sheet. The Company is pursuing additional financing and a refinancing of the Amended Credit Facility both independent of and in conjunction with the pending merger with IFCO (see Note 9). However, there can be no assurance that the Company will be able to obtain additional financing or refinance the Amended Credit Facility or that any additional financing or refinancing will be on terms that are as favorable to the Company as the Amended Credit Facility. The Company's failure to obtain additional financing or refinance the Amended Credit Facility before September 30, 1999, or any additional financing or new financing obtained by the Company on terms that are materially less favorable than those of the Amended Credit Facility, could have a material adverse effect on the Company's results of operations and financial condition. Advances under the Amended Credit Facility bear interest at Bank One's base interest rate, as defined, plus a margin of 50 basis points through March 31, 1999 and increasing by 50 basis points on that date and each quarter until maturity. At the Company's option, such advances may bear interest based on a designated LIBOR plus a margin of 275 basis points through March 31, 1999 and increasing by 50 basis points on that date and each quarter until maturity. Commitment fees of 50 basis points are payable on the unused portion of the line of credit through March 31, 1999 and increase by 50 basis points on that date and each quarter until maturity. The Amended Credit Facility contains a limit for standby letters of credit of up to $10.0 million. There were letter of credit commitments of approximately $3.0 million outstanding under the Amended Credit Facility as of March 28, 1999. The Amended Credit Facility prohibits the payment of dividends by the Company, restricts the Company's incurrence or assumption of other indebtedness and requires the Company to comply with certain financial covenants including consolidated net worth, fixed charge coverage, and funded debt and senior debt to earnings before interest, taxes, depreciation and amortization ratios. The approximate level of borrowings available under the Amended Credit Facility as of March 28, 1999 was $3.5 million. The Amended Credit Facility is secured by a lien on the real and tangible personal property of the Company, as defined, a pledge of the outstanding stock of each of the Company's U.S. subsidiaries and 65% of the outstanding stock of the Company's Canadian subsidiary. The amounts due under the Amended Credit Facility are also guaranteed by the Company's U.S. subsidiaries. Convertible Notes Payable to Related Parties The Company issued approximately $10.0 million in subordinated convertible notes payable (the "Convertible Notes") to certain former owners of the 1998 Purchased Companies. The Convertible Notes, which bear interest at rates ranging from six to eight percent, include provisions that allow conversion into shares of the Company's Common Stock beginning on the first anniversary date of the Convertible Notes (the "Conversion Date") at conversion prices ranging from $10.78 to $15.86 per share. If the Convertible Notes are not converted they become due and payable on their second anniversary. At the Company's option, Convertible Notes may be prepaid at any time following the Conversion Date. 10 4. CAPITAL STOCK On March 25, 1997, PalEx completed the Offering, which involved the sale by PalEx of 3,000,000 shares of Common Stock at a price to the public of $7.50 per share. The net proceeds to PalEx from the Offering (after deducting underwriting discounts, commissions and offering expenses) were approximately $20.1 million. Of this amount, $3.4 million was used to pay the cash portion of the purchase prices relating to the acquisitions of the Founding Companies with the remainder being used to pay certain indebtedness of the Founding Companies. On April 22, 1997, the Company sold an additional 450,000 shares of Common Stock at a price to the public of $7.50 per share (generating net proceeds to the Company of approximately $3.1 million after underwriting discounts and commissions) pursuant to an over-allotment option granted by the Company to the underwriters in connection with the Offering. The net proceeds from the sale of the additional shares were used to pay certain indebtedness of the Company. The shares outstanding as of December 27, 1998 and March 28, 1999 include as common stock equivalents shares of the Company's Canadian subsidiary which are convertible on a share for share basis into common stock of the Company. On September 30, 1998, the Company issued a warrant for the purchase of up to 250,000 shares of its Common Stock for professional advisory services at an exercise price of $11.375 per share. The warrant may be exercised in whole or in part upon the consummation of certain defined transactions, including, without limitation, the merger of PalEx with IFCO (see Note 9) and expires in May 2005. None of the defined transactions had occurred as of March 28, 1999. 5. EARNINGS PER SHARE Net income per share - basic for the three month period ended March 29, 1998 was computed using 17,920,864 shares (the shares attributable to the Founding Companies, the Pooled and the 1998 Pooled Companies, the shares issued pursuant to the Offering and the over-allotment option, the shares issued to Main Street Capital Partners, L.P. and PalEx management, the shares issued to the profit sharing plans of the Founding Companies and the weighted average shares issued to those companies acquired as purchases). Net income per share - basic for the three month period ended March 28, 1999 was computed using 20,291,619 shares (the shares attributable to the Founding Companies, the Pooled Companies, the 1998 Purchased Companies and the 1998 Pooled Companies, the shares issued pursuant to the Offering and the over-allotment option, the shares issued to Main Street Capital Partners, L.P. and PalEx management, the shares issued to the profit sharing plans of the Founding Companies and the weighted average shares issued in connection with the exercise of stock options). The shares used in computing net income per share-diluted also include the effect of unexercised stock options under the treasury method and considered the dilutive effect of subordinated convertible notes. 6. INCOME TAXES Prior to the Acquisitions, the stockholders of Fraser elected to be taxed under the provisions of Subchapter S of the Internal Revenue Code. Under these provisions, Fraser did not pay federal and certain state income taxes because their stockholders paid income taxes on their proportionate share of Fraser's earnings. Commencing with the Acquisitions and the Offering, the Company began to be taxed at applicable federal and state income tax rates. The Company files a consolidated federal income tax return which includes the operations of the Founding, Pooled, 1998 Pooled, and Purchased Companies for periods subsequent to their respective acquisitions. Each of the Companies has or will file a "short period" federal income tax return through their respective acquisition dates. 11 7. COMMITMENTS AND CONTINGENCIES Potential Environmental Liabilities In February 1998, the Company acquired DSF, a steel drum reconditioning company with a facility in Zellwood, Florida. DSF is a wholly-owned subsidiary of PalEx Container Systems, Inc., a wholly owned subsidiary of the Company ("PCS"). In 1982, DSF was notified by the U.S. Environmental Protection Agency (the "EPA") and the Florida Department of Environmental Regulation (the "DER") that they believed that DSF might be a potentially responsible party ("PRP") regarding the Zellwood Groundwater Contamination Site in Orange County, Florida (the "Zellwood Site"). The Zellwood Site was designated a "Superfund" environmental clean-up site after the DER discovered arsenic contamination in a shallow monitoring well adjacent to it. The DSF facility is a portion of the 57 acres constituting the Zellwood Site. The Company believes that DSF and its former shareholders were among approximately 25 entities and individuals identified as PRPs by the EPA. Between March 1990 and July 1996, the EPA issued various unilateral administrative orders and notices to DSF and various other PRPs. Those orders and notices demanded reimbursement from PRPs of approximately $2 million of the EPA's costs regarding the Zellwood Site and requested the PRPs to accept financial responsibility for additional clean-up efforts. During that time, the EPA estimated that the cost of the selected remedy for soil at the Zellwood Site would be approximately $1 million and the cost of the selected remedy for groundwater at the Zellwood Site would be approximately $5.1 million. DSF and the other PRPs did not agree to the EPA's demands or agree to fund any additional clean-up. In April 1997, the EPA issued an order unilaterally withdrawing its previous orders. On June 12, 1998 a suit was filed in the United States District Court for the Middle District of Florida (Orlando Division) against DSF and certain other PRPs with respect to the Zellwood Site (United States of America v. Drum Service Co. of Florida, John Michael Murphy, Douglass Fertilizer & Chemical, Inc., et, al., Civil No. 98-687-Civ-Orl-22C) (the "Zellwood Suit"). In this lawsuit, the EPA is seeking reimbursement of costs incurred at the Zellwood Site during the past 17 years and a declaratory judgment for future response costs. DSF has maintained comprehensive general liability insurance coverage for over 25 years, and a number of the policies providing such coverage did not contain exclusions for environmental contamination. DSF has notified the insurers that issued such policies of the EPA's claims regarding the Zellwood Site and the commencement of the Zellwood Suit. In addition, the former shareholders of DSF have agreed with DSF and the Company to bear liabilities and expenses with respect to the Zellwood Site, to the extent such liabilities exceed the Company's insurance recoveries. DSF and several other PRPs are currently negotiating with the EPA to settle the Zellwood Suit. DSF intends to vigorously defend the Zellwood Suit and pursue its insurance coverage with respect to losses and expenses incurred in connection with the Zellwood Site. Although there can be no assurance as to any ultimate liability of DSF under the Zellwood Suit, the amount of recoveries from other PRPs or the insurance coverage, or the amount of insurance recoveries, the Company's management believes that DSF's insurance coverage, recoveries from other PRPs and the obligations of DSF's former shareholders will be adequate to cover any liability or expenses of DSF arising from the Zellwood Suit. The accompanying consolidated balance sheet as of March 28, 1999 includes a $2.0 million receivable from a former shareholder of DSF and a corresponding amount in other long-term liabilities. In November 1998, Container Services Company ("CSC"), a subsidiary of PCS which acquired CDR, received notice from the EPA that it had been identified as a de minimis PRP with respect to the Casmalia Disposal Site in Santa Barbara County, California ("Casmalia Site"). 12 The Casmalia Site was a licensed hazardous waste disposal facility from 1974 to 1989. In 1989, the EPA refused to reissue Casmalia's Resource Conservation and Recovery Act permit on the grounds that the operator of the site was in violation of its preexisting permit and other environmental laws and regulations. As a result of the owner/operator abandoning efforts to properly close and clean up the site, the EPA took emergency action. There are (according to EPA estimates) approximately 10,000 generators who legally sent approximately 4.5 billion pounds of waste to the Casmalia Site. EPA estimates that the clean up of this site will cost approximately $500 million and will take over 30 years to complete. The EPA has entered in a partial settlement with 50 major PRPs and is currently in negotiations with over 50 other major PRPs. In October 1998, the EPA sent out general notices to 750 de minimis PRPs, including CSC. In addition, it is expected that the EPA will send out several hundred additional notice letters to de minimis PRPs. The EPA estimates that the original 750 de minimis PRPs are responsible for an aggregate of about 10% of the volume of waste shipped to the Casmalia Site. Based on CSC's alleged contribution of waste to the Casmalia Site, the EPA has offered to settle its claims against CSC for approximately $300,000, which represents a 100% premium over EPA's estimate of CSC's proportionate share of the estimated clean up costs. In return for settlement, CSC will be granted contribution protection against lawsuits by other PRPs who contributed waste to the Casmalia Site. CSC is currently reviewing the EPA's settlement offer and estimates of CSC's contribution of waste to the site. In addition, CSC has joined a joint defense group of over 140 other de minimis PRPs for the primary purpose of negotiating a reduction in, and the terms of, the EPA's settlement offer. The Company has included such settlement amount in accrued expenses in the accompanying consolidated balance sheet as of March 28, 1999. Contingent Purchase Price The Company is obligated under the terms of an agreement with the former owners of one of the 1998 Purchased Companies to pay, in either cash or equal amounts of cash and the Company's Common Stock, up to $6,000,000 based on the subsidiary's post-acquisition earnings, as defined. Amounts due under this contingency, if any, will be accrued as part of the purchase price when the contingency is resolved in 1999 and 2000. Insurance The Company carries a broad range of insurance coverage, including general and business auto liability, commercial property, workers' compensation and a general umbrella policy. The Company is self-insured for certain medical claims up to $50,000 per person per year. Provisions for expected future payments are accrued and are based on the Company's estimate of its aggregate liability for all open and unreported claims. Operating Lease Agreements The Company conducts a portion of its operations and warehouses certain of its products in leased facilities under leases accounted for as operating leases. The leases provide for payment of taxes and other expenses by the Company. Rent expense for operating leases was approximately $0.6 million and $1.2 million for the three month periods ended March 29, 1998 and March 28, 1999, respectively. 13 8. BUSINESS SEGMENTS The Company has two business segments, one operating in the pallet industry and the other in the steel drum reconditioning industry. The pallet segment produces, recycles, sells, repairs, leases and retrieves wooden pallets in the United States and Canada primarily for use in agricultural and industrial markets. The drum segment reconditions steel drums in the United States primarily for use in agricultural and industrial markets. There were no significant intercompany sales between the two segments for the three month periods ended March 29, 1998 and March 28, 1999. The Company's business segments are managed separately because they require different technology and marketing strategies. The accounting policies for the segments are the same as those described in Note 2 of Notes to Consolidated Financial Statements of PalEx, Inc. and Subsidiaries as filed with the Securities and Exchange Commission with the Company's Form 10-K on March 29, 1999. The Company evaluates the performance of its reportable segments based on income before corporate overhead charges, interest expense, non-recurring expenses, goodwill amortization and income taxes.
Three Month Period Ended ------------------------------------------------------------------- March 29, 1998 March 28, 1999 -------------------------------- --------------------------------- Pallet Drum Consolidated Pallet Drum Consolidated ------- -------- ------------- -------- -------- ------------- Revenues $51,953 $17,017 $68,970 $71,928 $24,460 $96,388 ======= ======= ======= ======= ======= ======= Earnings contribution $ 4,533 $ (552) $ 3,981 $ 7,376 $ 2,702 $10,078 ======= ======= ======= ======= Corporate expenses (674) (1,564) Interest expense (937) (3,540) Amortization of goodwill (342) (1,085) Other income (expense) 7 (191) ------- ------- Income before provision for income taxes $ 2,035 $ 3,698 ======= =======
Earnings contribution for the drum segment for the three month period ended March 29, 1998 includes charges of approximately $1.7 million for investment advisory fees related to the acquisition of one of the 1998 Pooled Companies and compensation differential (the difference between previous owners' and officers' compensation before the acquisitions and the amounts to which they have contractually agreed) of approximately $1.1 million incurred in conjunction with the acquisition of Acme and Western. 14 9. PENDING MERGER On March 30, 1999, PalEx entered into a definitive merger agreement with International Food Container Organization ("IFCO") to merge their businesses. The combined entity, to be named IFCO Systems, will include IFCO's European, U.S., Asian and Latin American returnable packaging operations and PalEx's North American pallet and industrial container operations. Under the terms of the agreement, PalEx will merge into a new subsidiary of IFCO Systems. The outstanding shares of PalEx's common stock will be exchanged for common stock of IFCO Systems representing between 32 percent and 35 percent of its outstanding shares. The remaining shares of IFCO Systems will be owned by Schoeller Packaging Systems. A subsidiary of General Electric Company will own a note convertible into shares of IFCO Systems. The merger will occur concurrently with an initial public offering of shares in IFCO Systems. The closing of the merger is subject to the approval of shareholders, expiration or termination of the applicable waiting period under the Hart-Scott-Rodino Act, completion of the initial public offering of IFCO Systems and other customary conditions. The transaction is expected to be completed in the third quarter of 1999. 15 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS INTRODUCTION The following discussion should be read in conjunction with the Consolidated Financial Statements of the Company and related notes thereto which are included in the Company's Form 10-K. Statements contained in this discussion regarding future financial performance and results and other statements that are not historical facts are forward-looking statements. The forward-looking statements are subject to numerous risks and uncertainties to the Company, including but not limited to the availability of attractive acquisition opportunities, the successful integration and profitable management of acquired businesses, improvement of operating efficiencies, the availability of working capital and financing for future acquisitions, the Company's ability to grow internally through expansion of services and customer bases and reduction of overhead, conditions in lumber markets, seasonality, weather conditions and other risk factors discussed in the Company's Annual Report on Form 10-K. RESULTS OF OPERATIONS The results of operations for the periods presented include Fraser, the Pooled Companies and the 1998 Pooled Companies. In addition, those companies acquired as purchases are included from their respective dates of acquisition. Quarterly results may be materially affected by the timing and magnitude of acquisitions, assimilation costs, costs of opening new facilities, gain or loss of a material customer, variation in product mix and weather conditions. Accordingly, the operating results for any interim period are not necessarily indicative of the results that may be achieved for any subsequent interim period or for a full fiscal year. THREE MONTH PERIODS ENDED MARCH 29, 1998 AND MARCH 28, 1999 The following table sets forth certain selected financial data as a percentage of revenues for the periods indicated (dollars in thousands):
Three Month Period Ended ------------------------------------------------------------- March 29, 1998 March 28, 1999 ------------------------------ ----------------------------- Revenues................................................ $68,970 100.0% $96,388 100.0% Cost of goods sold...................................... 56,370 81.7 77,392 80.3 ------- ----- ------- ----- Gross profit............................................ 12,600 18.3 18,996 19.7 Selling, general and administrative expenses............ 6,580 9.5 10,482 10.9 Goodwill amortization.................................. 342 .5 1,085 1.1 Pooling expenses........................................ 1,651 2.4 - - Compensation differential............................... 1,062 1.5 - - ------- ----- ------- ----- Income from operations.................................. 2,965 4.4 7,429 7.7 Interest expense........................................ (937) (1.4) (3,540) (3.7) Other income (expense), net............................. 7 - (191) (.2) ------- ----- ------- ----- Income before income taxes.............................. 2,035 3.0 3,698 3.8 Provision for income taxes.............................. 875 1.3 1,705 1.7 ------- ----- ------- ----- Net income.............................................. $ 1,160 1.7% $ 1,993 2.1% ======= ===== ======= =====
Revenues increased 39.8% from approximately $69.0 million in the three month period ended March 29, 1998 to approximately $96.4 million in the three month period ended March 28, 1999. On April 29, 1998, the Company notified its largest 16 customer, CHEP USA ("CHEP"), that PalEx was terminating all existing agreements with CHEP. Effective that date, the Company ceased supplying CHEP with new pallets and provided advance notice (generally, ten to sixty days) under contractual arrangements to discontinue repair and depot services to CHEP. The termination of the Company's relationship affected certain of the Company's facilities in the southeastern and western United States. Revenues related to CHEP sales for the three month period ended March 29, 1998 were approximately $14.3 million. The increase in revenues for the three month period ended March 28, 1999 over the same period in 1998 attributable to the Purchased Companies was approximately $36.4 million. The increase attributable to the Pooled and 1998 Pooled Companies was approximately $5.3 million. Unit sales of new pallets increased from approximately 3.6 million units for the three month period ended March 29, 1998 to approximately 4.2 million units for the three month period ended March 28, 1999. Unit sales of repaired and used pallets increased from approximately 2.5 million units for the three month period ended March 29, 1998 to approximately 3.4 million units for the three month period ended March 28, 1999. Unit sales of new and used pallets exclude products sold to CHEP in all periods. Unit sales of agricultural harvesting boxes and specialty bins were approximately 300,000 units for the three month period ended March 29, 1998 and approximately 200,000 units for the three month period ended March 28, 1999. The decrease in unit sales of harvesting boxes and specialty bins is attributed to lower demand and a delay in the start of the crating season. Unit sales of reconditioned drums were approximately 1.2 million units for the three month period ended March 29, 1998 and approximately 1.1 million units for the three month period ended March 28, 1999. The decrease in drum unit sales is due primarily to a reduction in lower unit margin business. Gross profit increased from approximately $12.6 million for the three month period ended March 29, 1998 to approximately $19.0 million for the three month period ended March 28, 1999, primarily as a result of increased volumes due to the acquisition of the Purchased Companies. Gross profit as a percentage of revenues increased from 18.3% for the three month period ended March 29, 1998 to 19.7% for the three month period ended March 28, 1999, primarily due to higher margins from recycled pallet sales. The Company's gross profit as a percentage of revenues may fluctuate as a result of competitive pricing in different market areas in which it operates, continued changes to product mix and changes in raw material costs. Selling, general and administrative expenses increased from approximately $6.6 million, or 9.5% of revenues, in the three month period ended March 29, 1998 to $10.5 million, or 10.9% of revenues, in the three month period ended March 28, 1999. This increase is generally attributable to the Purchased Companies acquired subsequent to March 29, 1998 and to the Company's efforts of organizing and building its regional operating structure. The results of operations for the three month period ended March 29, 1998 include approximately $1.7 million and $1.1 million for pooling expenses and compensation differential, respectively, related to the acquisition of Acme and Western. Goodwill amortization increased from approximately $0.3 million for the three month period ended March 29, 1998 to approximately $1.1 million for the three month period ended March 28, 1999. This increase was due to the additional companies acquired as purchases. Interest expense increased from approximately $0.9 million for the three month period ended March 29, 1998 to approximately $3.5 million for the three month period ended March 28, 1999, primarily as a result of the additional borrowings related to the acquisitions of the 1998 Purchased Companies. As a result of the foregoing, net income increased from approximately $1.2 million for the three month period ended March 29, 1998 to approximately $2.0 million for the three month period ended March 28, 1999. 17 LIQUIDITY AND CAPITAL RESOURCES On March 25, 1997, PalEx completed the Offering, which involved the sale of 3,000,000 shares of Common Stock at a price to the public of $7.50 per share. The net proceeds to PalEx from the Offering (after deducting underwriting discounts, commissions and offering expenses) were approximately $20.1 million. Of this amount, $3.4 million was used to pay the cash portion of the purchase prices relating to the Acquisitions with the remainder being used to repay certain indebtedness of the Founding Companies. On April 22, 1997, the Company sold an additional 450,000 shares of Common Stock at a price to the public of $7.50 per share (generating net proceeds to the Company of $3.1 million after underwriting discounts and commissions) pursuant to an over-allotment option granted by the Company to the underwriters in connection with the Offering. The net proceeds were used to repay debt borrowed under the Credit Facility. On March 25, 1997, the Company entered into a credit agreement with Bank One, Texas, N.A., which was amended on January 29, 1998, September 3, 1998, November 10, 1998, December 28, 1998 and May 10, 1999 (collectively, the "Amended Credit Facility"). The Amended Credit Facility provides the Company with a revolving line of credit of up to $150.0 million, which may be used for general corporate purposes, including acquisitions, the repayment or refinancing of indebtedness of all acquisitions including future acquisitions, capital expenditures, letters of credit and working capital. The Amended Credit Facility will terminate and all amounts outstanding thereunder, if any, will be due and payable on the earlier of September 30, 1999 or a change in control, which will occur upon consummation of the pending merger with IFCO, which is expected to close in the third quarter of 1999 and which is described below. The Company is pursuing additional debt financing and a refinancing of the Amended Credit Facility both independent of and in conjunction with the pending merger, as discussed below, with IFCO. However, there can be no assurance that the Company will be able to obtain additional financing or refinance the Amended Credit Facility or that any additional financing or refinancing will be on terms that are as favorable to the Company as the Amended Credit Facility. The Company's failure to obtain additional financing or refinance the Amended Credit Facility before September 30, 1999, or any additional financing or new financing obtained by the Company on terms that are materially less favorable than those of the Amended Credit Facility, could have a material adverse effect on the Company's results of operations and financial condition. Advances under the Amended Credit Facility bear interest at Bank One's base interest rate, as defined, plus a margin of 50 basis points through March 31, 1999 and increasing by 50 basis points on that date and each quarter until maturity. At the Company's option, such advances may bear interest based on a designated LIBOR plus a margin of 275 basis points through March 31, 1999 and increasing by 50 basis points on that date and each quarter until maturity. Commitment fees of 50 basis points are payable on the unused portion of the line of credit through March 31, 1999 and increase by 50 basis points on that date and each quarter until maturity. The Amended Credit Facility contains a limit for standby letters of credit of up to $10.0 million. There were letter of credit commitments of approximately $3.0 million outstanding under the Amended Credit Facility as of March 28, 1999. The Amended Credit Facility prohibits the payment of dividends by the Company, restricts the Company's incurrence or assumption of other indebtedness and requires the Company to comply with certain financial covenants including consolidated net worth, fixed charge coverage, and funded debt and senior debt to earnings before interest, taxes, depreciation and amortization ratios. The approximate level of borrowings available under the Amended Credit Facility as of March 28, 1999 was $3.5 million. The Amended Credit Facility is secured by a lien on the real and tangible personal property of the Company, as defined, a pledge of the outstanding stock of each of the Company's U.S. subsidiaries and 65% of the outstanding stock of the Company's Canadian subsidiary. The amounts due under the Amended Credit Facility are also guaranteed by the Company's U.S. subsidiaries. The Company issued approximately $10.0 million in subordinated convertible notes payable (the "Convertible Notes") to certain former owners of the 1998 Purchased Companies. The Convertible Notes, which bear interest at rates ranging from six to eight percent, include provisions that allow conversion into shares of the Company's Common Stock beginning on the first anniversary date of the Convertible Notes (the "Conversion Date") at conversion prices ranging from $10.78 to $15.86 per share. If the Convertible Notes are not converted they become due and payable on their second anniversary. At the Company's option, the Convertible Notes may be prepaid at any time following the Conversion Date. 18 Pending Merger On March 30, 1999, PalEx entered into a definitive merger agreement with International Food Container Organization ("IFCO") to merge their businesses. The combined entity, to be named IFCO Systems, will include IFCO's European, U.S., Asian and Latin American returnable packaging operations and PalEx's North American pallet and industrial container operations. Under the terms of the agreement, PalEx will merge into a new subsidiary of IFCO Systems. The outstanding shares of PalEx's common stock will be exchanged for common stock of IFCO Systems representing between 32 percent and 35 percent of its outstanding shares. The remaining shares of IFCO Systems will be owned by Schoeller Packaging Systems. A subsidiary of General Electric Company will own a note convertible into shares of IFCO Systems. The merger will occur concurrently with an initial public offering of shares in IFCO Systems. The closing of the merger is subject to the approval of shareholders, expiration or termination of the applicable waiting period under the Hart-Scott-Rodino Act, completion of the initial public offering of IFCO Systems and other customary conditions. The transaction is expected to be completed in the third quarter of 1999. SEASONALITY The pallet manufacturing and crating business is subject to seasonal variations in operations and demand and the Company's third quarter is traditionally the quarter with the lowest demand. The Company has a significant number of agricultural customers and typically experiences the greatest demand for new pallets from these customers during the citrus and produce harvesting seasons (generally October through May). Yearly results can fluctuate significantly in this region depending on the size of the citrus and produce harvests, which, in turn, largely depend on the occurrence and severity of freezing weather and changes in rainfall. Adverse weather conditions may also affect the Company's ability to obtain adequate supplies of lumber at a reasonable cost. The Company's locations serving predominantly manufacturing and industrial customers experience less seasonality. Management believes that the effects of such seasonality will diminish as the Company grows and expands its customer base both internally and through acquisition. The Company's drum reconditioning segment is seasonally impacted in the southeastern and western United States by the agricultural industries. Reconditioned drum sales are strongest during a period generally beginning in April and extending through September, with preseason production for this period running from January through March. YEAR 2000 ISSUES The Year 2000 Issue is the result of computer programs being written using two digits rather than four to define a specific year. Absent corrective actions, a computer program that has date-sensitive software may recognize a 19 date using "00" as the year 1900 rather than the year 2000. This could result in system failures or miscalculations causing disruptions to various activities and operations. The Company has conducted an evaluation of the actions necessary in order to ensure that its computer systems will be able to function without disruption with respect to the application of dating systems in the year 2000. The majority of the Company's information technology software with potential year 2000 concerns was licensed from vendors that have either changed their product to remove the effects of the Year 2000 Issue or have committed to have the necessary changes made during 1999. Reviews and inquiries concerning software used in the operation of the Company's manufacturing equipment have been conducted as well. The Company's operating businesses do not require extensive systems-oriented applications. The pallet manufacturing business consists of harvesting, transporting, cutting, assembling and delivering finished wood products. The drum reconditioning business consists of collecting, reconditioning and delivering empty steel containers. Isolated microprocessor- driven manufacturing equipment involved in the pallet manufacturing and drum reconditioning processes have either been conformed to year 2000 standards or are scheduled for conformity by the vendor in 1999. The Company is unaware of any material disruptions to its manufacturing operations that could occur because of year 2000 problems. The Company is also unaware of any exposure to contingencies related to the Year 2000 Issue for the products it has sold in the past. The Company does not anticipate the loss of any revenues due to the Year 2000 Issue. As a result of its evaluations of the Year 2000 Issue, the Company is engaged in the process of upgrading and replacing certain information and other computer systems in order to be able to operate without disruption after 1999. The Company's remedial actions are scheduled to be completed during the second and third quarters of 1999. Based upon information currently available, the Company does not anticipate that the costs of its remedial actions will exceed $250,000. The Company incurred costs as of December 27, 1998 of less than $50,000 for remediation of the Year 2000 Issue. The Company does not have a formal contingency plan, but believes it will be able to create one in the second or third quarter of 1999, if it is determined that any systems are at risk of being year 2000 non-compliant. However, the Company can not assure you that the remedial actions being implemented will be completed by the time necessary to avoid year 2000 problems or that the cost, which is based on the Company's estimates, will not be material. Although the Company is assessing the reliability of their year 2000 compliance, disruptions of the computer systems of banks, vendors, customers or other third parties, whose systems are outside the Company's control, could impair the Company's ability to obtain necessary raw materials or to sell to or service its customers. Disruption of the Company's computer systems, or the computer systems of its banks, vendors or customers, as well as the cost of avoiding such disruption, could have a material adverse effect upon the Company's financial condition and results of operations. 20 PALEX, INC. PART II -- OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS The Company has from time to time been a party to litigation arising in the normal course of business. Most of that litigation involves claims for personal injury or property damage incurred in connection with the Company's operations. The Company believes that none of these actions will have a material adverse effect on its financial condition or results of operations. Zellwood Superfund Site. In February 1998, the Company acquired DSF, a steel drum reconditioning company with a facility in Zellwood, Florida. DSF is a wholly owned subsidiary of PalEx Container Systems, Inc., a wholly owned subsidiary of the Company ("PCS"). In 1982, DSF was notified by the EPA and the Florida Department of Environmental Regulation ("DER") that DSF had been identified as a potentially responsible party ("PRP") with respect to the Zellwood Groundwater Contamination Site in Orange County, Florida (the "Zellwood Site"). The Zellwood Site was designated a "Superfund" environmental clean-up site after the DER discovered arsenic contamination in a shallow monitoring well adjacent to the site. The DSF facility is located on a portion of the 57 acres constituting the Zellwood Site. We believe that DSF and its former shareholders were among approximately 25 entities and individuals identified as PRPs by the EPA. Between March 1990 and July 1996, the EPA issued various unilateral administrative orders and notices to DSF and the other PRPs regarding the Zellwood Site. Those orders and notices demanded reimbursement from the PRPs of approximately $2 million of the EPA's costs related to the Zellwood Site and requested the PRPs to accept financial responsibility for additional clean-up efforts. During that time, the EPA estimated that the cost of the selected remedy for soil at the Zellwood Site would be approximately $1 million and the cost of the selected remedy for groundwater at the Zellwood Site would be approximately $5.1 million. DSF and the other PRPs did not agree to the EPA's demands or agree to fund any additional clean-up. In April 1997, the EPA issued an order unilaterally withdrawing its previous orders. On June 12, 1998 a suit was filed by the EPA in United States District Court in Orlando, Florida, against DSF and certain other PRPs with respect to the Zellwood Site. The EPA is seeking reimbursement of costs incurred at the Zellwood Site during the past 17 years and a declaratory judgment for future response costs. DSF has maintained comprehensive general liability insurance coverage over the past 25 years and has notified various insurers of the EPA's claims regarding the Zellwood Site. A number of those relevant insurance policies did not contain an exclusion for environmental contamination. DSF has notified the insurers that issued these policies of the EPA's claims regarding the Zellwood Site and the commencement of the lawsuit. In 1992, DSF settled a claim with one insurer for an amount that covered a substantial portion of the costs DSF had incurred at that time in dealing with the EPA and the DER. DSF has identified other umbrella liability policies for which coverage may also be available and has been approached by the insurer under two of those policies seeking a settlement. In addition, the former shareholders of DSF have agreed with DSF and us to bear liabilities and expenses with respect to the Zellwood Site, to the extent such liabilities and expenses exceed our insurance recoveries. DSF and several other PRPs are currently negotiating with the EPA to settle the lawsuit. DSF intends to vigorously defend the lawsuit and pursue its insurance coverage with respect to losses and expenses incurred in connection with the Zellwood Site. Although there can be no assurance as to any ultimate liability of DSF under the EPA's lawsuit, the amount of recoveries from other PRPs or the insurance coverage, or the amount of insurance recoveries, the Company's management believes that DSF's insurance coverage, recoveries from other PRPs and the obligations of DSF's former shareholders will be adequate to cover any liability 21 or expenses of DSF arising from the lawsuit. The Company will continue to determine the availability of additional insurance coverage for this matter. Casmalia Site. In November 1998, Container Services Company ("CSC"), a subsidiary of PCS, which acquired CDR, received notice from the EPA that it had been identified as a de minimis PRP with respect to the Casmalia Disposal Site in Santa Barbara County, California ("Casmalia Site"). The Casmalia Site was a licensed hazardous waste disposal facility from 1974 to 1989. In 1989, the EPA refused to reissue Casmalia's Resource Conservation and Recovery Act permit on the grounds that the operator of the site was in violation of the preexisting permit and other environmental laws and regulations. As a result of the owner/operator abandoning efforts to properly close and clean up the site, the EPA took emergency action. There are approximately 10,000 generators who legally sent (according to EPA estimates) approximately 4.5 billion pounds of waste to the Casmalia Site. EPA estimates that the clean up of this site will cost approximately $500 million and will take over 30 years to complete. The EPA has entered into a partial settlement with 50 major PRPs and is currently in negotiations with over 50 other major PRPs. In October 1998, the EPA sent out general notices to 750 de minimis PRPs, including CSC. In addition, it is expected that the EPA will send out several hundred additional notice letters to de minimis PRPs. The EPA estimates that the original 750 de minimis PRPs are responsible for an aggregate of about 10% of the volume of waste shipped to the Casmalia Site. Based on CSC's alleged contribution of waste to the Casmalia Site, the EPA has offered to settle its claims against CSC for approximately $300,000, which represents a 100% premium over EPA's estimate of CSC's proportionate share of the estimated clean up costs. In return for settlement, CSC will be granted contribution protection against lawsuits by other PRPs who contributed waste to the Casmalia Site. CSC is currently reviewing the EPA's settlement offer and estimates of CSC's contribution of waste to the site. In addition, CSC has joined a joint defense group of over 140 other de minimis PRPs for the primary purpose of negotiating a reduction in, and the terms of, the EPA's settlement offer. OTHER MATTERS The Company is involved in various other legal proceedings that have arisen in the ordinary course of business. While it is not possible to predict the outcome of such proceedings with certainty, in the Company's opinion, all such proceedings are either adequately covered by insurance or, if not so covered, should not ultimately result in any liability which would have a material adverse effect on the financial position, liquidity or results of operations of the Company. 22 ITEM 2. RECENT SALES OF UNREGISTERED SECURITIES None ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. (a) Exhibits Exhibit No ------- 27.0 Financial Data Schedule (b) Reports on Form 8-K On April 7, 1999, the Company filed a Current Report on Form 8-K to report the execution of a definitive agreement to merge the Company with International Food Container Organization. 23 SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. PALEX, INC. Date: May 12th, 1999 By: /s/ Casey A. Fletcher ----------------------------------------- Casey A. Fletcher Chief Accounting Officer 24 EX-27 2 FINANCIAL DATA SCHEDULE
5 1,000 3-MOS DEC-27-1998 DEC-28-1998 MAR-28-1999 5,623 0 51,834 1,301 28,550 92,621 126,459 50,372 299,872 184,239 0 0 0 203 97,868 299,872 96,388 96,388 77,392 87,874 1,276 39 3,540 3,698 1,705 1,993 0 0 0 1,993 .10 .10
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