CHASE CORP - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations

(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion provides an analysis of our financial condition and results of operations and should be read in conjunction with the unaudited Consolidated Financial Statements and notes thereto included in Item 1 of Part I of this Quarterly Report on Form 10-Q and with our Annual Report on Form 10-K filed for the fiscal year ended August 31, 2012.

Overview Our results in the first three months of fiscal 2013 reflect both revenue and profit increases over the prior year period. Revenues in the current quarter benefited from sales generated from our June 2012 acquisition of NEPTCO.

Additionally, favorable product mix and continued efforts to streamline overhead costs and consolidate our production facilities have improved our profitability. Revenues from the Industrial Materials segment increased over the same period in the prior year primarily due to the inclusion of sales from NEPTCO as well as increased sales from our electronic coatings and laminated durable paper products. These were partially offset by a reduction in our traditional wire and cable product sales in the current quarter as compared to those realized in the first quarter of the prior year.

Our Construction Materials segment benefited from increased demand for our coating and lining system products that resulted in higher sales and profits in the current quarter compared to the prior year period. This segment also benefitted from greater demand for our bridge and highway related construction products in the first quarter of fiscal 2013. These increases were partially offset by decreased project demand for our Pipeline Europe and private label products. Although this segment was positively impacted by some large, non-recurring projects in the first quarter, we observed decreased demand towards the end of the quarter and similar large projects may not occur in the upcoming quarters.

The upcoming second fiscal quarter has historically generated lower quarterly revenues for many of our product lines, especially within the Construction Materials segment. Our key objectives will be continued focus on our marketing and product development efforts, as well as the ongoing integration of the NEPTCO operations. Our balance sheet remains strong, with cash on hand of $15.4 million and a current ratio of 2.6. Our $15 million line of credit is fully available, while the balance of our unsecured term debt is $68.6 million.

We have two reportable segments as summarized below: Segment Product Lines Manufacturing Focus and Products Industrial Materials † Wire and Protective coatings and tape Cable products including insulating and † Electronic conducting materials for wire and Coatings cable manufacturers, moisture † Custom protective coatings for electronics Products and printing services, laminated † NEPTCO durable papers, flexible composites Products and laminates for the aerospace, packaging and industrial laminate markets, pulling and detection tapes used in the installation, measurement and location of fiber optic cables, water and natural gas lines, and cover tapes essential to delivering semiconductor components via tape and reel packaging; a joint venture also produces glass based strength elements designed to allow fiber optic cables to withstand mechanical and environmental strain † and stress.

† Construction Materials † Pipeline Protective coatings and tape † Construction products including coating and Products lining systems for use in liquid † Private storage and containment Label applications, protective coatings for pipeline and general construction applications, high performance polymeric asphalt additives, and expansion and control joint systems for use in the transportation and architectural † markets.

17 -------------------------------------------------------------------------------- Table of Contents Results of Operations Revenues and Operating Profit by Segment are as follows (Dollars in Thousands): Three Months Ended % of Total Three Months Ended % of Total November 30, 2012 Revenues November 30, 2011 Revenues Revenues from external customers Industrial Materials $ 39,850 75 % $ 19,486 61 % Construction Materials 13,550 25 % 12,644 39 % Total $ 53,400 $ 32,130 Three Months Ended % of Segment Three Months Ended % of Segment November 30, 2012 Revenues November 30, 2011 RevenuesIncome before income taxes Industrial Materials $ 5,530 (a) 14 % $ 3,754 (c) 19 % Construction Materials 1,430 (b) 11 % 525 4 % Total for reportable segments 6,960 13 % 4,279 13 % Corporate and Common Costs (1,663 ) (699 )(d) Total $ 5,297 10 % $ 3,580 11 % -------------------------------------------------------------------------------- (a) Includes $564 of costs of products sold related to inventory step up in fair value as part of the NEPTCO acquisition, $267 of pension related settlement costs due to the timing of lump sum distributions, and $150 of Randolph, MA plant closing expenses (b) Includes $85 of pension related settlement costs due to the timing of lump sum distributions (c) Includes $333 of Webster, MA and Randolph, MA plant closing expenses (d) Includes gain of $425 on Evanston sale leaseback transaction Total Revenues Total revenues increased $21,270,000 or 66% to $53,400,000 for the quarter ended November 30, 2012 compared to $32,130,000 in the same quarter of the prior year. Revenues in our Industrial Materials segment increased $20,364,000 or 105% to $39,850,000 for the quarter ended November 30, 2012 compared to $19,486,000 in the same quarter of the prior year. The increase in revenues from our Industrial Materials segment in the current quarter was primarily due to the following: (a) increased sales of $19,036,000 from NEPTCO products, which we acquired in June 2012; (b) increased sales of $1,317,000 from our electronic coatings products; and (c) increased sales of $1,048,000 from laminated durable paper products. These increases were partially offset by decreased sales of $768,000 from our traditional wire & cable products as we begin to integrate the manufacturing of some of these similar Chase products in with the NEPTCO facilities and production processes.

Revenues from our Construction Materials segment increased $906,000 or 7% to $13,550,000 in the current quarter compared to $12,644,000 in the same period last year. The higher sales from our Construction Materials segment in the current quarter was primarily due to increased sales of $1,391,000 of our coating and lining systems (CIM Industries). This increase was partially offset by decreased sales of $465,000 in pipeline products produced at our UK facility due to lower demand.

18 -------------------------------------------------------------------------------- Table of Contents Cost of Products and Services Sold Cost of products and services sold increased $15,272,000 or 69% to $37,271,000 in the quarter ended November 30, 2012 compared to $21,999,000 in the same period in fiscal 2012.

The following table summarizes our costs of products and services sold as a percentage of revenues for each of our reporting segments: Three Months Ended November 30, Cost of products and services sold 2012 2011 Industrial Materials 69 % 65 % Construction Materials 71 % 73 % Total 70 % 68 % Cost of products and services sold in our Industrial Materials segment was $27,677,000 for the first three months of fiscal 2013 compared to $12,708,000 for the same period in the prior year. As a percentage of revenues, cost of products and services sold in the Industrial Materials segment increased primarily due to the inclusion of the recently acquired NEPTCO operations in this segment (from June 2012). This includes the production costs of the NEPTCO JV which has higher cost of products sold as a percentage of revenues.

Additionally, this segment was impacted by incremental cost of products sold of $564,000 due to the sale of inventory which had a stepped up valuation as part of the NEPTCO acquisition.

Cost of products and services sold in our Construction Materials segment was $9,594,000 in the current quarter compared to $9,291,000 for the same period last year. As a percentage of revenues, cost of products and services sold in the Construction Materials segment decreased in the current quarter primarily due to the inclusion of incremental costs of $291,000 in the prior year quarter related to production issues at our Rye, UK plant. We continue to closely monitor raw material pricing across all product lines in this segment to preserve margins.

Selling, General and Administrative Expenses Selling, general and administrative expenses increased $3,547,000 or 51% to $10,539,000 in the quarter ended November 30, 2012 compared to $6,992,000 in the same period in fiscal 2012. As a percentage of revenues, selling, general and administrative expenses decreased to 20% in the first quarter of fiscal 2013 compared to 22% in the prior year period. The percentage decrease is attributable to our continued emphasis on controlling costs and leveraging fixed overhead.

Interest Expense Interest expense increased $326,000 to $362,000 in the quarter ended November 30, 2012, compared to $36,000 in the same period in fiscal 2012. The increase in interest expense from the prior year period is a direct result of the $70,000,000 long-term debt related to our acquisition of NEPTCO.

Other Income (Expense) Other income decreased $408,000 to $69,000 in the quarter ended November 30, 2012 compared to $477,000 in the same period in the prior year. Other income primarily includes interest income and foreign exchange gains (losses) caused by changes in exchange rates on transactions or balances denominated in currencies other than the functional currency of our subsidiaries. In the prior year quarter, other income also included a gain of $425,000 recognized on deposit payments previously received on the sale of our Evanston, IL property.

19 -------------------------------------------------------------------------------- Table of Contents Non-controlling Interest The income (loss) from non-controlling interest relates to a joint venture in which we have, through our NEPTCO subsidiary, a 50% ownership interest. The joint venture between NEPTCO and its joint venture partner (an otherwise unrelated party) is managed and operated on a day-to-day basis by NEPTCO. The purpose of this joint venture was to combine the elements of each member's fiber optic strength businesses.

Net Income Net income attributable to Chase Corporation increased $1,213,000 or 52% to $3,540,000 in the quarter ended November 30, 2012 compared to $2,327,000 in the same quarter of the prior year. The increase in net income in the current quarter is primarily due to the inclusion of NEPTCO for the three month period, as well as favorable product sales mix as discussed previously. These favorable items were partially offset by expenses of $564,000 in inventory fair value step up related to the NEPTCO acquisition, and the acceleration of defined benefit plan settlement costs of $352,000 resulting from the timing of lump sum distributions to participants.

Other Important Performance Measures We believe that adjusted EBITDA is a useful performance measure and is used by our executive management team and board of directors to measure operating performance, to allocate resources to enhance the financial performance of our business, to evaluate the effectiveness of our business strategies and to communicate with our board of directors and investors concerning our financial performance. Adjusted EBITDA is a non-GAAP financial measure.

We define adjusted EBITDA as follows: net income attributable to Chase Corporation before interest expense from borrowings, income tax expense, depreciation expense from fixed assets, amortization from intangible assets, costs related to our acquisitions, costs of products sold related to inventory step-up to fair value, and settlement (gains) or losses resulting from lump sum distributions to participants from our defined benefit plan.

The use of adjusted EBITDA has limitations and this performance measure should not be considered in isolation from, or as an alternative to, U.S. GAAP measures such as net income. Our measurement of adjusted EBITDA may not be comparable to similarly titled measures used by other companies.

The following unaudited table provides a reconciliation of net income attributable to Chase Corporation, the most directly comparable financial measure presented in accordance with U.S. GAAP, to adjusted EBITDA for the periods presented: Three Months Ended November 30, 2012 2011 Net income attributable to Chase Corporation $ 3,540,000 $ 2,327,000 Interest expense 362,000 36,000 Income taxes 1,820,000 1,253,000 Depreciation expense 1,508,000 676,000 Amortization expense 1,217,000 571,000 EBITDA $ 8,447,000 $ 4,863,000 Cost of sale of inventory step-up (a) 564,000 - Pension curtailment and settlement costs (b) 352,000 - Adjusted EBITDA $ 9,363,000 $ 4,863,000 -------------------------------------------------------------------------------- (a) Represents costs of product related to the step-up in fair value of inventory through purchase accounting from the June 2012 acquisition of NEPTCO (b) Represents pension related settlement costs due to the timing of lump sum distributions 20 -------------------------------------------------------------------------------- Table of Contents Liquidity and Sources of Capital Our overall cash and cash equivalents balance increased $193,000 to $15,373,000 at November 30, 2012, from $15,180,000 at August 31, 2012. The increased cash balance is primarily attributable to cash from operations offset by principal payments on outstanding debt and equipment purchases. A portion of cash held as of November 30, 2012 was subsequently used in December 2012 to pay our annual dividend of $3,626,000. We will continue to review our current cash balances denominated in foreign currency in light of current tax guidelines, working capital requirements, infrastructure improvements and potential acquisitions.

Cash flow provided by operations was $2,116,000 in the first quarter of fiscal 2013 compared to $1,251,000 in the prior year's first quarter. Cash provided by operations during the first three months of fiscal 2013 was primarily due to operating income, decreased accounts receivable and increased accounts payable balances offset by increased inventory balances and a decrease in accrued expenses due to the timing of tax payments and payment of our annual incentive compensation.

The ratio of current assets to current liabilities was 2.6 as of November 30, 2012, compared to 2.8 as of August 31, 2012. The decrease in our current ratio at November 30, 2012 was primarily attributable to increased accounts payable as well as an accrual for our fiscal 2012 annual dividend which was declared in the first quarter of fiscal 2013 and paid in December 2012. This was partially offset by increased inventory resulting from higher sales volume and strategic raw material purchases as well as decreased accrued payroll and other compensation due to the payment of our annual incentive program.

Cash flow used in investing activities of $596,000 was primarily due to cash paid for purchases of machinery and equipment at our manufacturing locations during the first quarter of fiscal 2013 as well as $101,000 of professional legal services that have been capitalized as prepaid patent costs.

Cash flow used in financing activities of $1,400,000 was due to payments made on the bank loans used to finance our recent acquisition of NEPTCO, described in more detail below.

On October 23, 2012, we announced an annual cash dividend of $0.40 per share (totaling $3,626,000), to shareholders of record on November 2, 2012 and payable on December 5, 2012.

In June 2012, as part of our acquisition of NEPTCO, we borrowed $70,000,000 under a five year term debt financing arrangement led and arranged by Bank of America, with participation from RBS Citizens (the "Credit Facility"). The applicable interest rate is based on the effective LIBOR plus a range of 1.75% to 2.25%, depending on our consolidated leverage ratio. At November 30, 2012, the applicable interest rate was 1.96% per annum and the outstanding principal amount was $68,600,000. We are required to repay the principal amount of the term loan in quarterly installments of $1,400,000 beginning in September 2012 through June 2014, increasing to $1,750,000 per quarter thereafter through June 2015, and to $2,100,000 per quarter thereafter through March 2017. The Credit Facility matures in June 2017. Prepayment of the Credit Facility is allowed at any time. In November 2012, we executed an amendment to this Credit Facility, to clarify the definition of the "measurement period" used in the agreement. All other terms of the Credit Facility remain the same.

21 -------------------------------------------------------------------------------- Table of Contents As part of the financing for this acquisition, we obtained a new revolving line of credit with Bank of America (the "Revolver") totaling $15,000,000, which replaced our then existing $10,000,000 line. The Revolver bears interest at LIBOR plus a range of 1.75% to 2.25%, depending on our consolidated leverage ratio, or, at our option, at the bank's base lending rate. As of November 30, 2012 and December 31, 2012, the entire amount of $15,000,000 was available for use. The Revolver is scheduled to mature in June 2017. This Revolver allows for increased flexibility for working capital requirements going forward, and we plan to use this availability to help finance our cash needs, including potential acquisitions, in fiscal 2013 and future periods.

The Credit Facility with Bank of America contains customary affirmative and negative covenants that, among other things, restrict our ability to incur additional indebtedness. It also requires us to maintain a ratio of consolidated indebtedness to consolidated EBITDA (each as defined in the facility) of no more than 3.00 to 1.00, and to maintain a consolidated fixed charge coverage ratio (as calculated in the facility) of at least 1.25 to 1.00.

We were in compliance with our debt covenants as of November 30, 2012.

We currently have several on-going capital projects that are important to our long term strategic goals. We continue to renovate our Oxford, MA and Blawnox, PA facilities as part of the relocation of our operations from Randolph, MA, which was completed in December 2012. Machinery and equipment will also be added as needed to increase capacity or enhance operating efficiencies in our other manufacturing plants.

We may consider the acquisition of companies or other assets in fiscal 2013 or in future periods that are complementary to our business. We believe that our existing resources, including cash on hand and our Revolver, together with cash generated from operations and additional bank borrowings, will be sufficient to fund our cash flow requirements through at least the next twelve months.

However, there can be no assurances that additional financing will be available on favorable terms, if at all.

To the extent that interest rates increase in future periods, we will assess the impact of these higher interest rates on the financial and cash flow projections of our potential acquisitions.

We have no significant off balance sheet arrangements.

Contractual Obligations Please refer to Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations" section in our Annual Report on Form 10-K for the fiscal year ended August 31, 2012 for a complete discussion of our contractual obligations.

Recent Accounting Standards In July 2012, the Financial Accounting Standards Board ("FASB") issued ASU 2012-02, "Testing Indefinite-Lived Intangible Assets for Impairment." This ASU amends ASC 350, "Intangibles - Goodwill and Other" to allow entities an option to first assess qualitative factors to determine whether it is necessary to perform the quantitative impairment test. Under that option, an entity no longer would be required to calculate the fair value of the intangible asset unless the entity determines, based on that qualitative assessment, that it is more likely than not that its fair value is less than its carrying amount. The amendments in this ASU are effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012, with early adoption permitted.

The adoption of ASU 2012-02 will not have an impact on our consolidated financial position, results of operations or cash flows.

22 -------------------------------------------------------------------------------- Table of Contents Critical Accounting Policies and Estimates Our financial statements are prepared in accordance with accounting principles generally accepted in the United States. To apply these principles, we must make estimates and judgments that affect our reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. In many instances, we reasonably could have used different accounting estimates and, in other instances, changes in the accounting estimates are reasonably likely to occur from period to period. Accordingly, actual results could differ significantly from our estimates. To the extent that there are material differences between these estimates and actual results, our financial condition or results of operations will be affected. We base our estimates and judgments on historical experience and other assumptions that we believe to be reasonable at the time and under the circumstances, and we evaluate these estimates and judgments on an ongoing basis. We refer to accounting estimates and judgments of this type as critical accounting policies, judgments, and estimates. Management believes there have been no material changes during the three months ended November 30, 2012 to the critical accounting policies reported in Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K for the fiscal year ended August 31, 2012.

Forward Looking Information The part of this Quarterly Report on Form 10-Q captioned "Management's Discussion and Analysis of Financial Condition and Results of Operations" contains certain forward-looking statements, which involve risks and uncertainties. Forward-looking statements include, without limitation, statements as to our future operating results, plans for manufacturing facilities, future economic conditions and expectations or plans relating to the implementation or realization of our strategic goals and future growth. These statements are based on current expectations, estimates and projections about the industries in which we operate, and the beliefs and assumptions made by management. Readers should refer to the discussions under "Forward Looking Information" and "Risk Factors" contained in our Annual Report on Form 10-K for the fiscal year ended August 31, 2012 concerning certain factors that could cause our actual results to differ materially from the results anticipated in such forward-looking statements. These discussions and Risk Factors are hereby incorporated by reference into this Quarterly Report.

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