SOVEREIGN SPECIALTY CHEMICALS INC - 10-K Annual Report

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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002

OR

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

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SOVEREIGN SPECIALTY CHEMICALS, INC.
(Exact name of registrant as specified in its charter)

DELAWARE 36-4176637
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)

225 WEST WASHINGTON STREET, CHICAGO, IL 60606
(Address of principal executive offices) (Zip Code)

(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE):
(312) 419-7100

(REGISTRANT'S EMAIL ADDRESS:)
SOVEREIGNSC.COM

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NONE

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
NONE

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K (Section 229.405 of this chapter) is not contained herein,
and will not be contained, to the best of registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. [X]

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [ ] No [X]

The common stock of the registrant is not publicly traded. Therefore, the
aggregate market value of the common stock of the registrant is not readily
available.

On March 14, 2003, the registrant had 1,441,189 shares of voting common
stock outstanding and 730,182 shares of non-voting common stock outstanding.
Approximately 75% of the voting common stock and of the non-voting common stock
of the registrant is held by an affiliate of the registrant.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the following documents are incorporated herein by reference
into the part of the Form 10-K indicated:

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TABLE OF CONTENTS

FORWARD-LOOKING STATEMENTS

Some of the information presented in, or connection with, this report
include "forward-looking statements" based on our current expectations and
projections about future events and involve potential risks and uncertainties.
Our future results could differ materially from those discussed in this report.

You should not place undue reliance on these forward-looking statements,
which are applicable only as of March 14, 2003. All written and oral
forward-looking statements attributable to us are expressly qualified in their
entirety by the factors discussed under "Item 7. Management's Discussion and
Analysis of Financial Conditions and Results" and those identified in Exhibit
99.1 to this report. We undertake no obligation to revise or update our
forward-looking statements to reflect events or circumstances that arise after
March 14, 2003 or to reflect the occurrence of unanticipated events. New risks
emerge from time to time and it is not possible for us to predict all such
risks, nor can we assess the impact of all such risks on our business or the
extent to which any risks, or combination of risks, may cause actual results to
differ materially from those contained in any forward-looking statement.

Unless otherwise indicated, industry data contained herein is as of
December 31, 2002 and was derived from a report prepared by The ChemQuest Group,
Inc., an independent management consultancy specializing in the adhesives,
sealants and coatings industry, for which we pay a nominal fee, as well as
publicly available sources, which we have not independently verified but which
we believe to be reliable.

PART I

ITEM 1. BUSINESS

We are a leading developer, producer and distributor of adhesives, sealants
and coatings for use in three primary end markets: industrial; packaging,
converting and graphic arts; and construction. We focus on select value-added
market niches in which we have established leadership positions and competitive
advantages in product development, manufacturing and distribution. We frequently
design our products in cooperation with our customers to meet unique
specifications and to provide critical performance attributes to their products,
resulting in a significant number of long-lived primary supplier relationships.

We are headquartered in Chicago, Illinois, and were formed as a limited
partnership by Robert B. Covalt and other investors in 1995 to acquire and
consolidate specialty chemicals businesses in the highly fragmented adhesives,
sealants and coatings segment of the specialty chemicals industry. In 1997, we
organized our business into a corporation. In 1999, 75% of our common stock was
acquired by SSCI Investors LLC. We have successfully expanded our business
through ten strategic acquisitions. Currently, our business is comprised of the
Commercial segment and the Construction segment. Our Commercial segment
manufactures a range of products for industrial markets, including
high-performance specialty adhesives and coatings for automotive, aerospace,
recreational vehicle, manufactured housing, air handling and transportation
textile applications. Our Commercial segment also manufactures coating and
adhesive products for packaging, paper converting and graphic arts applications.
Our Construction segment manufactures branded caulk, sealants and adhesives for
professional contractors and do-it-yourself applications. We plan to continue
our growth through a combination of new product development, leveraging
technology across business units, continued market penetration, international
expansion and, in the longer term, strategic equity financed acquisitions.

DEVELOPMENTS

During 2002, we made significant strategic progress by initiating
aggressive action in a number of areas. We increased productivity through
further manufacturing actions, including the implementation of lean
manufacturing initiatives at most of our facilities, improved warehouse
logistics and product line rationalization. Key areas of focus were and continue
to be, containing costs, reorganizing sales approach and capturing business
development opportunities. We continue our focus on standardizing business
processes and corporate identity to reduce internal and external complexity.

A key management focus was on working capital improvement, debt reduction
and improved liquidity to allow us to focus on improving our core business
through productivity and internal growth initiatives. During 2002, we reduced
total debt by approximately $28.3 million from year end 2001 and in December
2002, we amended our credit agreement to, among other things, refinance
substantial portions of our required term loan amortization over the next two to
three years with new credit agreement indebtedness with a longer term. We
reduced inventory and accounts receivable levels by approximately $16.0 million
combined year over year.

In 2002, we bolstered our management team. In early 2002, we hired a new
President and Chief Operating Officer, John R. Knox, who has extensive industry
experience. In July, we announced that Norman E. Wells, Jr. was appointed as our
Chief Executive Officer. Robert B. Covalt continued in his position as Chairman
of the Board of Sovereign through December 31, 2002. Mr. Wells has historically
had success leading middle market companies through the development of strategic
and operating plans, which have resulted in accelerated debt reduction,
operating cost improvements and top-line growth. Mr. Wells has served on our
Board of Directors since 1999 and both Mr. Wells and Mr. Covalt will continue to
serve on our Board of Directors. In late 2002, John Mellett, our Chief Financial
Officer, decided to leave us and was replaced by Terry D. Smith following a
transition period.

In November 2002, we announced plans to close two of our higher-cost
manufacturing plants. The first plant is located in Cincinnati, Ohio and
primarily produces water-borne adhesives sold to the industrial market.
Production from this plant will be transferred to Sovereign's plants in
Greenville, South Carolina, and Carol Stream and Plainfield, Illinois
progressively over the next nine months. Also housed in Cincinnati are
technical, sales support, customer service, and administrative functions some of
which will be transitioned to our other locations during 2003. The second plant,
located in Kapellen, Belgium, produces water-borne and
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hot-melt adhesives for the European packaging and converting market. This
production will be shifted to the Newark, United Kingdom plant during the first
half of 2003. The Kapellen facility will continue to provide sales, technical
and distribution support to continental Europe.

There were disappointments in 2002, primarily related to the economic
environment. Our financial performance fell short of management's expectations.
We continued to experience challenging specialty chemical industry conditions,
with end-market demand down in many of the applications sold through our
Commercial segment. On the other hand, the Construction segment performance was
aided by stable housing market and gains in the retail do-it-yourself market.

We believe that our ongoing initiatives, together with the actions we have
taken in 2002 have positioned us to continue our goal of top-line growth driven
by the leveraging of technologies, expanding geographic reach and utilizing
existing customer relationships to create customers for other products in the
our portfolio.

INDUSTRY OVERVIEW

The adhesives, sealants and coatings segment of the specialty chemicals
industry is a large global segment, which has historically exhibited strong
stable growth. Total sales for the adhesives, sealants and coatings segment in
the United States were approximately $29.0 billion in 2002 and $28.0 billion in
2001. This was an increase of 4.3% from 2001 levels. Over the next five years
the segment is forecasted to grow at an average annual rate of 7.5% per year.
Adhesives are replacing mechanical fasteners in many manufacturing processes,
and adhesives and sealants can reduce weight and parts requirements and provide
superior performance characteristics such as protection against corrosion and
vibration. In addition, we expect international sales of adhesives, sealants and
coatings to grow due to increased use in developing markets.

Adhesives, sealants and coatings are used in a wide range of products with
applications in numerous categories, including

- Industrial. Typical industrial applications include corrosion resistant
industrial coatings, general assembly adhesives, fire-retardant textile
coatings, coatings for electronic components and industrial lamination
adhesives.

- Automotive. Automotive applications include primers and top coats, body
sealants, structural adhesives and interior and exterior trim adhesives.

- Packaging. Packaging applications include portion packaging and flexible
consumer packaging films and foils, seam sealers and container coatings.

- Aerospace. Aerospace applications include commercial, military and
general aviation coatings, composite bonding adhesives and structural
epoxies.

- Construction. Typical construction applications include
contractor-applied architectural coatings, joint sealants and flooring
and roofing adhesives.

- Consumer. Consumer applications include various consumer-applied
adhesives such as white glues, caulks and sealants, architectural
coatings and miscellaneous do-it-yourself sealing applications for
bathtub and kitchen fixtures.

We participate in the industrial, automotive, packaging and aerospace
categories through our Commercial segment and in the construction and consumer
categories through our Construction segment.

The U.S. adhesives, sealants and coatings segment is highly fragmented with
over 500 companies, a significant majority of which we believe are small and
regional. While smaller companies have successfully competed in market niches,
the industry is expected to consolidate as companies seek to enhance operating
efficiencies in new product development, sales and marketing, distribution,
production and administrative overhead. Larger specialty chemicals companies
also benefit through a greater diversification of end-use applications,
customers, technologies and geography, reducing the impact of industry or
regional cyclicality.

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Long term future growth for the U.S. adhesives, sealants and coatings
segment is expected to result from the following factors:

New Markets and More Stringent Demands of End-Users. Adhesives and
sealants are increasingly being used in new applications, particularly in the
transportation and construction sectors, as end-users desire simpler design and
manufacture, lower costs, improved bonding, lower weight, and reduced vibration
and corrosion. For example, in the bonding of automotive window glass to steel
body panels, high-performance adhesives provide structural reinforcement to the
adjacent steel panels, thus providing additional integrity to the car body. In
highway construction, new, long-lasting sealants are replacing traditional
bitumen, a traditional sealant used between adjacent slabs of concrete and other
materials that exhibit poor longevity.

New Materials. The growing use of nonferrous parts including aluminum and
plastics in car bodies, appliances, buildings and other fabricated goods
requires the use of adhesives that are specially formulated to bond dissimilar
materials. On these substrates, traditional mechanical fasteners are frequently
not suitable.

International Sales. International sales of adhesives, sealants and
coatings are also expected to grow due to increased use of these products
internationally. Total worldwide sales for adhesives, sealants and coatings were
approximately $94.0 billion in 2002 and $91 billion in 2002. In 2001, the United
States accounted for approximately 31% of worldwide sales, while Europe
accounted for approximately 33% of worldwide sales and Japan accounted for
approximately 10% of worldwide sales. Sales to the remainder of the world
accounted for approximately 26% of total segment sales. Growth is expected in
developing markets, particularly in the Far East, Eastern Europe and Latin
America.

COMPETITIVE STRENGTHS

We believe we have the following competitive strengths:

Leadership Positions in Attractive Market Niches. We enjoy leadership
positions in growing, value-added market niches as a result of our
customer-driven product development, reputation for quality, high levels of
customer service and brand name recognition. Our brand and trade names are
particularly well recognized among our customers, and include OSI(R),
Pro-Series(R), PL(R), Polyseamseal(R), Miracure(R), Plastilock(R), Latiseal(TM),
Dualite(R), Hybond(R), Proxseal(TM), Primaseal(TM), Primalam(TM), Avadyne(TM),
Bondrite(TM), NailPower(TM) and Proxmelt(TM). We believe our leadership
positions, technological expertise and strong customer relationships provide us
with meaningful advantages in the development of new products and the
penetration of new market niches.

Technological Expertise. We are a technology leader within many of the
markets we serve. Our current technology portfolio, comprising numerous
customized and proprietary formulations with unique performance characteristics,
provides us with a broad technological base to satisfy our customers'
requirements. We continually leverage our technological expertise to develop new
products and additional applications for existing product formulations. In
addition, we have enhanced our technological expertise both through cooperative
research and development efforts and joint technological alliances with
world-class suppliers, and customers.

Strong Customer Relationships. Our business teams work hand-in-hand with
our customers to develop innovative, high-performance solutions to satisfy
current and future needs. By directly involving customers in the product
development process, we strengthen our relationships with them and are better
able to develop products that will add value to their businesses. We sell our
products to some of the world's largest companies, including Airbus Industries,
Baxter International Inc., Bemis, The Boeing Company, General Motors
Corporation, The Home Depot, Inc., International Paper Company, Johns Manville
Corporation, Lowe's Companies, Inc. and RR Donnelly. Many of our industrial,
overprint coatings and flexible packaging products have been certified through
rigorous, customer-specific technical and regulatory approval processes. Once
our products have been approved, our customers are often unwilling to switch to
another supplier because of the significant costs involved. Our relationships
with retailers and professional distributors of our housing repair, remodeling
and construction products are strengthened by our broad product line, strong
brands and reputation for quality.

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Broad Product Offerings and Diverse Customer Base. We manufacture over
5,000 products that are sold through multiple distribution channels to over
6,000 customers for a wide variety of applications. In 2002, no single customer
accounted for over 4% of our net sales, and our top 20 customers accounted for
less than 20% of our net sales. This diversity of customers, products and
distribution channels provides us with a broad base from which to increase sales
and expand customer relationships, and limits our exposure to any particular
customer, end market or geographic region.

Strong Management Team. Our strong management team averages nearly 18
years experience in the specialty chemicals industry. Current members of
management and our Board of Directors hold approximately 14.1% of our equity on
a fully diluted basis. As part of our philosophy, management seeks to foster an
entrepreneurial environment, which empowers employees and encourages and rewards
individual initiative. This philosophy has been successful in generating
top-line growth. Since inception, our management team has successfully executed
and integrated ten strategic acquisitions. From 1996 to 2002 we increased our
annual net sales from $37.8 million to $361.1 million through acquisitions and
internal growth.

BUSINESS STRATEGY

Continued Focus on Niche Products in Attractive Markets. We will continue
to develop product offerings for value-added, end-use applications with
attractive growth prospects, including

- structural adhesives

- coating and adhesives systems for graphic arts applications

- flame-retardant adhesives and coatings

- food and medical packaging adhesives and coatings

- environmentally friendly products

Emphasize Cash Flow Improvements. We continue to target working capital
improvement through improved accounts receivable collection, optimization of
inventory management, consolidation of warehouses and rationalization of product
lines.

Accelerate New Product Pipeline. We deploy our research and development
resources to align with the most promising growth opportunities. We assign
technical experts by chemistry and market to leverage our broad product
portfolio. We are seeking to shorten the time it takes to bring new products to
our customers.

Achieve Significant Operating Efficiencies. We believe we can continue to
achieve operating efficiencies resulting in enhanced performance, cost savings
and improved cash flow through:

- lowering working capital levels by optimizing SKU counts, better
management of inventory and improving customer receivable collections

- improving manufacturing and distribution operations, through lean
manufacturing initiatives and recently announced facility
rationalizations

- cross-selling our products across the broader distribution and customer
network that we have developed through our acquisitions

- improving freight logistics to lower our costs.

Increase International Presence. We believe we have significant
opportunities in international markets to increase sales to existing
multinational customers, enter developing markets and establish new customer
relationships. While sales of adhesives, sealants and coatings outside the
United States in 2002 represented approximately $64.6 billion or 69% of the
worldwide market, our net sales outside the United States represented
approximately 13% of our net sales for 2002. In addition, international sales
are expected to benefit from the increased use of adhesives, sealants and
coatings in developing markets. We have expanded our global sales, particularly
in Europe and Latin America complemented by our manufacturing operations in
Mexico, Brazil, the United Kingdom and Belgium. We have announced the closing of
the Belgium facility in 2003 in order to consolidate production and reduce
costs. In addition, we have sales and technical offices in the

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U.K., Italy, Canada, Sweden, France, Switzerland and Singapore. The principal
office for our European operation is in the U.K.

Pursue Strategic Acquisitions. We have successfully grown through
acquisitions and, although our near term strategy revolves around optimizing our
existing resources, our long-term strategy is to continue to pursue additional
strategic acquisitions that will allow us to further increase sales in targeted
markets. We believe that the high degree of fragmentation in the global
adhesives, sealants and coatings segment will continue to provide suitable
acquisition candidates.

Potential acquisition candidates will be evaluated based upon our ability
to:

- expand existing product lines and customer relationships

- enhance our product development capabilities

- market products through new or expanded distribution channels

- increase utilization of available manufacturing capacity

- generate cost savings

- augment our technology portfolio

- open new market opportunities

SEGMENT REPORTING

We have two reportable segments: the Commercial segment and the
Construction segment. The table below sets forth the primary product
applications as categorized within our reportable segments:

COMMERCIAL SEGMENT:

Industrial applications sold by our Commercial segment consist primarily of
high-performance, specialty adhesives and coatings for automotive, aerospace,
manufactured housing and textile applications. We often develop structural
adhesives in conjunction with the technical staff of our customers and they are
used in many demanding automotive applications which include brake bonding and
body panel assembly. Our aerospace bonding films are used to bond composite
structures in commercial aircraft and meet rigid performance requirements. In
addition, we manufacture and market microspheres, including Dualite(R), a
lightweight inert filler that can both reduce the weight and enhance the
strength of products to which it is added. Our customers include Airbus
Industries, Baxter International Inc., The Boeing Company, General Motors
Corporation, Johns Manville Corporation, Milliken & Company, Forest River and
The Stanley Works.

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This segment also produces flexible packaging adhesives including:
heat-activated lidding adhesives used to apply flexible paper or foil lids to
plastic tubs used in the food industry, including individually packaged
condiments, creamers and cream cheese tubs; film-to-film adhesives used to bond
different types of plastic film, such as metalized and moisture barrier films
used in snack food bags; foil or paper blister packaging for products such as
pharmaceuticals, batteries, toys and tool accessories; and medical packaging
adhesives. We produce a variety of high quality, high gloss, scratch and
abrasion resistant coatings used on paperback book and magazine covers,
decorative packaging, annual reports, catalog covers, and playing and trading
cards. We are a leading manufacturer of coatings for paperback book covers and
trading cards. Overprint coatings customers include printers, custom coaters and
magazine manufacturers.

CONSTRUCTION SEGMENT:

Through this segment, we manufacture and sell housing repair, remodeling
and construction sealants and adhesives used in exterior and interior
applications. We are a leader in aluminum and vinyl siding sealants as well as
kitchen and bath sealants, offering ease of use, durability and color match
capabilities. These products are marketed for do-it-yourself retail and
professional applications. We offer a broad range of well-established branded
products including PL(R) and Polyseamseal(R) for retail do-it-yourself
applications and Pro-Series(R) and PL(R) for professional applications.

SALES AND MARKETING

We operate an extensive sales and marketing network for our customers. This
network consists of a direct sales force of over 100 professionals, as well as
independent agents and distributors. This network works closely with customers
to satisfy existing product needs and to identify new applications and product
improvement opportunities. Our sales efforts are complemented by our product
development and technical support staff, who work together with the sales force
to develop new products based on customer needs. We augment our direct sales and
marketing coverage through a network of distributors and independent agents who
specialize in particular areas. This specialization allows our applications to
gain access to a broader range of distribution channels and end users and
further strengthens our brand names.

Our sales and marketing efforts and customer relationships are further
enhanced by the numerous customer-specific technical approvals we have secured.
These approvals typically involve significant customer time and effort and
result in a strong competitive position for qualified products. Once qualified,
products are often referenced in customer specifications or qualified product
lists. These qualification processes also reinforce the partnership between us
and our customers and can lead to additional sales and marketing opportunities.

TECHNOLOGY

We maintain a strong commitment to technology, with over 90 chemists and
chemical engineers focused on the development of new products and processes. We
work hand-in-hand with our business teams and customers to develop innovative,
high-performance solutions to satisfy current and future needs. This methodology
of involving the customer throughout the product development process enhances
the creation of products that will add value to our customers' businesses.

During the past several years, we have focused our research and development
efforts on the development of high performance, environmentally safe products.
This effort has led to a broad range of technologies and applications,
including:

- high temperature resistant, reactive hot melt used in industrial
construction applications

- reactive epoxy liquid used as structural bonding adhesive in truck bed
assembly

- acrylated epoxy ultraviolet/electron-beam curable systems used as
coatings for multi-wall bags that allow bags to be stacked without
slipping while greatly enhancing their appearance

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- pre-formulated dispersions that function as medical packaging adhesives,
fiber locking binders, and food packaging lidding adhesives

- advanced toughened epoxy systems used to bond plastics, composites and
metals in both automotive and aerospace construction

Our technical activities are further enhanced through alliances with key
industry suppliers and large multi-national customers. These include BASF AG,
Baxter International Inc., The Boeing Company, The Dow Chemical Company, E.I. du
Pont de Nemours and Company, General Motors, and Johns Manville Corporation,
among others.

We hold approximately 10 patents and trademarks, primarily in the U.S. Our
products include a wide variety of technology, some of which is protected, some
of which is not. No one patent or trademark or group of patents or trademarks is
material to our business. Our patents and qualified formulations, in combination
with our customer integrated approach to product and application design, should
enhance our ability to create a sustainable, competitive advantage in the next
several years. We have several brands and trademarks that are well recognized by
customers, including OSI(R), Pro-Series(R), PL(R), Polyseamseal(R), Miracure(R),
Plastilock(R), Latiseal(R), Dualite(R), Hybond(R), Proxseal(TM), Primaseal(TM),
Primalam(TM), Avadyne(TM), Bondrite(TM), NailPower(TM), and Proxmelt(TM).

COMPETITION

The adhesives, sealants and coatings segment of the specialty chemicals
industry is highly competitive. This segment is highly fragmented, with over 500
manufacturers ranging from small regional companies to large multinational
producers. No one company holds a dominant position on a national basis and very
few compete across all levels of our product line. Our competitors include Ciba
Specialty Chemicals, Cytec Industries Inc., GE Sealants and Adhesives (a unit of
General Electric Company), H.B. Fuller Company, Imperial Chemical Industries
Plc., Rohm & Haas Co. and RPM Incorporated. Competition is generally regional
and is based on product quality, technical service for specialized customer
requirements, breadth of product line, brand name recognition and price. Some of
our competitors are larger, have greater financial resources and are less
leveraged than we are. As a result, these competitors may be better able to
withstand a change in market conditions within the specialty chemical industry
and throughout the economy as a whole. These competitors may also be able to
maintain significantly greater operating and financial flexibility than we can.

EMPLOYEES

As of December 31, 2002, we had 930 employees, of whom 149 were members of
unions under contracts which expire between 2004 and 2006. Approximately 775 of
our employees are employed in the U.S. and approximately 155 are employed
internationally. We believe that our relations with our employees are good. As
of December 31, 2001, we had 1,007 employees.

ENVIRONMENTAL MATTERS

We are subject to extensive laws and regulations pertaining to air
emissions, waste water discharges, the handling and disposal of solid and
hazardous wastes, the remediation of contamination, and otherwise relating to
health, safety and protection of the environment. Our operations and the
environmental condition of our real property could give rise to liabilities
under these laws, which could result in material costs.

In connection with our acquisitions, we have performed substantial due
diligence to assess the environmental liabilities associated with acquired
businesses and have negotiated contractual indemnifications, which, supplemented
by commercial environmental insurance coverage, is currently expected to
adequately address a substantial portion of known and foreseeable environmental
liabilities. We do not currently believe that environmental liabilities will
have a material adverse effect on our business, financial condition or results
of operations. We cannot be certain, however, that indemnitors or insurers will
in all cases meet their obligations or that the discovery of presently
unidentified environmental conditions, or other unanticipated events, will not
give rise to expenditures or liabilities that may have a material adverse
effect.

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In connection with soil and groundwater contamination resulting from
historic operations under prior ownership of our Greenville, South Carolina
facility, in November 1994, the former owner of the business entered into a
consent agreement with the South Carolina Department of Health and Environmental
Control that requires the successors to complete investigation and remediation
of soil and groundwater contamination at the site. These activities are
currently projected to cost approximately $2.0 million, $1.5 million of which
had been spent by December 31, 2002. We are indemnified by the former owner with
respect to this matter, as well as certain other known and unknown pre-closing
environmental liabilities, subject to an overall limit well in excess of the
currently estimated cost of cleanup. The former owner has agreed to conduct and
finance the investigation and remediation of this matter.

Our facility located in Akron, Ohio is part of a larger industrial complex
formerly operated by The B.F. Goodrich Company, the prior owner of SIA
Adhesives, Inc. The B.F. Goodrich Company, as part of a voluntary cleanup
agreement with the Ohio Environmental Protection Agency, is conducting an
assessment of soil and groundwater contamination throughout the entire complex.
In connection with our 1996 acquisition of SIA Adhesives, Inc., The B.F.
Goodrich Company agreed to indemnify us with respect to this matter (as well as
other known and unknown pre-closing environmental liabilities).

In connection with the 1996 acquisition of Pierce & Stevens Corp., our
environmental due diligence detected conditions of subsurface contamination
primarily associated with storage tank farms and at various other areas of the
Pierce & Stevens Corp. facilities. Our current estimated total cost of
investigation and remediation is approximately $5.0 million. This amount could
be higher, depending upon the extent of required remediation. In connection with
the acquisition, The Sherwin-Williams Company agreed to indemnify us with
respect to this and other environmental and non-environmental pre-closing
liabilities, subject to a $9.0 million overall limit and has already paid us for
all our expenses related to these facilities, which has totaled greater than
$4.0 million to date. We have entered into a voluntary agreement with the New
York State Department of Environmental Conservation with regard to the Buffalo
facility remediation. Completion of the majority of this project is expected in
2003, with full funding of the estimated additional $0.8 million cost by Sherwin
Williams.

As part of our Imperial Adhesives Inc. acquisition, we acquired our
Cincinnati, Ohio and Nashville facilities. At our Cincinnati facility we are
conducting a voluntary soil and groundwater remediation project over a period of
several years. This project is currently estimated to cost $1.0 million. The
former owner of the site will contribute approximately two thirds of the cost of
this project. If costs exceed $1.5 million, insurance totaling $10.0 million is
available. PCB soil contamination issues, currently estimated to cost $0.2 to
$0.3 million, are fully indemnified by the former owner. We have voluntarily
assumed the estimated $0.1 million cost of for the closure of seven,
non-hazardous substance, underground storage tanks subsequent to the ceasing of
production in July 2002.

Imperial Adhesives Inc. has been identified as a "PRP" (potentially
responsible party) with regard to the remediation of a drum
reconditioning/disposal site. Imperial Adhesives Inc. settled for $0.04 million
with the U.S. EPA as a "de minimus contributor" for the remedial investigation
and feasibility study costs (RIFS). Our additional clean up cost liability is
capped at $0.07 million by the former owner.

As part of our acquisition of the Croda International Plc. adhesives
business, we acquired our Kapellen, Belgium and Newark on Trent, United Kingdom
facilities. Soil and groundwater at the Kapellen facility is contaminated with
various solvents. The former owner of the site had initiated an investigation,
which lead their consultant to believe that natural attenuation of this
contamination might be one of the feasible options. However, in the event that
active remediation is necessary, our consultant has estimated a cost of $0.7
million. The cost of this remediation is covered by a guarantee from Croda
International Plc. to the Belgian authority. Indemnification is available for
this matter from Croda International Plc., subject to certain thresholds,
deductibles, caps and cost-sharing arrangements described in the Croda
International Plc. acquisition agreement. In addition, under that agreement,
Croda International Plc. has retained responsibility for compliance with the
applicable Flemish statute on soil clean up and any other applicable laws
concerning the transfer of the Kapellen facility.

Regarding the Newark On Trent, facility in the United Kingdom, potential
issues related to soil and groundwater remediation, tank containment
improvements and site investigation monitoring were identified.
8

Indemnification from Croda International Plc. is available for the remediation
of this matter, and others (if required), subject to certain thresholds,
deductibles, caps and cost-sharing arrangements described in the Croda
International Plc. acquisition agreement.

As is the case with manufacturers in general, if a release of hazardous
materials occurs at real property owned or operated by us or our predecessors or
at any off-site disposal location utilized by us or our predecessors, we may be
held strictly, jointly and severally liable for cleanup costs and natural
resource damages under the federal Comprehensive Environmental Response,
Compensation, and Liability Act and similar environmental laws. Typically,
liability at such sites is shared by all of the viable responsible parties based
on their relative contribution of waste to the site. We have been named
potentially responsible parties under these laws for cleanup of approximately
fifteen multi-party waste disposal sites, the liability for several of which has
been resolved, subject to standard terms, including the ability to reopen the
matter, found in these kinds of settlements. Due to what we currently believe is
our relatively minor contribution of waste to these sites, we do not believe
that our liability with respect to these sites will have a material adverse
effect on our business, financial condition or results of operations. In
addition, the agreements with former owners of our business include
indemnification for these issues.

We do not currently believe that capital expenditures relating to achieving
compliance with environmental regulations will have a material adverse effect on
our business, financial condition or results of operations. However,
environmental laws are constantly evolving and we cannot predict accurately the
effect they may have upon our capital expenditures, cash flow or competitive
position in the future. Should these laws become more stringent, the cost of
compliance would increase. If we cannot pass on future costs to our customers,
such increases may have an adverse effect on our business, financial condition
or results of operations.

RAW MATERIALS

We use a broad variety of specialty and some commodity raw materials in our
manufacturing processes. In 2002, the company purchased about $195 million of
raw materials including acrylic monomers and polymers, resins, natural and
synthetic rubbers, solvents, and urethanes. Although these raw materials are
derived from crude oil or natural gas, the raw materials used by us are several
manufacturing steps removed (downstream) from these basic feedstocks. The price
of oil and gas will affect our costs for these raw materials both upward and
downward, but the magnitude of change is diluted.

We typically purchase strategic raw materials on a contract basis to
moderate price changes during the contract period, however, prices can change
significantly at the end of contract periods if supply shortages, feedstock cost
pressures, or other unforeseen market events occur. Commodity raw materials are
available from numerous independent suppliers, and specialty raw materials are
usually available from several suppliers.

We expect the cost of many raw materials to increase during 2003 and in the
long term. In aggregate, we have been successful historically in passing on raw
material cost increases through selective price increases to our customers over
time, but under certain competitive market conditions we may not be able to
continue to do so in the future or we may not be able to do so as to maintain
margins.

BACKLOG

Most orders for our products are received and shipped in the same month.
Total backlog orders at December 31, 2002 were approximately $10.0 million. All
2002 backlog orders are expected to be filled within the current year. Backlog
orders at December 31, 2001 were $12.0 million.

GEOGRAPHIC FINANCIAL INFORMATION

For information regarding the allocation of our revenue and long lived
assets among the U.S. and our international markets, see Note 15 to the
Consolidated Financial Statements.

PRODUCTION

The production of adhesives, sealants and coatings is a multi-stage process
which involves extensive formulation, mixing and, in some cases, chemical
synthesis. Following one or more of these processes, the
9

product is packaged in totes, drums, pails, cartridges or other delivery forms
for sale based upon the customer's requirements. Our principal manufacturing
processes are blending, polymerization, extrusion and film coating. Blending
consists of dissolving or dispersing various compounds in organic solvents,
water or solvent-free systems. In polymerization, vinyl, acrylic and urethane
polymers are synthesized in closed reactor systems. Extrusion consists of
feeding formulated materials through an extruder to compound pressure sensitive
and hot melt products. Film coating consists of transferring blended
formulations onto release paper or polyethylene liners to produce thin films of
pressure sensitive, hot melt and epoxy products. Many of our manufacturing
processes can be performed at more than one of our facilities.

ITEM 2. PROPERTIES

We operate the manufacturing plants and facilities described in the table
below. Management believes that our plants and facilities are maintained in good
condition and are adequate for its present and estimated future needs.

Listed below are the principal manufacturing facilities that we operate.

- ---------------

(1) All of our owned facilities are subject to mortgages pursuant to our credit
agreement. In addition, the Seabrook, New Hampshire/Salisbury, Massachusetts
property is subject to mortgages relating to the financing of the
acquisition of the property.

(2) Lease expires December 31, 2008.

(3) Lease expires December 31, 2004.

(4) Lease expires December 31, 2014.

Our executive offices are located in Chicago, Illinois. We also have sales
and technical offices in Singapore, United Kingdom, Canada, Sweden, France,
Italy and Brazil.

ITEM 3. LEGAL PROCEEDINGS

We are a party to various litigation matters incidental to the conduct of
our business. We do not believe that the outcome of any of the matters in which
we are currently involved will have a material adverse effect on our financial
condition or results of operations.

10

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None.

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

As of March 14, 2003, we had 96 holders of record of voting common stock
and 2 holders of record of non-voting common stock. There is no public trading
market for our equity securities. We have not historically declared dividends
and do not anticipate paying cash dividends on common stock in the foreseeable
future. Any future determination as to the payment of dividends will be made at
the discretion of the Board of Directors and will depend upon our operating
results, financial condition, capital requirements, general business conditions
and such other factors as the Board of Directors deems relevant. Our debt
instruments include certain restrictions on the payment of cash dividends on our
common stock.

11

ITEM 6. SELECTED FINANCIAL DATA

SELECTED HISTORICAL FINANCIAL DATA

The following table presents our selected historical financial data at the
dates and for the periods indicated. The data for each of the years presented
are derived from our audited financial statements. The information set forth
below should be read in conjunction with our consolidated financial statements
and related notes and "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and other financial information included
elsewhere herein.

- ---------------

(1) Extraordinary losses relate to the write-off of deferred financing costs and
any associated premiums paid as a result of the early extinguishment of
debt.

(2) Cumulative effect of change in accounting principle relates to the write-off
of goodwill, net of income tax benefit, as a result of the adoption of SFAS
142, "Goodwill and other Intangible Assets".

12

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

The following discussion and analysis is provided to increase the
understanding of, and should be read in conjunction with, the consolidated
financial statements and accompanying notes included herein.

GENERAL

We were formed to acquire and consolidate adhesives, sealants and coatings
businesses in the highly fragmented adhesives, sealants and coatings business
segment of the specialty chemical industry. We have grown through the
acquisition and integration of businesses. From 1996 to 2002, we increased
annual net sales through acquisitions and internal growth from $37.8 million to
$361.1 million. We plan to continue our growth through a combination of new
product development, continued market penetration, international expansion, and
in the longer term, strategic acquisitions.

This table describes the acquisitions since inception in March 1996.

13

- ---------------

(1) The companies acquired from Laporte Plc. comprised Laporte Construction
Chemicals North America, Inc., which was renamed OSI Sealants, Inc. and
Evode-Tanner Industries, Inc., which was renamed Tanner Chemicals, Inc.

The operating results of acquired businesses have been included in our
consolidated operating results for all periods after their respective dates of
acquisition.

SUMMARY OF CRITICAL ACCOUNTING POLICIES

The discussion and analysis of our financial condition and results of
operations are based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires us to make
estimates and judgments that affect the reported amounts of assets, liabilities,
revenues and expenses, and related disclosure of contingent assets and
liabilities. On an ongoing basis, we continually evaluate our estimates. We base
our estimates on historical experience and on various other assumptions that are
believed to be reasonable under the circumstances, the results of which form the
basis for making judgments about the carrying values of assets and liabilities
that are not readily apparent from other sources. Actual results may differ from
these estimates.

We believe the following critical accounting policies affect our more
significant judgments and estimates used in the preparation of our consolidated
financial statements.

Revenue Recognition. Revenue is recognized when products are shipped to
the customer and title transfers.

Cost of Goods Sold. Cost of goods sold represents the actual cost of
purchased raw materials, direct and indirect labor, warehousing and
manufacturing overhead costs, including depreciation, utilized directly in the
production of products for which revenue has been recognized.

Selling, General & Administrative Expenses. Selling, general &
administrative expenses generally are those costs not directly related to the
production process and include all selling, marketing, research and development
customer service expenses as well as expenses related to general management,
finance and accounting, information services, human resources, legal and
corporate overhead expense.

Goodwill. Goodwill represents the excess of acquisition cost over the fair
value of net assets acquired and was being amortized using the straight-line
method over periods ranging from 15 to 25 years through December 31, 2001.
Accumulated amortization of goodwill was $30.1 million at December 31, 2001. On
January 1, 2002, the Company adopted SFAS No. 142, Goodwill and Other Intangible
Assets, which eliminated the amortization of goodwill and instead required that
goodwill be tested for impairment at least annually.

Reserve for Inventory Obsolescence. Our estimated reserves for
obsolescence or unmarketable inventory is equal to the difference between the
cost of the inventory and the estimated market value based upon assumptions
about market conditions, future demand and expected usage rates. We periodically
review inventory and if applicable, record additional inventory writedowns. If
actual market conditions are less favorable than those projected by management
and cause usage rates to vary from those estimated, additional inventory
write-downs may be required, however these would not be expected to have a
material adverse impact on our financial statements.

Allowance for Doubtful Accounts. We maintain allowances for doubtful
accounts for estimated losses resulting from the failure of our customers to
make required payments. We evaluate the adequacy of our allowance for doubtful
accounts and make judgments and estimates in determining the appropriate
allowance at each reporting period. If a customer's financial condition were to
deteriorate, additional allowances may be required.

14

SEGMENT REPORTING

We have two reportable segments: the Commercial segment and the
Construction segment. Applications sold by the Commercial segment consist
primarily of high performance, specialty adhesives and coatings for automotive,
aerospace, manufactured housing , textile applications, flexible packaging
adhesives and coatings for a number of applications. Through the Construction
segment, we manufacture and sell housing repair, remodeling and construction
sealants and adhesives used in exterior and interior applications.

We evaluate the performance of each segment based on operating income.
Segment profit is calculated as a reportable segment's operating income. Total
segment profits exceed consolidated operating profits to the extent of
unallocated corporate expenses included in selling, general and administrative
expenses. Unallocated corporate expenses were $12.5 million, $9.7 million, and
$6.8 million for the years ended December 31, 2002, 2001, and 2000,
respectively.

RESULTS OF OPERATIONS

2002 COMPARED TO 2001

Net Sales. Net sales were $361.1 million in 2002, an increase of $4.4
million, or 1.2% over 2001 net sales of $356.7 million. The increase was due to
gains in the Construction segment, which were partially offset by a decrease in
net sales from the Commercial segment. Construction segment sales were $121.0
million in 2002, up $9.7 million, or 8.7% from the prior year reflecting a good
housing market and gains in the retail do-it-yourself market. Commercial segment
sales were $240.1 million in 2002, down $5.3 million, or 2.2% from the prior
year due to declines in a number of end markets including aerospace, furniture
and graphic arts, particularly high-end printing applications end markets. Sales
levels were also negatively affected by continued general economic weakness in
the United States during the year.

Cost of Goods Sold. Cost of goods sold was $259.8 million in 2002, an
increase of $0.5 million, or 0.2% over 2001 cost of sales of $259.3 million.
Gross profit as a percentage of net sales increased in 2002 to 28.1% from 27.3%
in 2001. The increase in gross profit as a percentage of net sales was due
primarily to two factors. First, we experienced decreases in certain raw
material costs primarily in the first half of the year from the prior year.
Second, as a result of productivity initiatives, including implementation of
lean manufacturing and the full year benefit during the current year of plant
closures completed during the year ended December 31, 2001, manufacturing
expenses decreased. These positive factors were offset partially by the effect
of a shift in sales mix to lower margin products. Lower sales in our aerospace
business, which carries higher than average margins for our products, was a
contributor to this shift.

Selling, General and Administrative Expenses. Selling, general and
administrative expenses were $76.0 million in 2002, an increase of $8.0 million,
or 11.8% from 2001 expenses (excluding goodwill amortization) of $68.0 million.
As a percentage of net sales, selling, general and administrative expenses
increased to 21.0% for 2002 from 19.1% in 2001. This increase was due primarily
to a $4.1 million provision recorded relative to the announced closures of our
facilities in Cincinnati, Ohio and in Kapellen, Belgium. In addition,
contributing to the increase were: the costs of additions to our management
team, including $0.4 million of costs not expected to occur in the future; $0.5
million of professional fees related to financing alternatives; higher insurance
expenses, $1.2 million incurred as a result of the reorganization of our senior
management and of management of businesses in our Commercial segment and $0.9
million of outside consulting costs related to implementation of lean
manufacturing practices at many of our manufacturing locations in 2002.

For financial reporting purposes, we have added a line to our income
statement to segregate the impact of the adoption of SFAS No. 142 and the
discontinuation of goodwill amortization expense. Amortization of goodwill for
the year ended December 31, 2001 was $10.0 million. The elimination of goodwill
amortization contributed greatly to the $6.0 million increase in operating
income over the prior year.

Interest Expense. Net interest expense was $25.5 million in 2002 and $27.0
million in 2001. The decrease in interest expense was due primarily to a
decrease in the weighted average interest rate on our variable rate debt to 5.7%
from 7.1% and lower average debt levels partially offset by increased
amortization of deferred financing costs. In December 2002, we refinanced $45.1
million of borrowings under our existing term
15

loan under our credit agreement with $47.5 million of borrowings under a new
term loan facility. The applicable margin or "spread" on the new term loan
facility is 75 basis points higher than the applicable margin that was in effect
for the existing term loan during most of 2002. As a result, in the absence of
continued decreases in the interest rates on which our variable rate debt is
based, we will expect to have an increase in the weighted average interest rate
of our variable rate debt in 2003.

Income tax expense (benefit). Income tax expense was $0.3 million in 2002.
Income tax benefit was $1.5 million in 2001. Although we have stopped recording
goodwill amortization for financial reporting purposes, we continue to be able
to deduct a portion of goodwill amortization expense for income tax purposes.

Net income (loss) before cumulative effect of change in accounting
principle. Net loss before the cumulative effect of change in accounting
principle for the year ended December 31, 2002 and 2001 was $0.4 million and
$6.0 million, respectively. The decrease in loss from the prior year is
primarily related to the $10.0 million of goodwill amortization not recorded in
2002 as a result of the adoption of SFAS No. 142, partially offset by the
provision for announced plant closures of $4.1 million.

Cumulative effect of change in accounting principle. In connection with
our completion of the transitional goodwill impairment test required by SFAS No.
142, we have recorded a $27.6 million ($17.1 million, net of income tax benefit)
goodwill impairment loss and write-down of goodwill associated with our European
reporting unit. Our assessment of our goodwill impairment for this reporting
unit is reflective of both lower operating performance in Europe and the use of
lower market multiples. The carrying value of goodwill associated with our other
reporting units was not impaired.

COMMERCIAL SEGMENT

The following table presents net sales and segment profit expressed in
millions of dollars and segment profit margin, which is segment profit expressed
as a percentage of net sales:

Net segment sales were $240.1 million in 2002, representing a $5.3 million
decrease from 2001. This decrease was due primarily to declines in a number of
end markets including aerospace, furniture, and graphic arts, particularly
high-end printing applications. Segment profit was $19.8 million for the year
ended December 31, 2002, representing a $2.6 million or 11.6% decrease from the
prior year $22.4 million segment profit excluding goodwill amortization. The
decrease in segment profit resulted primarily from a $4.1 million provision for
the closure of our Cincinnati, Ohio and Kapellen, Belgium facilities discussed
below and, to a lesser extent, from lower sales volume and a shift in sales mix
to products with lower profit margins. These factors were partially offset by a
decrease in expenses attributable to management's focus on cost containment, the
full year benefit in 2002 of the 2001 plant closures and lower annualized raw
material costs.

In November 2002, we announced plans for the closure in 2003 of two of our
higher-cost manufacturing plants. The first plant is located in Cincinnati,
Ohio, and employs 118 people. The Cincinnati plant primarily produces
water-borne adhesives sold to the industrial market. Production from this plant
will be transferred to our plants in Greenville, South Carolina, and Carol
Stream, Illinois and Plainfield, Illinois progressively over the next nine
months. Also housed in Cincinnati are technical, sales support, customer
service, and administrative functions, some of which will be transitioned to
other of our locations during 2003. As part of

16

the closure, approximately 88 employees, primarily in manufacturing, but also
including some technical, sales support, customer service and administrative
functions, will be terminated in 2003.

The second plant is located in Kapellen, Belgium and employs 24 people. In
accordance with the laws of Belgium, and following a consultation period, on
October 25, 2002, we announced our intent to cease manufacturing in Kapellen.
This plant produces water-borne and hot-melt adhesives for the European
packaging and converting market. This production will be shifted to the Newark,
United Kingdom plant during the first half of 2003. The Kapellen facility will
continue to provide sales, technical and distribution support to continental
Europe. Approximately 14 employees, primarily in manufacturing functions, will
be terminated as part of the closure in 2003.

These closures will include the termination of certain existing employees,
the abandonment or sale at a loss of certain fixed assets, the disposal of
certain inventory and the sale of certain buildings. We expect the closure of
both plants to be completed by the third quarter of 2003. The closure of these
two plants is expected to produce annual cost savings of approximately $3.0
million when the shutdowns are complete. As a result of the announced closures,
we recorded a charge of approximately $4.1 million in the fourth quarter of 2002
relative to the following costs: termination benefits of approximately $1.6
million, loss on fixed assets of $1.3 million and other exit costs of $1.2
million. These costs will be incurred over the next several quarters. Our 2003
capital spending budget of $8 million includes the capital expenditures required
to accomplish the production transfers.

CONSTRUCTION SEGMENT

The following table presents net sales and segment profit expressed in
millions of dollars and segment profit margin, which is segment profit expressed
as a percentage of net sales:

Net sales for the Construction segment were $121.0 million for the year
ended December 31, 2002 and $111.3 million for the year ended December 31, 2001.
The increase in sales in 2002 was primarily due to resilience of its end markets
and strength at major retail accounts. Segment profit increased by $5.8 million,
or 21.2%, primarily as a result of higher sales volume, management actions to
reduce costs and selective pricing increases.

2001 COMPARED TO 2000

Net Sales. Net sales were $356.7 million in 2001, an increase of $90.9
million, or 34.2% over 2000 net sales of $265.8 million. Excluding the impact of
acquisitions, net sales decreased slightly by $2.4 million or 0.7% in 2001.
Weakness in high end printing, graphic arts and many industrial end markets more
than offset the $5.9 million gain in construction segment net sales. Sales
levels were also negatively impacted by continued general economic weakness in
the United States during the year.

Cost of Goods Sold. Cost of goods sold was $259.3 million in 2001, an
increase of $72.9 million, or 39.1% over 2000 cost of sales of $186.4 million.
Gross profit as a percentage of net sales decreased in 2001 to 27.3% from 29.9%
in 2000. The decrease in gross profit as a percentage of net sales was due
primarily to three factors. First, we experienced increases in certain raw
material costs primarily in the first half of the year that were not fully
recovered through price increases. Second, the businesses we acquired at the end
of 2000

17

historically have lower gross margins than our other businesses. Third, we
incurred additional manufacturing expenses primarily in the first half of the
year to support the transition of manufacturing from the plants that were closed
to our other facilities. Excluding the results of acquisitions, cost of goods
sold decreased by 1.1% from the prior year.

Selling, General and Administrative Expenses. Selling, general and
administrative expenses were $78.0 million in 2001, an increase of $20.4
million, or 35.5% from 2000 expenses of $57.6 million. Excluding acquisitions,
selling, general and administrative expenses increased $1.3 million in 2001. As
a percentage of net sales, selling, general and administrative expenses
increased to 21.9% for 2001 from 21.7% in 2000. This increase was due primarily
to increased goodwill amortization, and one-time expenses associated with
integration actions and bad debts related to certain customers that sought
bankruptcy protection from asbestos claims partially offset by management
actions, including selective headcount reductions.

Interest Expense. Net interest expense was $27.0 million in 2001 and $21.2
million in 2000. The increase in interest expense was due to the full year
impact of increases in debt levels from the prior year related to acquisitions
we completed in the last quarter of 2000, offset somewhat by a decrease in
interest rates on credit facility borrowings.

Income Taxes. Income tax benefit was $1.5 million in 2001. Income tax
expense was $1.4 million in 2000.

Income (loss) before extraordinary loss. Losses before extraordinary loss
for the years ended December 31, 2001 and 2000 were $6.1 million and $0.8
million, due primarily to the factors discussed above.

Extraordinary Loss (net of tax benefit). The extraordinary loss of $4.8
million in 2000 is net of the income tax benefit of $3.2 million and relates to
the write off of unamortized deferred financing costs and payment of the 1%
premium in connection with the repurchase of our 9 1/2% senior subordinated
notes.

Net Income (loss). Net loss for the year ended December 31, 2001 was $6.1
million an increase in net loss of $0.4 million from 2000. The increase resulted
primarily from increased interest and amortization expense.

COMMERCIAL SEGMENT

The following table presents net sales and segment profit expressed in
millions of dollars and segment profit margin, which is segment profit expressed
as a percentage of net sales:

Net sales for the Commercial segment were $245.4 million and $160.4 million
for the years ended December 31, 2001 and 2000, respectively. The increase of
$85 million was due to acquisitions completed in late 2000. Segment profit
excluding goodwill amortization was $22.4 million and $21.9 million for the
years ended December 31, 2001 and 2000, respectively. The decrease in segment
profit as a percentage of sales was due primarily to lower sales of
higher-margin products raw material cost.

18

CONSTRUCTION SEGMENT

The following table presents net sales and segment profit expressed in
millions of dollars and segment profit margin which is segment profit expressed
as a percentage of net sales:

Net sales for the Construction segment were $111.3 million for the year
ended December 31, 2001 and $105.4 million for the year ended December 31, 2000.
The increase in sales in 2001 was primarily due to resilience of its end markets
and strength at major retail accounts. Segment profit increased by $1.7 million
and 12.5% as a result of higher sales volume, management actions to reduce costs
and selective pricing increases.

PRO FORMA RESULTS OF OPERATIONS

Our audited financial results include the operations acquired in our Croda
International Plc. and Imperial Adhesives Inc. acquisitions only after their
acquisition in October 2000. The following sets out and discusses our unaudited
pro forma consolidated results of operations for 2000, giving effect to our
October 2000 Imperial Adhesives Inc. and Croda International Plc. acquisitions
as if they had occurred at January 1, 2000. This pro forma presentation is
included to allow comparisons of the performance of the businesses we owned in
2001 with the full year results of these businesses in 2000.

During 2000, Croda International Plc. restructured operations prior to our
acquisition of the businesses in October 2000. They terminated certain employees
and relocated certain manufacturing activities from Italy and Belgium to the
United Kingdom and from a less efficient plant to a new leased facility in
Illinois. In connection with these activities, costs were expensed as incurred.
These costs are included in the results above, but were not borne by us.

In addition, since we did not purchase Croda International Plc.'s Ewing New
Jersey plant, we leased it on a short-term basis while production was
transferred to other of our plants.

19

In 2001, we closed Imperial's Nashville manufacturing facility and
transferred manufacturing to our existing facilities. We incurred approximately
$1.1 million in costs directly attributable to the closure of the facility. We
sold the facility in December 2002.

LIQUIDITY AND CAPITAL RESOURCES

Net cash provided by operating activities was $35.3 million in 2002. Net
loss, adjusted for non-cash charges, such as depreciation and amortization,
amortization of deferred financing costs, deferred income taxes, foreign
currency gains/losses and cumulative effect of change in accounting principle,
accounted for approximately $9.2 million of cash flow. Cash provided from
operations increased as we decreased inventory levels by $9.8 million and
accounts receivable balances by $6.8 million. Accounts payable and other
liabilities increased by $6.8 million in 2002, driven primarily by the recording
of a $4.1 million liability relative to announced plant closures of our
Cincinnati and Kapellen facilities.

Net cash provided by operating activities was $18.6 million in 2001. Net
loss, adjusted for non-cash charges, such as depreciation and amortization,
amortization of deferred financing costs and extraordinary loss, accounted for
approximately $14.2 million of cash flow. Additional cash was provided as
inventory decreased by $4.7 million and accounts payable and accrued expenses
increased by $1.6 million in 2001. These increases in cash flow from operations
were partially offset by an accounts receivable increase of $2.1 million.

Net cash used in investing activities was $6.2 million in 2002 and resulted
from capital additions to property, plant and equipment of $6.6 million less
$0.4 million of proceeds from the sale of the Nashville facility in December
2002. Current year capital expenditures were $1.4 million less than 2001, due to
the construction of a manufacturing facility in Brazil in 2001 as well as
moderate spending levels in 2002.

Net cash used in investing activities was $16.3 million in 2001 and
resulted from capital additions to property, plant and equipment of $8.0 million
and acquisition costs of $8.3 million. In February 2001, we paid $2.8 million in
additional consideration to Croda International Plc. based on the results of
operations of certain of the businesses acquired in 2000. We incurred an
additional $3.8 million during 2001 related to the 2000 acquisitions of Croda
International Plc and Imperial. As part of the finalization of the purchase
price allocations, these costs were recorded as an increase to goodwill.
Effective June 30, 2001, we completed the purchase of the distribution business
related to our products of IMPAG, a long standing European distributor of our
products for $1.7 million. Consideration is payable in four installments. In
July, 2001, we paid $0.5 million and in January, 2002 we paid approximately $0.3
million. Approximately $0.5 million is due in each of January 2003 and 2004.
This acquisition was accounted for as a purchase. We recognized $1.5 million in
goodwill in connection with this acquisition.

Net cash used in financing activities was $30.6 million for the year ended
December 31, 2002. We repaid $11.3 million of principal required under our Term
A loan and decreased our borrowings under our revolving credit facility by $16.2
million during the year ended December 31, 2002. We incurred $2.2 million of
deferred financing costs associated with amendments of our credit agreement
dated March 1, 2002 and December 20, 2002.

Net cash provided by financing activities was $5.8 million in 2001. Net
borrowings under our credit agreement were $4.6 million in the year ended
December 31, 2001. We added $1.3 in acquisition notes payable.

CREDIT FACILITIES

We amended our credit agreement (Credit Agreement) on December 20, 2002.
The amended Credit Agreement provides for aggregate borrowings of $108.6
million. The Credit Agreement as amended includes (1) a $50.0 million revolving
credit facility (Credit Facility) (including letters of credit of up to $20
million), (2) Term Loan A with remaining outstanding balance of $11.1 million at
December 31, 2002 and no capacity to borrow additional funds under that facility
and (3) Term Loan B with an aggregate principal balance of $47.5 million at
December 31, 2002 and no additional capacity to borrow additional funds under
that facility. The Credit Agreement prior to amendment dated December 20, 2002,
included (1) a $50.0 million Credit

20

Facility and (2) a $75.0 million term loan (Term Loan A) to fund acquisitions
with an outstanding balance of $56.3 million at December 20, 2002, and no
capacity to borrow additional funds under that facility.

The Credit Facility matures December 30, 2005. Commitment fees on the
unused portion of the Credit Facility of 0.375% to 0.050% are payable quarterly
in arrears. At December 31, 2002, we had $13.4 million outstanding and $34.6
million in available borrowings under the Credit Facility (net of approximately
$2.0 million outstanding letters of credit). Our effective interest rate for our
borrowings under the Credit Agreement was 5.7% and 7.1%, for the year ended
December 31, 2002 and 2001, respectively.

Borrowings under the Credit Facility are available on a revolving basis and
may be used for general corporate purposes, excluding, however, loans, advances
and investments, including acquisitions, by us other than specified exceptions.
Scheduled quarterly repayments of $75.0 million outstanding under Term Loan A
began on September 30, 2001 and through September 30, 2002 we had repaid $18.3
million of the amount outstanding under Term Loan A. Prior to December 20, 2002,
we were to continue to make scheduled quarterly repayments through December 31,
2003 totalling 50% of the $75.0 million amount drawn under the Term Loan A. The
scheduled amortization for 2003 was $15.0 million. The remaining 50% was
scheduled to be repaid in equal quarterly payments through December 30, 2005.

On December 20, 2002 we amended our Credit Agreement and we refinanced
$45.1 million of the $56.3 Term Loan A outstanding balance with a new six year,
$47.5 million Term Loan B facility. The Term Loan B includes a $2.4 million
discount (representing a fee) which will be amortized through interest expense
over the life of the facility. The Term Loan B will mature December 30, 2007.
Scheduled principal repayment under the Term Loan B facility for the years
ending December 31, 2003 through 2006 will be $0.5 million per year payable
quarterly. The remaining balance under Term Loan B, will be repaid in 2007. We
have three scheduled quarterly payments in 2007 at the same rate of $0.5 million
per year and a final payment due for the balance outstanding at December 30,
2007. There is no scheduled amortization for the $11.1 million outstanding under
the Term Loan A for the years ending December 31, 2003 and 2004. The remaining
$11.1 million drawn under Term Loan A will be repaid in 2005. The most
significant effects of the amendment are:

- restoration of the full availability of our $50.0 million Credit Facility
by eliminating a previously existing covenant to maintain borrowing
availability under our Credit Facility (a) of at least $10.0 million at
all times prior to December 31, 2002 and (b) of at least $12.5 million
from January 1, 2003,

- amendment of our financial covenants to decrease the restrictiveness of
those covenants for the quarter ended December 31, 2002 and each of the
fiscal quarters prospectively beginning with first quarter of 2003,

- elimination of the fixed charge ratio covenant beginning December 31,
2002, which was replaced by an asset coverage ratio covenant under which
we must maintain at the end of each fiscal quarter a ratio (determined by
the sum of accounts receivable, inventory and property, plant and
equipment divided by total amount advanced, including outstanding letters
of credit, under the Credit Agreement) greater than 1.25 to 1.

The following effects of previous amendments are still in effect under the
current amended Credit Agreement:

- a limitation on the use of advances under the Credit Facility for, among
other things, acquisitions and investments in non-guarantor, offshore
entities,

- prohibition of any significant acquisitions unless capital stock is used
as the primary purchase consideration and no indebtedness is assumed or
acquired, and

- a decrease in our permitted levels of capital expenditures and
indebtedness outside the credit facilities.

Borrowings under the Credit Agreement bear interest at our option at a rate
per annum equal to either (1) the higher of (a) the current base rate as offered
by JPMorgan Chase or (b) 1/2 of 1% per annum above the federal funds rate plus,
in either case, an applicable margin or (2) a Eurodollar rate plus an applicable

21

margin. The applicable margin varies by facility. For amounts drawn under the
Term Loan A and the Credit Facility the Eurodollar margin is 3.75% and the base
rate margin is 2.75%. For amounts drawn under the Term Loan B facility, the
Eurodollar margin is 4.50% and the base rate margin is 3.50%. Amounts
outstanding under the Credit Facility, Term Loan A and Term Loan B bear
interest, payable quarterly in the case of base rate advances and payable at the
end of the relevant interest period of one, two, three or six months (or
quarterly in certain cases) for all Eurodollar advances. Our credit ratings do
not affect the interest rates for our borrowings under our Credit Agreement.

Our Singapore-based sales office has a facility providing for borrowings up
to approximately $1.1 million in U.S. dollars and is secured by a letter of
credit. Interest is payable at United States prime plus 1.0%. At December 31,
2002, approximately $0.8 million was drawn on the facility.

At December 31, 2002, we have $13.4 million drawn under our Credit
Facility, and approximately $2.0 million of outstanding letters of credit. At
December 31, 2002, we had approximately $34.6 million of borrowing availability
under the Credit Facility.

Our Credit Agreement obligates us to make mandatory prepayments in certain
circumstances with the proceeds of asset sales or issuance of capital stocks or
indebtedness and with certain excess cash flow. Our Credit Agreement include
covenants that restrict our and our subsidiaries' ability to incur additional
indebtedness, incur liens, dispose of assets, prepay or amend other
indebtedness, pay dividends or purchase our stock, and change the business
conducted by us or our subsidiaries. We must also comply with several financial
and other covenants, including that we maintain at the end of each fiscal
quarter, the following criteria described below as specifically defined in our
Credit Agreement. These criteria are not intended and should not be relied upon
to replace GAAP measures. Rather, these measures are included to provide
information with respect to our compliance with these financial criteria under
our Credit Agreement.

- ---------------

(1) EBITDA is a defined term in our Credit Agreement.

(2) A ratio of EBITDA to interest expense.

(3) A ratio of the sum of accounts receivable, inventory and property plant and
equipment to EBITDA.

Each of these covenants continues for the term of the Credit Agreement at
the latest level above, or a more restrictive level. A deterioration in our
current operating performance could result in our failure to satisfy our
financial covenants. A failure by us to satisfy the covenants under the Credit
Agreement would trigger the lenders' right to require immediate repayment of all
or part of the indebtedness; such acceleration, in turn, would also give rise to
a right to require immediate repayment by holders of our subordinated notes. The
Credit Facility, Term Loan A and Term Loan B are secured by a security interest
in substantially all of our subsidiaries' assets, including pledges of the
common stock of our subsidiaries. In addition, the Credit Facility, Term Loan A
and Term Loan B are guaranteed by our subsidiaries. Some of our guarantees and
pledges are in support of only offshore advances, if any, under the Credit
Facility.

SENIOR SUBORDINATED NOTES

On December 30, 1999, SSCI Investors LLC, an entity owned by an investor
group led by AEA Investors Inc., acquired approximately 75% of our outstanding
capital stock directly from the former majority

22

stockholder with the balance owned by other investors, including members of our
current management team. SSCI Investors LLC's acquisition of our common stock
constituted a change of control under the terms of the indenture relating to our
9 1/2% Senior Subordinated Notes due 2007 and, as a result, we were required to
make an offer to purchase for cash any and all of the outstanding $125.0 million
principal amount of 9 1/2% Senior Subordinated Notes for 101% of the principal
amount thereof plus accrued and unpaid interest to the date of repurchase. The
repurchase was completed on March 6, 2000 with the repurchase of the entire
$125.0 million principal amount of 9 1/2% Senior Subordinated Notes for an
aggregate purchase price of approximately $127.4 million which was financed with
borrowings under the Credit Agreement. On March 29, 2000 we completed an
issuance of $150.0 million in aggregate principal amount of 11 7/8% Senior
Subordinated Notes due 2010 in a private placement to qualified institutional
investors in accordance with Securities and Exchange Commission Rule 144A and
outside of the United States in accordance with Regulation S under the
Securities Act of 1933. The privately placed 11 7/8% Senior Subordinated Notes
were subsequently exchanged for notes with substantially identical terms that
were registered with the Securities and Exchange Commission. The cash proceeds
from this private placement of notes of approximately $143.8 million were used
to repay amounts drawn under our Credit Facilities for the repurchase of the
9 1/2% Senior Subordinated Notes and for general corporate purposes.

At December 31, 2002 the aggregate principal amount of 11 7/8% Senior
Subordinated Notes was $149.2 million. The 11 7/8% Senior Subordinated Notes
mature on March 15, 2010. Interest is payable semi-annually in arrears each
March 15 and September 15. On or after March 15, 2005, we may redeem these
notes, at our option, in whole or in part, at specified redemption prices plus
accrued and unpaid interest. The redemption price is 105.938% in 2005 and
decreases in equal annual increments to 100.000% in 2008 and thereafter. In
addition, at any time on or prior to March 15, 2003, we may redeem, in the
aggregate, up to 35% of the original aggregate principal amount of 11 7/8%
Senior Subordinated Notes (calculated after giving effect to the issuance of
additional notes, if any) with the net cash proceeds of one or more public
equity offerings by us, at a redemption price in cash equal to 111.875% of the
principal amount, plus accrued and unpaid interest. In the event of a change in
control, we would be required to offer to repurchase the notes at a price equal
to 101.0% of the principal amount plus accrued and unpaid interest.

The 11 7/8% Senior Subordinated Notes are our general obligations,
subordinated in right of payment to all existing and future senior debt and are
guaranteed by our subsidiaries. The indenture under which the 11 7/8% Senior
Subordinated Notes were issued contains certain covenants that, among other
things, limit our ability to incur additional indebtedness, incur liens, dispose
of assets, prepay or amend other indebtedness, pay dividends or purchase our
stock, and engage in transactions with affiliates.

LIQUIDITY AND CAPITAL REQUIREMENTS

We have a management agreement with AEA Investors Inc. under which we
receive advisory and consulting services provided by AEA Investors LLC, the
successor company to AEA Investors Inc. and sometimes referred to in this report
collectively with its successor as AEA Investors. The management agreement
provides for an annual aggregate fee of $1.0 million plus reasonable
out-of-pocket costs and expenses.

Interest payments on the amounts drawn under the Credit Agreement, as well
as other indebtedness and obligations, represent significant obligations for us.
Our remaining liquidity demands relate to capital expenditures and working
capital needs. Our capital expenditures were approximately $6.6 million in 2002
and management currently anticipates capital expenditures will be approximately
$8.0 million in 2003 and approximately $8.5 million in 2004. While we engage in
ongoing evaluations of, and discussions with, third parties regarding possible
acquisitions, as of the date of this report, we have no current expectations
with respect to any acquisitions. Exclusive of the impact of any future
acquisitions, joint venture arrangements or similar transactions, our management
does not expect capital expenditure requirements to increase materially in the
foreseeable future.

The following summarizes certain of our contractual obligations at December
31, 2002 and the effect of such obligations are expected to have on our
liquidity and cash flow in future periods. During the ordinary

23

course of business, we enter into contracts to purchase raw materials and
components for manufacture. In general, these commitments do not extend for more
than a few months.

- ---------------

(1) Represent principal amounts, but not interest. See Note 8 to the
Consolidated Financial Statements.

(2) As described in Note 12 to the Consolidated Financial Statements.

(3) Represents minimum future payments. See Note 13 to the Consolidated
Financial Statements for further discussion.

Our primary sources of liquidity are cash flows from operations and
borrowings under our Credit Agreement. Based on current and anticipated
financial performance, we expect that cash flow from operations and borrowings
under our Credit Agreement will be adequate to meet anticipated requirements for
capital expenditures, working capital and scheduled interest payments, including
interest payments on the amounts outstanding under the 11 7/8% Senior
Subordinated Notes, the Credit Agreement and other indebtedness through December
31, 2003. Our ability to satisfy capital requirements will be dependent upon our
future financial performance. Additionally our ability to repay or refinance our
debt obligations will also be subject to economic conditions and to financial,
business and other factors, many of which are beyond our control.

INFLATION

After peaking in mid-2001 and then declining through early 2002, the costs
of certain of our raw materials have increased. We expect costs to stabilize by
mid 2003. To offset these increases we raised our selling prices selectively.
Historically, in aggregate, price increases have been sufficient to recover new
raw material cost increases, but not to maintain margins. There can be no
assurance, however, that our business will not be affected by inflation in the
future.

FORWARD-LOOKING STATEMENTS

Some of the information presented in, or connection with, this report
include "forward-looking statements" based on our current expectations and
projections about future events and involve potential risks and uncertainties.
Our future results could differ materially from those discussed in this report.
Some of the factors that could cause or contribute to such differences include:

- changes in economic and market conditions that impact the demand for our
products and services;

- risks inherent in international operations, including possible economic,
political or monetary instability;

- uncertainties relating to our ability to consummate our business
strategy, including realizing synergies and cost savings from the
integration of acquired businesses or from plant closures.

- the impact of new technologies and the potential effect of delays in the
development or deployment of such technologies; and,

- changes in raw material costs and our ability to adjust selling prices.

You should not place undue reliance on these forward-looking statements,
which are applicable only as of March 14, 2003. All written and oral
forward-looking statements attributable to us are expressly qualified in their
entirety by the foregoing factors and those identified in Exhibit 99.1
incorporated by reference into this report. We undertake no obligation to revise
or update these forward-looking statements to reflect events or circumstances
that arise after March 14, 2003 or to reflect the occurrence of unanticipated
events. New risks emerge from time to time and it is not possible for us to
predict all such risks, nor can we assess the impact of

24

all such risks on our business or the extent to which any risks, or combination
of risks, may cause actual results to differ materially from those contained in
any forward-looking statement.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The principal market risks, which are potential losses in fair values, cash
flows or earnings due to adverse changes in market rates and prices, to which we
are exposed, as a result of our holdings of financial instrument and commodity
positions, are:

- interest rates on debt;

- foreign exchange rates; and

- commodity prices, which affect the cost of raw materials.

Our financial instruments include short-term debt and long-term debt. Trade
accounts payable and trade accounts receivable are not considered financial
instruments for purposes of this item because their carrying amount approximate
fair value. We do not maintain a trading portfolio and do not utilize derivative
financial instruments to manage our market risks. In the future, we may enter
into foreign exchange currency hedging agreements in connection with our
international operations.

MARKET RISK MANAGEMENT

We have measured our market risk related to our financial instruments based
on changes in interest rates and foreign currency rates utilizing a sensitivity
analysis. The sensitivity analysis measures the potential loss in fair values,
cash flows and earnings based on a hypothetical change (increase and decrease)
in interest rates and a decline in the U.K. pound/dollar exchange rate. We used
market rates as of December 31, 2002 on our financial instruments to perform the
sensitivity analysis. We believe that these potential changes in market rates
are reasonably possible in the near-term (one year or less). We have conducted
an analysis of the impact of a 100 basis point change in interest rates and a
10% decline in the U.K. pound/dollar exchange rate, discussed below.

INTEREST RATE EXPOSURE

Our primary interest rate exposure relates to our variable rate debt. We
utilize a combination of variable rate debt, primarily under our Credit
Agreement, and fixed rate debt, primarily under our 11 7/8% Senior Subordinated
Notes. Our Credit Agreement requires that, at least 45% of our funded
indebtedness be fixed-rate or subject to interest rate hedging agreements to
reduce the risk associated with variable-rate debt. At December 31, 2002
approximately 69% of our funded indebtedness was fixed-rate. The variable rate
debt is primarily exposed to changes in interest expense from changes in the
U.S. prime rate, the federal funds effective rate and the eurodollar borrowing
rate, while the fixed rate debt is primarily exposed to changes in fair value
from changes in medium term interest rates. Based on our indebtedness at
December 31, 2002, we estimate that an immediate 100 basis point rise in
interest rates would result in $0.7 million increase in interest expense for the
period January 1, 2003 to December 31, 2003. For purposes of this estimate, we
have assumed a constant level of variable rate debt and a constant interest rate
over the period equal to those existing on December 31, 2002.

CURRENCY RATE EXPOSURE

Our primary foreign currency exchange rate exposure relates to the U.K.
pound which results in our exposure to changes in the dollar exchange rate. Our
exposure to changes in U.S. dollar exchange rates with currencies other than the
U.K. pound are not currently material. Changes in translation risk are reported
as adjustments to stockholders' equity. We estimate that the impact of a 10%
decline in the dollar/U.K. pound exchange rate from $1.60/L1.00 to $1.44/L1.00
at December 31, 2002 would result in a decrease in our earnings before taxes of
$1.3 million for the period from January 1, 2003 to December 31, 2003.

25

COMMODITIES RISK

We are subject to market risk with respect to commodities because our
ability to recover increased raw materials costs through higher pricing may be
limited by the competitive environment in which we operate.

We use a broad variety of specialty and some commodity raw materials in our
manufacturing processes. In 2002, the company purchased about $195 million of
raw materials including acrylic monomers and polymers, resins, natural and
synthetic rubbers, solvents, and urethanes. Although these raw materials are
derived from crude oil or natural gas, the raw materials are several
manufacturing steps removed (downstream) from these basic feedstocks. The price
of oil and gas will affect our costs for these raw materials both upward and
downward, but the magnitude of change is diluted.

We typically purchase strategic raw materials on a contract basis to
moderate price changes during the contract period, however, prices can change
significantly at the end of contract periods if supply shortages, feedstock cost
pressures, or other unforeseen market events occur. Commodity raw materials are
available from numerous independent suppliers, and specialty raw materials are
usually available from several suppliers.

We expect the cost of many raw materials to increase during 2003 and in the
long term. In aggregate, we have been successful historically in passing on raw
material cost increases through selective price increases to our customers over
time under certain competitive market conditions, but we may not be able to do
so in the future or we may not be able to do so as to maintain margins.

These sensitivity analyses are estimates and are based on certain
simplifying assumptions. These analyses should not be viewed as predictive of
our future financial performance. Additionally, we cannot give any assurance
that the actual impact in any particular year will not materially exceed the
amounts indicated above.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The consolidated financial statements of the Company are submitted as a
separate section of this report. For a list of financial statements and
schedules filed as part of this report, see the "Index to Financial Statements"
beginning on page F-1.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

None.

26

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The following table sets forth certain information with respect to: (1)
each member of our Board of Directors; (2) each of our executive officers; and
(3) certain of our key managers and key managers of our subsidiaries.

- ---------------

* Positions are with Sovereign, unless otherwise noted.

Norman E. Wells, Jr., has served as our Chief Executive Officer since July,
2002 and has been a Director since December 1999. He became Chairman of the
Board of Directors on January 1, 2003. Mr. Wells currently is a Managing
Director and Operating Partner of AEA Investors LLC, the successor company of
AEA Investors Inc. with which he has been associated for over 10 years. Mr.
Wells has served as a Director of Rand McNally from May 2001 until the present
and served as Chairman from May 2001 until December 2002. Mr. Wells also served
as Interim Chief Executive Officer of Rand McNally from December 2000 until June
2002. Mr. Wells was retained by Rand McNally to manage a comprehensive
restructuring of the business. In February, 2003, Rand McNally filed a
prepackaged bankruptcy petition in the United States Bankruptcy Court. Prior to
the filing, the Rand McNally debt holders unanimously approved the Plan of
Reorganization. Mr. Wells served as President and Chief Executive Officer of
Easco Aluminum Inc. from November 1996 to December 1999. Mr. Wells was a
Director of CasTech Aluminum Group Inc. from June 1992 to September 1996 and
served as CasTech's President and Chief Executive Officer from March 1993 to
September 1996.

John R. Knox has served as our President and Chief Operating Officer since
September, 2002 and as our Executive Vice President and Chief Operating Officer
from February 2002 to August, 2002. Prior to joining our company, Mr. Knox was
President of the European, Middle Eastern and African operations for Valspar
Corporation's packaging and industrial coatings businesses. Mr. Knox has a B.S.
in Chemical Engineering from the University of Virginia and an MBA from Harvard
University.

27

Terry D. Smith has served as our Vice President and Chief Financial Officer
since November 1, 2002. Prior to joining our company, Mr. Smith was Chief
Operating Officer of Roetzel and Andress, Legal Professional Association from
March, 2000 to November, 2002. From November, 1996 until February, 2000, Mr.
Smith was Executive Vice President and Chief Financial Officer of Easco, Inc.,
and from 1987 through 1996 was Vice President and Chief Financial Officer of
Castech Aluminum Group Inc. Mr. Smith is a certified public accountant and holds
a B.S. in Accounting from the University of Akron.

Louis M. Pace has been our Vice President of Business Development since
November 2000 and Vice President of Information Technology since October 2001.
He had been Vice President -- Mergers & Acquisitions since March 1999 and has
served as our Director of Mergers & Acquisitions since January 1998. From August
1996 to December 1997, he served as our Director of Corporate Development and
Assistant Secretary. From 1995 to August 1996, Mr. Pace was an associate with
First Chicago Equity Capital. Mr. Pace holds a B.A. in Economics from Harvard
University and an M.B.A. from J.L. Kellogg Graduate School of Management at
Northwestern University.

Martyn Howell-Jones has served as our Vice President -- International since
October 1996 pursuant to a consulting arrangement. Mr. Howell-Jones is
responsible for our international sales and marketing efforts. Prior to joining
our company, Mr. Howell-Jones was engaged as a consultant to National Starch and
Chemical Company from June 1994 to September 1996, where he assisted in the
development of National Starch and Chemical Company's international adhesives
business. From 1966 to 1992, Mr. Howell-Jones was employed by Morton in its
European specialty chemicals business. Mr. Howell-Jones holds a B.S. degree from
London University.

Richard W. Johnston has served as our Vice President -- Science and
Technology since March 1997 and as Executive Vice President of Pierce & Stevens
since 1995. From 1992 to 1995, Mr. Johnston served as Vice
President -- Technology of Pierce & Stevens. Prior to that time, Mr. Johnston
served as Vice President of Pierce & Stevens' Canadian operations from 1988 to
1992. Mr. Johnston joined Pierce & Stevens in 1966 and has served in several
technical capacities with expertise in coatings and adhesives technology. Mr.
Johnston holds a B.S., M.S. and M.E.S. in Chemistry from the University of
Waterloo, Canada.

Paul Gavlinski has served as our Vice President -- Manufacturing and
Engineering since February 1998 and Vice President -- Operations of Pierce &
Stevens since September 1996. From 1995 to July 1996, Mr. Gavlinski served as
President of Catalyst Development, a management consulting firm. Prior to that
time, Mr. Gavlinski was Vice President Manufacturing of Emulsion Systems Inc., a
polymer manufacturing company. From 1969 to 1992, Mr. Gavlinski was employed by
Morton International Inc. in various chemical manufacturing capacities. Mr.
Gavlinski holds a B.S. in Chemical Engineering from the University of Illinois.

Thomas DuFore has been our Vice President -- Human Resources since
September 2002. Mr. DuFore has served as the Vice President of Human Resources
for Grand Eagle, Inc., Easco Aluminum, and Columbia National Group. Other
positions held include Director of Human Resources for Castech Aluminum and
Corporate Director of Compensation for Carondalet Healthcare Corporation. Mr
DuFore holds a BA from Westminster College, Pa.; MLS from The University of
Pittsburgh, Pa. and a JD from The University of Akron, Oh. He is a member of the
Ohio State Bar Association.

Peter Longo has been President of OSI Sealants Inc. since 1991. OSI
Sealants Inc. comprises the Construction Segment for financial reporting
purposes. From 1989 to 1991, Mr. Longo was Vice President of Operations of OSI
Sealants. Mr. Longo has been employed by OSI Sealants for more than 20 years and
has served in a variety of capacities, including sales and marketing. Mr. Longo
attended Lakeland Community College.

Patrick W. Stanton has served as our Principal Accounting Officer since
September 1998. From April 1998 to August 1998, he served as our Manager of
Financial Planning and Control. From 1990 to March 1998, Mr. Stanton was with
Arthur Andersen LLP. Mr. Stanton is a Certified Public Accountant and holds a
B.S. in Accounting from Marquette University.

Robert B. Covalt has served as a Director of our Company since its
inception, as our Chairman from its inception in 1996 to December 31, 2002, and
as Chief Executive Officer of our company since its inception in 1996 to August
2002. Mr. Covalt was President from inception to July 2000. Mr. Covalt is
currently President
28

of RBC Associates, Inc. From 1979 to 1990, Mr. Covalt served as President of the
Specialty Chemicals Group of Morton International, Inc. During this period, Mr.
Covalt grew Morton's specialty chemicals group from $175.0 million to $1.3
billion in sales and he completed 13 acquisitions ranging in size from $3.0
million to $170.0 million. From 1990 to 1993, Mr. Covalt was Morton's Corporate
Executive Vice President. Prior to that time, Mr. Covalt served in various
capacities in Morton's Chemical Division which he joined in 1956. Mr. Covalt
serves on the board of directors of CFC International, Inc., a specialty
chemical coating manufacturer. Mr. Covalt has a B.S. in Chemical Engineering, an
honorary doctorate from Purdue University, and an M.B.A. from the University of
Chicago.

John L. Garcia has been a Director since December 1999. For administrative
purposes, Mr. Garcia has also served as Vice President, Assistant Treasurer, and
Assistant Secretary since December 1999. Mr. Garcia is currently President of
AEA Investors LLC, the successor company of AEA Investors Inc. of which he was
President since September 2002. From 1994 to 1999, Mr. Garcia was a Managing
Director with Credit Suisse First Boston, where he served as Global Head of the
Chemical Banking Group and Head of the European Acquisition and Leveraged
Finance and Financial Sponsors Group. His previous experience was at ARCO
Chemicals, in research, strategic planning and corporate development roles. Mr.
Garcia is currently a director of Acetex Corporation and Noveon, Inc. Mr. Garcia
is a graduate of the University of Kent in England and holds a master's degree
and Ph.D. in organic chemistry from Princeton University. He also holds a
master's degree in business administration from The Wharton School of the
University of Pennsylvania.

John D. Macomber has been a Director since December 1999. Mr. Macomber has
been a principal of JDM Investment Group since 1992 and is a Director of Lehman
Brothers Holdings Inc., Mettler-Toledo International Inc. and Textron Inc. Mr.
Macomber is the former Chairman and President of the Export-Import Bank of the
United States, Chairman and Chief Executive Officer of Celanese Corporation and
Senior Partner of McKinsey & Co.

Robert H. Malott has been a Director since December 1999. Prior to his
retirement in 1997, Mr. Malott was Chairman of the Executive Committee of FMC
Corporation from November 1991 through May 1997. Mr. Malott served as Chairman
of the Board and Chief Executive Officer of FMC Corporation from 1973 to 1991.
Mr. Malott is a former Director of FMC Corporation, Amoco Corporation and United
Technologies Corporation.

Daniel B. Mulholland has been a Director since April 2002. Mr. Mulholland
is currently President and Chief Executive Officer of DBMulholland & Associates,
a consulting firm. From 1996 to 2001, Mr. Mulholland served as President of
Mallinckrodt Baker, Inc., a specialty chemical manufacturer. From 1995 to 1996,
Mr. Mulholland was Vice President and General Manager of Mallinckrodt Baker,
Inc. From 1992 to 1995, Mr. Mulholland served as President of J.T.Baker, Inc.
(prior to its acquisition by Mallinckrodt Chemical Company in 1995). Mr.
Mulholland has also held numerous other positions in sales, operations, and
marketing with J.T.Baker since joining the company in 1974. Mr. Mulholland is
also a director of Nazareth National Bank. Mr. Mulholland has a B.S. degree in
Finance from Lehigh University and an MBA from Ohio State University.

Thomas P. Salice has been a Director since December 1999. For
administrative purposes, Mr. Salice has also served as Vice President, Assistant
Treasurer, and Assistant Secretary since December 1999. He is Vice Chairman of
AEA Investors LLC, the successor company of AEA Investors Inc. and has been
associated with AEA Investors Inc. since June 1989. Mr. Salice is also a
Director of Marbo, Inc., Waters Corporation and Mettler-Toledo International
Inc.

BOARD COMMITTEE MEMBERSHIP

Our Board of Directors has two standing committees: a compensation
committee and an audit committee. The Compensation Committee of our Board of
Directors is comprised of Messrs. Macomber and Garcia. The audit committee is
comprised of Messrs. Malott, Garcia and Mulholland.

29

ITEM 11. EXECUTIVE COMPENSATION

The table below summarizes compensation information for our Chief Executive
Officer and each of the four other most highly compensated executive officers of
our company and/or our domestic subsidiaries for services rendered during the
years ended December 31, 2002, 2001 and 2000.

SUMMARY COMPENSATION TABLE

- ---------------

(1) Except as set forth below, the aggregate amount of perquisites and other
personal benefits for any of the executives named in the above table was
less than the lesser of $50,000 or 10% of the total annual salary and bonus
reported for the named executive officer.

(2) For fiscal year 2002, represents matching and profit sharing contributions
under the 401(K) plans in the amount of $5,500, $1,697, $4,745, $5,500 and
$4,724 for Messrs. Wells, Knox, Mellett, Longo and Johnston.

(3) Reflects salary paid to Mr. Wells for November and December 2002. From July
24, 2002 through October 31, 2002 we paid $105,000 in an additional
management fee to AEA Investors relative to Mr. Wells performance as Chief
Executive Officer.

(4) Represents salary for services as Chairman and Chief Executive Officer from
January 1, 2002 through July 23, 2002 in an amount of $176,917 and salary
for services as Chairman from July 24, 2002 through December 31, 2002 in an
amount of $138,083. In addition, pursuant to a separation agreement
described below, Mr. Covalt will receive severance equal to one year of
continued salary payable over the course of the 2003 fiscal year.

(5) Reflects payments made to Mr. Knox for relocation expenses.

(6) Reflects payments made to Mr. Mellett for living accommodations and travel
expenses.

30

(7) In addition, pursuant to a separation agreement described below, Mr. Mellett
will receive severance equal to six months of continued salary payable in
2003.

DIRECTOR COMPENSATION

Members of our Board of Directors are reimbursed for traveling costs and
other out-of-pocket expenses incurred in attending board of directors and
committee meetings. Members of the Board of Directors who are also our officers
or employees of AEA Investors do not receive additional compensation for being
on the Board of Directors or its committees. Messrs. Macomber and Malott were
given a one-time opportunity to purchase units in a partnership which owns all
of the equity in SSCI Investors LLC upon their election to the Board of
Directors but receive no compensation for their services as directors. Mr.
Mulholland was granted 2,500 options to purchase our common stock in April 2002.

COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION

Our compensation committee approved various actions with respect to the
current compensation arrangements of our executive officers. As of February
2003, the compensation committee of our Board of Directors is comprised of John
D. Macomber, Thomas P. Salice and John L. Garcia. Messrs. Garcia and Salice are
officers of Sovereign for administrative purposes only and are officers of AEA
Investors. We have a management agreement with AEA Investors Inc. under which
AEA Investors LLC provides us with advisory and consulting services provides for
an annual aggregate fee of $1.0 million plus reasonable out-of-pocket costs and
expenses. Approximately 75% of our capital stock is owned by SSCI Investors LLC,
which is owned by an investor group led by AEA Investors Inc. For a more
detailed discussion of relationships between AEA Investors and Sovereign see
"Certain Relationships and Related Transactions."

The following table sets forth information concerning stock options granted
to each of the executive officers in the Summary Compensation Table during the
fiscal year ended December 31, 2002.

OPTION GRANTS IN LAST FISCAL YEAR

- ---------------
(1) The per share exercise price is the fair market value of our common stock on
the date of grant and the options have a term of 10 years, subject to the
earlier termination in the event of termination of employment. Mr. Wells'
options vest in sixteen equal installments over the four year period
following the date of grant. Mr. Knox's options vest in equal installments
on each of the first five anniversaries of the date of the grant. The
vesting schedule may be accelerated in connection with a transaction that is
a "change in control" as defined in our option plan.

(2) Based on options to purchase a total of 154,400 shares of our common stock
granted during our 2002 fiscal year.

(3) Values are based on assumed rates of stock appreciation of 5% and 10%
compounded annually from the date the option was granted over the full
option term. These assumed rates of appreciation are established by the SEC
and do not represent our estimate or projection of future stock price.

31

The following table sets forth information concerning the value of
unexercised in-the-money options held for each of the executives listed in the
Summary Compensation Table as of December 31, 2002.

AGGREGATE OPTION EXERCISES IN FISCAL 2002
AND FISCAL YEAR-END OPTION VALUES

- ---------------

(1) There was no public trading market for our common stock at December 31,
2002. Accordingly, these values of exercisable and un-exercisable
in-the-money options are based on the fair market value of our common stock
as determined by our board of directors, and the applicable exercise price
per share.

In January, 2003, we offered to any participant in our stock option plan
who so elected, the opportunity to voluntarily surrender all existing option
grants, both vested and unvested, and agreed to reissue new options to those
participants approximately 181 days after the existing options have been
surrendered. The strike price of the new grants will be the greater of $115.00
or the fair market value of our stock on the date of reissuance. At the time of
the offer, there were options to purchase 281,950 shares outstanding. Options in
respect of 189,450 shares had an exercise price of $129.50 per share and options
in respect of 92,500 shares had an exercise price of $115.00 per share. No
options have been exercised at December 31, 2002. The weighted average remaining
contractual life and weighted average exercise price of the options at December
31, 2002 are 8.5 years and $124.74 per option share, respectively. As of
February 19, 2003, all of the participants holding options at $129.50 per share
have elected to surrender all such options and receive a like number of options
at the strike price to be determined as described above.

MANAGEMENT INCENTIVE COMPENSATION PLAN AND EMPLOYMENT AGREEMENTS

We believe that equity and performance-based plans and programs should
constitute a major portion of management's compensation so as to provide
significant incentives to achieve corporate goals. We have instituted the
following plans and programs for this purpose.

MANAGEMENT INCENTIVE COMPENSATION PLAN

Selected members of our management and corporate staff judged to have the
greatest impact on our economic results are eligible to participate in this
plan. Participants are eligible for cash bonus awards based on our financial
performance as specifically defined in this plan, measured in terms of earnings
before interest, taxes, depreciation and amortization, working capital targets,
and on individual role-specific goals. Participants in this program are assigned
a percentage of their base salary as their bonus target for the then current
fiscal year. Awards may be higher or lower than the target bonus as our
financial performance and/or the individual's performance is above or below the
level expected to achieve the target bonus. Target bonuses range from 25% to
100% of base salary dependent upon position. In addition, our chief executive
officer may award participants bonuses supplemental to those earned under the
plan for producing extraordinary results. The management incentive compensation
plan is administered by our chief executive officer and vice president-human
resources, under the general direction of the compensation committee of our
board of directors.

32

EMPLOYMENT AGREEMENTS

We have an employment agreement with Mr. Wells dated October 1, 2002
providing for his employment as Chief Executive Officer. Under the terms of his
employment agreement, Mr. Wells has agreed to devote substantially all of his
business time and skill to his duties under his employment agreement, except for
customary matters and the performance of his duties as a Managing Director of
AEA Investors Inc. that are expected to be part time and that do not interfere
with the performance of his duties to us and our subsidiaries. We have
employment agreements with Messrs. Smith, Knox, Longo and Johnston. Pursuant to
these agreements, Messrs. Wells, Smith, Knox, Longo and Johnston are entitled to
annual base salaries of $350,000, $240,000, $250,000, $205,000 and $166,300,
respectively. Messrs. Knox, Longo and Johnston are eligible to receive an annual
target bonus, depending on our results of operations and personal performance of
75%, 40% and 40% respectively, of their base salary determined in accordance
with the terms of the bonus plan adopted by our Board of Directors for the
calendar year. The employment agreements for Messrs. Wells and Smith provided
for a 2002 bonus of $150,000 and $50,000, respectively. They both will
participate in the management incentive compensation plan beginning with the
calendar year 2003 and will be eligible to receive a target bonus of 100% of
base salary in the case of Mr. Wells and 58.3% of base salary in the case of Mr.
Smith. Additionally, each executive is eligible for a discretionary bonus as
determined by the Board of Directors.

Under their respective employment agreements, the executives received
non-qualified stock options and are entitled to participate in all health,
welfare and other benefit plans we provide to our executives. The employment
agreements for Mr. Wells and Mr. Smith provide that the executives will be
reimbursed for housing and living expenses in Chicago, Illinois and for travel
expenses between Chicago, Illinois and the executives' residences in Ohio. In
addition, the executives will be paid an additional amount such that there is no
after-tax cost to the executives in connection with receiving such
reimbursements. Under Mr. Wells' employment agreement, in the event payments
received by him in connection with a change in control of our Company are
subject to an excise tax under Section 4999 of the Internal Revenue Code, he may
be entitled to a gross-up payment to negate the cost of such excise tax.

The employment agreements for Messrs. Wells, Smith, Knox, Longo and
Johnston provide for terms expiring on December 31, 2004, 2005, 2004, 2003 and
2003, respectively. All of these agreements are subject to automatic one-year
renewal terms in the absence of us or the officer giving notice to the other of
its election not to renew the agreement. If we terminate an executive's
employment without cause (as defined in the employment agreements), or an
executive resigns with good grounds (as defined in the employment agreements),
we are required to

(1) pay the executive any unpaid portion of his base salary earned
through the date of termination or resignation,

(2) continue to pay the executive his then current annual base salary
during the one-year period following termination or resignation,

(3) continue the executive's participation in employee benefit plans
during the one-year period following termination or resignation, and

(4) pay the executive a pro rata portion of his potential target
annual bonus for the calendar year of termination if the executive resigns
for good grounds. However, if we terminate the executive's employment
without cause, in the case of Mr. Wells, the pro rata potential target
annual bonus will be paid, and in the case of all other executives, the pro
rata potential annual bonus will be paid at the discretion of the chief
executive officer.

All severance benefits and payments are conditioned on the executive's
execution of a general release and his compliance with certain non-competition,
non-solicitation and non-disclosure covenants.

The employment agreement for Mr. Knox provided for the following payments
within the first year of employment: a lump-sum of $100,000 for relocation costs
and, on the date of Mr. Knox first anniversary with us, a special bonus of
$275,000.

33

In connection with Mr. Wells' employment as our Chief Executive Officer,
AEA Investors Inc. permitted Mr. Wells to subscribe for 10,000 units of
partnership interests in SSCI Investors LP at a price per unit of $0.05 pursuant
to a subscription agreement dated as of October 1, 2002. SSCI Investors LP is
the holding entity through which the investor group led by AEA Investors Inc.
holds our capital stock. Pursuant to the related vesting agreement between AEA
Investors Inc. and Mr. Wells, also dated as of October 1, 2002, Mr. Wells'
rights to such units vest immediately as to 20% thereof, with an additional 20%
vesting on each of the subsequent four anniversaries of the date of issuance,
subject to acceleration of vesting upon a change of control and termination of
vesting and repurchase of vested and/or unvested units by AEA Investors Inc.
under various other circumstances, including termination of Mr. Wells'
employment as our Chief Executive Officer.

SEPARATION AGREEMENTS

We have entered into separation agreements with Messrs. Covalt and Mellett,
pursuant to which the executives will receive severance in the form of continued
base salary and participation in our health and disability plans for one year in
the case of Mr. Covalt or six months in the case of Mr. Mellett. In addition,
Messrs. Covalt and Mellett will retain 36,000 and 9,000 options, respectively,
until December 31, 2009.

STOCK OPTION PLAN

The Sovereign Specialty Chemicals, Inc. Stock Option Plan provides for the
grant of nonqualified stock options to our key employees and directors. The
maximum number of shares of common stock underlying the options available for
award under the stock option plan is 299,950 shares. Under the Plan, if any
options terminate, or expire unexercised, the shares subject to such unexercised
options are again available for grant under the stock option plan.

The stock option plan is administered by the compensation committee of the
Board of Directors. Generally, the committee interprets and implements the stock
option plan, grants options, exercises all powers, authority, and discretion of
the Board under the stock option plan, and determines the terms and conditions
of option agreements, including the vesting provisions, exercise price, and
termination date of options.

Each option is evidenced by an agreement between us and an optionee. Unless
determined otherwise by the committee, 20% of the shares subject to the option
vest on each of the first five anniversaries of the grant date. Additionally,
the committee may accelerate the vesting of any option grant. The option price
is specified in each option agreement at an amount not less than the fair market
value on the grant date, unless determined otherwise by the committee. All
optionees are required to become parties to the management shareholders
agreement, which is described under "Certain Relationships and Related
Transactions."

In the event of a transaction that constitutes a change in control of our
company, as described in the stock option plan, unless determined otherwise by
the compensation committee, all options become fully exercisable immediately
prior to the date of the transaction, and we may cancel any options unexercised
as of the change in control upon our payment to the holders of options the
difference between the fair market value of the underlying stock and the option
exercise price. In the event of specified transactions that result in holders of
common stock receiving payments or securities in respect of, or in exchange for,
their common stock that do not result in a change in control of our company, as
described in the stock option plan, unless determined otherwise by the
compensation committee, options remain subject to the terms of the stock option
plan and the applicable option agreement, and thereafter upon exercise,
optionees will be entitled to receive in respect of any option the same per
share consideration received by holders of common stock at the time of the
transaction. Options will in no event entitle the holder of the option to
ordinary cash dividends payable upon the common stock issuable upon exercise of
the options.

In order to prevent dilution or enlargement of the rights of participants,
the stock option plan provides that the aggregate number of shares subject to
the stock option plan, any option, the purchase price to be paid upon exercise
of an option and the amount to be received in connection with the exercise of
any option will be automatically adjusted to reflect any stock splits, reverse
stock splits or dividends paid in the form of common stock, and equitably
adjusted as determined by the committee for any other increase or decrease in
the

34

number of issued shares of common stock resulting from the subdivision or
combination of shares or other capital adjustments.

Our Board of Directors may amend, alter, or terminate the stock option
plan. Any board action may not adversely alter outstanding options without the
consent of the optionee. The stock option plan will terminate ten years from its
effective date, but all outstanding options will remain effective until
satisfied or terminated under the terms of the stock option plan.

Pursuant to their employment agreements, Messrs, Wells, Smith, Knox, and
DuFore were granted 60,000, 25,000, 30,000 and 7,500 options in 2002 at an
exercise price not less than the fair market value of the grant dates.

EMPLOYEE STOCK PURCHASE PLAN

In 2000, we adopted the Sovereign Specialty Chemicals, Inc. Employee Stock
Purchase Plan. Under the stock purchase plan eligible employees had the
opportunity to purchase up to 20,000 shares of our voting common stock. Our
employees purchased 7,045 shares at $100.00 per share. The stock purchase plan
terminated in 2000.

Common stock acquired under the stock purchase plan was purchased pursuant
to subscription agreements which define the rights and limitations of holders of
the shares. A management subscription agreement was used for grants to employees
who have entered into the management shareholders agreement, which are described
in "Certain Relationships and Related Transactions," and are governed by the
terms of the management shareholders agreement. An employee subscription
agreement will be used for grants to other employees. A summary of the employee
subscription agreement is provided below.

The employee subscription agreement provides for (1) restrictions on
transfer, (2) the right of SSCI Investors LLC, in a sale of 50% or more of its
ownership interest in the company to compel holders of shares of common stock
acquired under the stock purchase plan to sell a proportionate number of shares
and (3) rights for holders of shares of common stock acquired under the stock
purchase plan to participate in certain sales by SSCI Investors LLC.

The agreement provides further that, if we terminate for cause the
employment of a holder of shares purchased under the stock purchase plan, then
we will have the opportunity to purchase all of the holder's shares of common
stock purchased under the stock purchase plan at the lower of (1) the price paid
for the shares and (2) the then current fair market value of the shares. If the
holder's employment is terminated other than by us for cause, then we will have
the opportunity to purchase all of his or her shares at 100% of their then
current fair market value.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

EQUITY COMPENSATION PLAN INFORMATION

The following table provides certain information with respect to all of our
equity compensation plans in effect as of December 31, 2002:

All of the securities included in the above table represent shares of our
common stock that may be issued under the Sovereign Specialty Chemicals, Inc.
Stock Option Plan. The stock option plan as originally adopted and as approved
by our security holders provided for a maximum of 240,713 shares to be issued
upon the

35

exercise of options granted under the plan. The stock option plan was amended by
our Board of Directors in 2002 to increase the maximum number of shares that may
be issued upon the exercise of options by 59,237. Our security holders have not
approved this amendment. A description of the material terms of the stock option
plan is provided on page 34.

The following table presents information as of March 14, 2003 regarding the
beneficial ownership of our voting common stock by each person known by us to
beneficially own more than five percent of our voting common stock and by our
Directors, certain executive officers and key managers, individually, and as a
group.

As used in this table, beneficial ownership means the sole or shared power
to vote or direct the voting or to dispose or direct the disposition of any
security. A person is deemed to be the beneficial owner of securities that can
be acquired within 60 days from March 14, 2003 through the exercise of any
option, warrant or right. Shares of common stock subject to options, warrants or
rights that are currently exercisable or exercisable within 60 days are deemed
outstanding for the computation of the ownership percentage of the person
holding such options, warrants or rights, but are not deemed outstanding for the
computation of the ownership percentage of any other person. Our non-voting
common stock is convertible into voting common stock, unless the holder or its
affiliate is prohibited by law or regulation from holding our voting common
stock. As a result, certain holders of our non-voting common stock are deemed to
hold the voting common stock into which their non-voting common stock may be
converted. This table excludes any vested options that were surrendered by
employees in response to our January 2003 offer to reissue stock options to
participants who surrendered their outstanding options, as described under "Item
11. Executive Compensation -- Stock Options."

In the table below, unless otherwise noted, the address of the person is in
care of our company.

- ---------------

* Represents beneficial ownership of less than one percent.

(1) Includes 547,636.50 shares of non-voting common stock. The address for SSCI
Investors LLC is c/o AEA Investors LLC, Park Avenue Tower, 65 East 55th
Street, New York, New York 10022. The general partner of a partnership that
wholly owns SSCI Investors LLC is a wholly owned subsidiary of AEA Investors
Inc. AEA Investors disclaims beneficial ownership of the shares owned by
SSCI Investors
36

LLC, except to the extent of its pecuniary interest therein. The address for
AEA Investors Inc. is Park Avenue Tower, 65 East 55th Street, New York, New
York 10022.

(2) Includes 47,544.61, 642.76, and 642.76 shares of common stock held by
Tregooden Partners, L.P., Nautical Partners, L.P. and Serendipity Partners,
L.P., respectively, which may be deemed to be beneficially owned by Mr.
Covalt.

(3) Does not include shares beneficially owned by AEA Investors Inc. or SSCI
Investors LLC. Messrs. Wells, Garcia and Salice are each limited partners in
SSCI Investors LP, the partnership which owns SSCI Investors LLC. Messrs.
Salice and Garcia are also officers and directors of AEA SSC Investors Inc.,
the general partner of SSCI Investors LP. Mr. Garcia is also President of
AEA Investors Inc.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

In connection with the acquisition of approximately 75% of our common stock
by SSCI Investors LLC, we entered into an arrangement with our former parent
pursuant to which it agreed to indemnify us for any liability in excess of $2.5
million in the aggregate that is determined to be payable under a note we issued
in connection with an acquisition. Our obligations under this note have been
settled, for an amount less than this indemnification threshold. In addition,
our former parent has agreed to provide indemnification to us in respect of
various tax matters pursuant to an agreement with SSCI Investors LLC.

Affiliates of J.P. Morgan Securities Inc. and JPMorgan Chase Bank currently
own 63,330.71 shares of our voting common stock and 182,545.5 shares of our
non-voting common stock. J.P. Morgan Securities Inc. acted as our financial
advisor in connection with SSCI Investors LLC's acquisition of our capital
stock. J.P. Morgan Securities Inc. is also the sole lead arranger and
book-running manager and JPMorgan Chase Bank is the administrative agent and
documentation agent under our Credit Agreement. J.P. Morgan Securities Inc. and
JPMorgan Chase Bank received customary fees in connection with the December 2002
amendment of our Credit Agreement.

See also "Executive Compensation" for a description of the arrangements
between us and our shareholders who are employees.

In connection with SSCI Investors LLC's acquisition of approximately 75% of
our common stock, we, SSCI Investors LLC and several members of our management
entered into a shareholders agreement. Under the management shareholders
agreement, as amended to date, SSCI Investors LLC has agreed that, prior to the
completion of an underwritten public offering of our common stock, SSCI
Investors LLC will vote all shares of common stock owned or controlled by it,
and will take all necessary or desirable actions within its control to (1) cause
at least two members of the board of directors to be members of the investor
group led by AEA Investors Inc. who are not also officers or employees of AEA
Investors Inc. and (2) for so long as the Covalt Family Group, as defined in the
shareholders agreement, owns at least 5% of the outstanding shares of our common
stock, to elect Robert B. Covalt as a director of our company and of each of our
domestic subsidiaries and, if employed by us, to cause Mr. Covalt to hold the
position of Chairman of the Board and Chief Executive Officer of our company and
Chairman of the Board of each domestic subsidiary. The obligation to elect Mr.
Covalt to be a director and have the titles described above will terminate if:
(1) the Covalt Family Group no longer holds the minimum amount of shares; (2)
Mr. Covalt, if employed by us, is terminated by us for Cause or (3) Mr. Covalt
is in Competition with us, as each of those terms are defined in the
shareholders agreement. The management shareholders agreement also (1) imposes
certain transfer restrictions on the management parties, (2) subjects employee
parties to the right of SSCI Investors LLC, in a sale of 50% or more of its
ownership interest in our company, to compel other shareholders to sell a
proportionate number of shares, (3) provides rights to management to participate
in sales by SSCI Investors LLC, (4) provides for a call option on employees'
options and subsequently acquired shares in specified termination events, (5)
provides that employee parties may request that we purchase some of their stock
in specified events, and (6) provides employee parties with piggyback
registration rights under specified circumstances.

37

We have also entered into a shareholders agreement with SSCI Investors LLC
and our remaining (non-employee) shareholders. This shareholders agreement
provides for (1) board observer rights for 10% shareholders, (2) restrictions on
transfer, (3) the right of SSCI Investors LLC, in a sale of 50% or more of its
ownership interest in our company to compel other shareholders to sell a
proportionate number of shares, (4) rights for other shareholders to participate
in sales by SSCI Investors LLC, (5) preemptive rights to 5% shareholders to
purchase new issuances, (6) information rights, and (7) piggyback registration
rights.

We have a management agreement with AEA Investors Inc. under which AEA
Investors LLC provides us with advisory and consulting services for an annual
aggregate fee of $1.0 million plus reasonable out-of-pocket costs and expenses.
In addition, we paid AEA Investors Inc. $0.1 million of additional management
fees relative to Mr. Wells' performance as Chief Executive Officer from July 24,
2002 to October 31, 2002.

In connection with our employee stock purchase plan, which we terminated in
2000, we repurchased 7,045 shares of voting common stock from AEA Investors Inc.
at $100.00 per share. All shares repurchased were sold to our employees pursuant
to the stock purchase plan at the same price per share.

ITEM 14. CONTROLS AND PROCEDURES

(A) EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES

Within 90 days prior to the date of this report, we carried out an
evaluation, under the supervision and with the participation of our management,
including our Chief Executive Officer and Chief Financial Officer, of the
effectiveness of the design and operation of our disclosure controls and
procedures. Based upon that evaluation, our Chief Executive Officer and Chief
Financial Officer concluded that our disclosure controls and procedures are
effective in timely alerting them to material information relating to us
(including our consolidated subsidiaries) required to be included in our
periodic SEC filings.

(B) CHANGES IN INTERNAL CONTROLS

There were no significant changes in our internal controls or in other
factors that could significantly affect these controls subsequent to the date of
our Chief Executive Officer's and Chief Financial Officer's most recent
evaluation. There have been no corrective actions taken with regard to
significant deficiencies and material weaknesses subsequent to the date of our
Chief Executive Officer's and Chief Financial Officer's most recent evaluation.

38

PART IV

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

(a) The following documents are filed as a part of this report:

1. The financial statements listed in the "Index to Financial
Statements" included on page F-2 of this report.

2. Financial statement schedule. Schedule II -- Valuation and
Qualifying Accounts included on page S-1 of this report.

3. The exhibits listed in the "Exhibit Index" included on pages E-1,
E-2 and E-3 of this report.

(b)Reports on Form 8-K.

On October 25, 2002 we filed a Current Report on Form 8-K disclosing
that we had issued a press release on October 23, 2002 naming Terry D.
Smith as our new Chief Financial Officer.

On November 14, 2002, we filed a Current Report on Form 8-K disclosing
that we had issued a press release on November 12, 2002 commenting on
our financial results for the third quarter ended September 30, 2002.

On November 14, 2002, we furnished a Current Report on Form 8-K
disclosing that we had provided to the Securities and Exchange
Commission certifications pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 with
our Quarterly Report on Form 10-Q for the period ended September 30,
2002.

On November 27, 2002, we filed a Current Report on Form 8-K disclosing
that we had issued a press release on November 21, 2002 announcing our
plan to close two of our higher-cost manufacturing plants.

On December 3, 2002, we filed a Current Report on Form 8-K disclosing
that we had entered into employment agreements with Norman E. Wells,
Jr. regarding his employment as our Chief Executive Officer and with
Terry D. Smith regarding his employment as our Chief Financial Officer,
that we had initiated discussions with lenders under our senior credit
facility regarding the modification of our credit agreement and that we
had provided certifications pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 with
an amendment to our quarterly report on Form 10-Q for the period ended
September 30, 2003.

On December 19, 2002, we furnished a Current Report on Form 8-K
disclosing that we had provided to the Securities and Exchange
Commission certifications pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 with
an additional amendment to our quarterly Report on Form 10-Q for the
period ended September 30, 2002.

On December 27, 2002, we filed a Current Report on Form 8-K disclosing
that we had issued a press release on December 27, 2002 announcing that
we had refinanced most of our senior secured Term A credit facility
with a new six year Term B facility as part of an amendment to our
credit agreement.

(c) Exhibits. The response to this portion of Item 15 is submitted as a
separate section of this report.

(d) Financial statement schedule. See Item 15(a)(2).

39

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized on March 14, 2003.

SOVEREIGN SPECIALTY CHEMICALS, INC.

By: /s/ NORMAN E. WELLS, JR.
------------------------------------
Norman E. Wells, Jr.
Chairman and Chief Executive Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities indicated on March 14, 2003.

40

CERTIFICATIONS

I, Norman E. Wells, Jr., certify that:

1. I have reviewed this annual report on Form 10-K of Sovereign Specialty
Chemicals, Inc.;

2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;

3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;

4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:

(a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report is being
prepared;

(b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing
date of this annual report (the "Evaluation Date"); and

(c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;

5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit committee
of the registrant's board of directors (or persons performing the equivalent
functions):

(a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified
for the registrant's auditors any material weaknesses in internal controls;
and

(b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and

6. The registrant's other certifying officer and I have indicated in this
annual report whether there were significant changes in internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.

/s/ NORMAN E. WELLS, JR.
--------------------------------------
Norman E. Wells, Jr.
Chairman and Chief Executive Officer

Date: March 14, 2003

41

CERTIFICATIONS

I, Terry D. Smith, certify that:

1. I have reviewed this annual report on Form 10-K of Sovereign Specialty
Chemicals, Inc.;

2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;

3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;

4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:

i. designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report is being
prepared;

ii. evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing
date of this annual report (the "Evaluation Date"); and

iii. presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;

5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit committee
of the registrant's board of directors (or persons performing the equivalent
functions):

i. all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and

ii. any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and

6. The registrant's other certifying officer and I have indicated in this
annual report whether there were significant changes in internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.

/s/ TERRY D. SMITH
--------------------------------------
Terry D. Smith
Vice President and Chief Financial
Officer

Date: March 14, 2003

42

SUPPLEMENTAL INFORMATION TO BE FURNISHED WITH REPORTS FILED PURSUANT TO SECTION
15(d) OF THE ACT BY REGISTRANTS WHICH HAVE NOT REGISTERED SECURITIES PURSUANT TO
SECTION 12 OF THE ACT.

The registrant has not sent an annual report or proxy materials to its
security holders during the last fiscal year. The registrant does not currently
intend to send an annual report or proxy materials to security holders
subsequent to this filing.

43

ANNUAL REPORT ON FORM 10-K

ITEMS 8 AND 15(A)

INDEX TO FINANCIAL STATEMENTS

F-1

SOVEREIGN SPECIALTY CHEMICALS, INC.
AND SUBSIDIARIES

CONSOLIDATED FINANCIAL STATEMENTS

CONTENTS

Consolidated Financial Statements........................... F-2
Report of Independent Auditors.............................. F-3
Consolidated Balance Sheets................................. F-4
Consolidated Statements of Operations....................... F-5
Consolidated Statements of Stockholders' Equity............. F-6
Consolidated Statements of Cash Flows....................... F-7
Notes to Consolidated Financial Statements.................. F-8

F-2

REPORT OF INDEPENDENT AUDITORS

The Board of Directors
Sovereign Specialty Chemicals, Inc.

We have audited the accompanying consolidated balance sheets of Sovereign
Specialty Chemicals, Inc. and subsidiaries (the Company) as of December 31, 2002
and 2001, and the related consolidated statements of operations, stockholders'
equity, and cash flows for each of the three years in the period ended December
31, 2002. Our audits also included the financial statement schedule listed in
the index at Item 15(a). These financial statements and schedule are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements and schedule based on our audits.

We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.

In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Sovereign
Specialty Chemicals, Inc. and subsidiaries at December 31, 2002 and 2001, and
the consolidated results of their operations and their consolidated cash flows
for each of the three years in the period ended December 31, 2002, in conformity
with accounting principles generally accepted in the United States. Also, in our
opinion, the related financial statement schedule, when considered in relation
to the financial statements taken as a whole, presents fairly in all material
respects the information set forth therein.

As discussed in Note 2, in 2002 the Company changed its method of
accounting for goodwill and other intangible assets to conform to Statement of
Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets".

ERNST & YOUNG LLP

Chicago, Illinois
February 19, 2003

F-3

SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

See accompanying notes to consolidated financial statements.
F-4

SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

See accompanying notes to consolidated financial statements.
F-5

SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

See accompanying notes to consolidated financial statements.
F-6

SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

See accompanying notes to consolidated financial statements.
F-7

SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE PERIODS ENDED DECEMBER 31, 2002, 2001 AND 2000
(DOLLARS IN THOUSANDS, UNLESS OTHERWISE NOTED)

1. NATURE OF BUSINESS

The Company develops, produces and distributes adhesives, sealants and
coatings utilized in numerous industrial and commercial applications. Commercial
applications of the Company's products include industrial packaging, converting
and graphic arts and housing repair, remodeling and construction. Products are
sold and distributed throughout the United States, Europe, Latin America and
Asia.

The Company has two reportable segments: the Commercial segment and the
Construction segment. Applications sold by the Commercial Segment consist
primarily of flexible packaging adhesives and coatings for a number of
applications, high performance, specialty adhesives and coatings for automotive,
aerospace, manufactured housing and textile applications. Through the
Construction segment, the Company manufactures and sells housing repair,
remodeling and construction sealants and adhesives used in exterior and interior
applications.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

PRINCIPLES OF CONSOLIDATION

The accompanying consolidated financial statements include the accounts and
transactions of the Company and its wholly owned subsidiaries. All significant
intercompany balances and transactions have been eliminated in consolidation.

CASH AND CASH EQUIVALENTS

The Company considers all highly liquid debt instruments with original
maturities of three months or less to be cash equivalents.

INVENTORIES

Inventories are valued at the lower of cost or market. Cost is determined
primarily using the first-in first-out (FIFO) method.

PROPERTY, PLANT, AND EQUIPMENT

Property, plant, and equipment are stated at cost, less accumulated
depreciation. Depreciation is provided using the straight-line method over the
respective estimated useful lives of the assets for financial reporting
purposes, as follows: three to fifteen years for machinery and equipment; five
to fifteen years for furniture and fixtures, and 39 to 40 years for buildings.
Leasehold improvements are amortized over the lesser of the lease term or 40
years. Accelerated depreciation methods are used for income tax purposes.
Depreciation expense was $8,632, $8,159 and $5,739, for the years ended December
31, 2002, 2001, and 2000, respectively.

GOODWILL

Goodwill represents the excess of acquisition cost over the fair value of
net assets acquired and was being amortized using the straight-line method over
periods ranging from 15 to 25 years through December 31, 2001. Accumulated
amortization of goodwill was $30.1 million at December 31, 2001. On January 1,
2002, the Company adopted SFAS No. 142, Goodwill and Other Intangible
Assets,which eliminated the amortization of goodwill and instead required that
goodwill be tested for impairment at least annually. The transitional impairment
test of goodwill made by the Company during the quarter ended June 30, 2002
resulted in an impairment of goodwill charge of $17.1 million, net of income tax
benefit. The adoption of SFAS No. 142 resulted in a $10.0 million decrease in
amortization expense in 2002 (See Note 2).

F-8

SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

DEFERRED FINANCING COSTS

The costs of obtaining financing are capitalized and are being amortized as
interest expense over the term of the related financing using a method which
approximates the interest method. Accumulated amortization was $4,327 and $2,537
at December 31, 2002 and 2001, respectively.

IMPAIRMENT OF LONG-LIVED AND INTANGIBLE ASSETS

Long-lived assets and finite-lived intangible assets are reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying amount of the related asset may not be recoverable. Recoverability of
assets to be held and used is measured by a comparison of the carrying amount of
the asset to future undiscounted cash flows expected to be generated by the
asset. If the asset is determined to be impaired, the impairment recognized is
measured by the amount by which the carrying value of the asset exceeds its fair
value.

INCOME TAXES

Deferred taxes have been recognized for the tax consequences of temporary
differences by applying the enacted statutory income tax rates applicable to
future years of differences between the financial statement carrying amounts and
the tax bases of the existing assets and liabilities. Deferred taxes have been
recognized due to differences in timing for financial reporting and tax
reporting of depreciation, goodwill amortization, net operating loss
carry-forwards, inventory reserves and capitalization, the allowance for
doubtful accounts, and various accruals.

REVENUE RECOGNITION

Revenue is recognized when products are shipped to the customer and title
transfers.

RESEARCH AND DEVELOPMENT

Research and development costs are charged to expense as incurred. Research
and development expenses were $7.0 million, $6.4 million and $5.2 million for
the years ended December 31, 2002, 2001 and 2000, respectively.

TRANSLATION OF FOREIGN CURRENCIES

The Company's foreign subsidiaries use the local currency of each
operation's home country as their functional currency. Accordingly, assets and
liabilities are translated using the exchange rates as of the balance sheet
dates and the statement of operations account balances are translated using a
weighted-average exchange rate during the applicable period. Adjustments
resulting from such translation are included in accumulated other comprehensive
loss, a separate component of stockholders' equity.

FAIR VALUE OF FINANCIAL INSTRUMENTS

The carrying value of cash and cash equivalents, trade accounts receivable
and accounts payable approximate to their fair value at December 31, 2002 and
2001, due to the short-term nature of these instruments.

The carrying amounts reported in the Company's balance sheets for
variable-rate long term debt, including current portion, approximate fair-value,
as the underlying long-term debt instruments are comprised of notes that are
re-priced on a short term basis.

The Company estimates the fair value of fixed rate long-term debt
obligations including current portion, using the discounted cash flow method
with interest rates currently available for similar obligations. The carrying
amounts reported in the Company's balance sheets for these obligations
approximate fair value.
F-9

SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The fair value of the Company's 11 7/8% Senior Subordinated Notes
approximated $135.0 million at December 31, 2002 based upon trading in public
debt market.

CONCENTRATION OF CREDIT RISK

Financial instruments that potentially subject the Company to significant
concentrations of credit risk consist principally of trade accounts receivable.
To minimize this risk, ongoing credit evaluations of customers' financial
condition are performed, although collateral is not required. In addition, the
Company maintains an allowance for potential credit losses. The Company
estimates an allowance for doubtful accounts based on the creditworthiness of
its customers as well as general economic conditions. Consequently, an adverse
change in those factors could affect the Company's estimate of its allowance for
doubtful accounts.

At December 31, 2002 and 2001, the Company maintained cash deposits with
certain financial institutions which were in excess of federally insured limits.

USE OF ESTIMATES

The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Actual results could differ from those
estimates.

RECLASSIFICATIONS

Certain prior years' amounts have been reclassified to conform to the 2002
presentation.

STOCK OPTIONS

The Company accounts for stock options granted to employees and directors
in accordance with Accounting Principles Board Opinion No. 25, Accounting for
Stock Issued to Employees (APB 25). In accordance with APB 25, employee and
director compensation expense is recognized based upon the excess of fair value
of the underlying stock over the option exercise price on the measurement date,
the date at which both the exercise price and the number of shares to be issued
are known.

As permitted under the provisions of SFAS No. 123, "Accounting for
Stock-Based Compensation," as amended by SFAS No. 148, the Company will continue
to apply APB Opinion No. 25 and related interpretations in accounting for the
options under the Company's Plan. Accordingly, compensation expense has only
been recognized for options with an exercise price below the market value at the
date of grant. Had the provisions of SFAS 123 been used in the calculation of
compensation expense (calculated using the minimum value method for non-public
companies), pro forma net loss would have been as follows for the three years
ended December 31, 2002:

NEW ACCOUNTING STANDARDS

In April 2002, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 145, Rescission of FASB
Statements No. 4, 44, and 62, Amendment of FASB Statement No. 13, and Technical
Corrections. SFAS No. 145 requires that certain gains and losses on

F-10

SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

extinguishments of debt be classified as income or loss from continuing
operations rather than as extraordinary items as previously required under SFAS
No. 4, Reporting Gains and Losses from Extinguishment of Debt. This statement
also amends SFAS No. 13, Accounting for Leases, to require certain modifications
to capital leases be treated as sale-leaseback and modifies the accounting for
sub-leases when the original lessee remains a thirdary obligor (or guarantor).
The Company will be required to adopt SFAS No. 145 on January 1, 2003, and will
reclassify extraordinary items to continuing operations.

In August 2002, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 146 (SFAS 146), "Accounting for Costs
Associated with Exit or Disposal Activities." SFAS 146 nullifies the guidance of
the Emerging Issues Task Force (EITF) Issue No. 94-3, "Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs incurred in a Restructuring)." SFAS 146 requires that a
liability for a cost that is associated with an exit or disposal activity be
recognized when the liability is incurred. SFAS 146 also establishes that fair
value is the objective for the initial measurement of the liability. The
provisions of SFAS 146 are required for exit or disposal activities that are
initiated after December 31, 2002. At this time we do not believe the adoption
of SFAS 146 will have a material impact on our financial statements.

2. GOODWILL AND INTANGIBLE ASSETS

In June 2001, the Financial Accounting Standards Board issued SFAS No. 141,
Business Combinations, and SFAS No. 142, Goodwill and Other Intangible Assets.

On July 1, 2001, the Company adopted SFAS No. 141. SFAS No. 141 requires
that the purchase method of accounting be used for all business combinations
initiated after September 30, 2001 and also includes guidance on the initial
recognition and measurement of goodwill and other intangible assets acquired in
a business combination. The initial adoption of SFAS No. 141 did not affect the
Company's results of operations or its financial position.

On January 1, 2002, the Company adopted SFAS No. 142. The adoption of SFAS
No. 142 eliminated the amortization of goodwill beginning January 1, 2002 and
instead required that goodwill be tested for impairment. The adoption of SFAS
No. 142 resulted in a $10.0 million decrease in amortization expense in 2002.
Amortization expense recognized was $2.4 million, $2.5 million, $2.3 million and
$2.8 million, respectively for the four quarters of 2001. In connection with our
adoption of SFAS No. 142, the transitional intangible asset impairment test
required an impairment of goodwill charge of $27.6 million ($17.1 million, net
of income tax benefit). The loss was recorded as a cumulative effect of change
in accounting principle. The impairment loss and write-down of goodwill was
recorded relative to the Company's European reporting unit of its Commercial
Segment. Our assessment of the goodwill impairment charge for this reporting
unit is reflective of both lower operating performance in Europe and the use of
lower market multiples. The carrying value of goodwill associated with our other
reporting units was not impaired.

At December 31, 2002 the Company has no unamortized definite lived
intangible assets. Amortization expense for intangible assets for the year ended
December 31, 2002 was $0.6 million.

Actual results of operations for the year ended December 31, 2002 and the
pro forma results of operations for the year ended December 31, 2001 had we
applied the non-amortization provisions of SFAS No. 142 in the prior period are
as follows:

F-11

SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

3. PLANT CLOSURE COSTS

In November 2002, the Company announced the closure of two of its
higher-cost manufacturing plants in 2003. The first plant is located in
Cincinnati, Ohio where 118 people are employed. The Cincinnati plant primarily
produces water-borne adhesives sold to the industrial market. Production from
this plant will be transferred to Sovereign's plants in Greenville, South
Carolina, and Carol Stream and Plainfield, Illinois progressively over the next
nine months. Some of the technical, sales support, customer service, and
administrative functions will be transitioned to other Sovereign locations
during 2003. Approximately 88 employees, primarily in manufacturing, but also
including some in technical, sales support, customer service and administrative
functions will be terminated as part of the closure in 2003.

The second plant is located in Kapellen, Belgium and employs 24 people. On
October 25, 2002, Sovereign announced its intent to cease manufacturing in
Kapellen. In accordance with the laws of Belgium and following a consultation
period, a final decision was made. This plant produces water-borne and hot-melt
adhesives for the European packaging and converting market. This production will
be shifted to the Newark United Kingdom plant during the first half of 2003.
Approximately 14 employees primarily in manufacturing functions will be
terminated as part of the plant closure. The Kapellen facility will continue to
provide sales, technical and distribution support to continental Europe.

These closures will include the termination of certain existing employees,
the abandonment or sale at a loss of certain fixed assets, the disposal of
certain inventory and the sale of certain buildings. The Company expects the
closure of both plants to be completed by the third quarter of 2003. The closure
of these two plants is expected to produce annual cost savings of over $3.0
million when the shutdowns are complete. As a result of the announced closures
we recorded a charge of approximately $4.1 million in the fourth quarter of 2002
included in selling, general and administrative expense, relative to the
following costs: termination benefits of approximately $1.6 million, loss on
fixed assets of $1.3 million and other exit costs of $1.2 million. These costs
will be incurred over the next several quarters. $2.5 million of these costs
will be incurred in 2003 and is accrued for in accrued liabilities on the
balance sheet. Our 2003 capital spending budget of $8 million includes the
capital expenditures required to accomplish the production transfers.

4. BUSINESS COMBINATIONS

Effective August 2000, the Company purchased the coatings business of
Aurachem Inc. a privately owned company, for $4.3 million. In connection with
the acquisition, the Company recognized goodwill of approximately $3.5 million.

Effective October 2000, the Company purchased the outstanding common stock
of Imperial Adhesives, Inc. ("Imperial"), a subsidiary of NS Group, Inc., for
$27.3 million including transaction costs of $0.6 million. In connection with
the acquisition, the Company recognized goodwill in the amount of $18.2 million.
In 2001, the Company incurred an additional $0.2 million in transaction costs
and $0.4 million in costs relative to income tax payments made for periods prior
to date of acquisition. These costs were recognized as additional goodwill in
2001.

Simultaneous with the acquisition of Imperial, the Company announced its
plan to exit Imperial's Nashville manufacturing facility. Management incurred
approximately $1.1 million in costs directly attributable to the closure of the
facility which included $0.4 million of severance costs and $0.7 million
primarily for costs to restore the land and building to saleable condition. As a
result, the provision for plant closure was recorded as part of the acquisition
cost. The facility was closed on July 31, 2001 and sold on December 30, 2002.

Effective October 2000, the Company acquired certain assets of the global
specialty adhesives and coatings business of Croda International Plc. The cost
of the acquisition was $66.2 million including $2.0 million of transaction
costs. Additional contingent consideration of $2.8 million was paid on February
8, 2001 based on the performance of certain of the acquired operations which was
included in the $66.2 million
F-12

SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

cost of the acquisition. In connection with the acquisition, the Company
recognized goodwill in the amount of $35.8 million in 2000. During 2001, the
Company finalized the purchase price allocation of the Croda acquisition and
recorded an additional $2.1 million of goodwill. The additional goodwill related
to $0.9 million of additional acquisition costs and a $1.9 million write-down to
fair value of fixed assets and inventory.

Effective June 30, 2001, the Company completed the purchase of certain
distribution activities and inventory of IMPAG, a long standing European
distributor of products produced by Sovereign for $1.7 million. Consideration is
payable in four installments. In July, 2001, the Company paid $0.5 million.
Approximately $0.3 million was paid in January, 2002 and $0.5 million will be
paid in January 2003 and 2004. The Company recognized $1.5 million in goodwill.

These acquisitions have been accounted for under the purchase method of
accounting. Accordingly, the allocation of the cost of the acquired assets and
liabilities have been made on the basis of the fair value. The consolidated
financial statements include the operating results of each business from the
date of acquisition.

The unaudited pro forma consolidated statement of operations as if the
Imperial and Croda acquisitions had occurred as of the beginning of the
perspective periods, would have been as follows for the year ended December 31,
2000:

5. INVENTORIES

Inventories are summarized as follows:

6. PROPERTY, PLANT, AND EQUIPMENT

Property, plant, and equipment are summarized as follows:

F-13

SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

7. ACCRUED EXPENSES

Accrued expenses are summarized as follows:

8. LONG-TERM DEBT

Long-term debt is summarized as follows:

SENIOR SUBORDINATED NOTES

As a result of a change of controlling stockholder of the Company at the
end of 1999, under the terms of the indenture relating to the Company's 9 1/2%
Senior Subordinated Notes due 2007 (9 1/2% Notes), the Company was required to
make an offer to purchase for cash any and all of its outstanding $125.0 million
principal amount of 9 1/2% Senior Subordinated Notes for 101% of the principal
amount thereof plus accrued and unpaid interest to the date of repurchase. On
March 6, 2000, the entire $125.0 million principal amount of 9 1/2% Senior
Subordinated Notes was repurchased for an aggregate purchase price of $127.4
million which was financed with borrowings under the Company's Credit Agreement.
In connection with the repurchase transaction, the Company recognized an
extraordinary loss of $4.8 million, net of tax benefit of $3.2 million resulting
from the 1% premium paid at repurchase and the write-off of approximately $3.5
million of unamortized deferred financing costs.

On March 29, 2000, the Company completed a private placement of $150.0
million in principal amount of 11 7/8% Senior Subordinated Notes (the Notes) due
2010. The Notes were subsequently exchanged for notes with substantially
identical terms that were registered with the SEC. The Notes were issued at a
discount of $1.1 million which is being amortized to interest expense over the
life of the Notes. At December 31, 2002 the unamortized discount is $0.8
million.

F-14

SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The Notes mature on March 15, 2010. Interest is payable semi-annually in
arrears each March 15 and September 15. On or after March 15, 2005, the Notes
may be redeemed at the option of the Company, in whole or in part, at specified
redemption prices plus accrued and unpaid interest:

In addition, at any time on or prior to March 15, 2003, the Company may
redeem, in the aggregate, up to 35% of the original aggregate principal amount
of the Notes (calculated after giving effect to the original issuance of
additional Notes, if any) with the net cash proceeds of one or more public
equity offerings by the Company, at a redemption price in cash equal to 111.875%
of the principal amount thereof, plus accrued and unpaid interest. In the event
of a change in control, the Company would be required to offer to repurchase the
Notes at a price equal to 101.0% of the principal amount plus accrued and unpaid
interest.

The Notes are general obligations of the Company, subordinated in right of
payment to all existing and future senior debt and are guaranteed by the
Company's wholly-owned domestic subsidiaries -- (the Guarantor Subsidiaries).
Each of the Guarantor Subsidiaries' guarantees of the Notes are full,
unconditional, and joint and several.

The indenture under which the Notes were issued contains certain covenants
that, among other things, limit the Company from incurring other indebtedness,
engaging in transactions with affiliates, incurring liens, making certain
restricted payments (including dividends), and making certain asset sales.

CREDIT FACILITIES

The Company amended its Credit Agreement (Credit Agreement) on December 20,
2002. The amended Credit Agreement provides for aggregate borrowings of $108.6
million. The Credit Agreement as amended includes (1) a $50.0 million revolving
credit facility (Credit Facility) (including letters of credit of up to $20
million), (2) Term Loan A with remaining outstanding balance of $11.1 million at
December 31, 2002 and no capacity to borrow additional funds under that facility
and (3) Term Loan B with an aggregate principal balance of $47.5 million at
December 31, 2002 and no additional capacity to borrow additional funds under
that facility. The Credit Agreement prior to amendment dated December 20, 2002,
had included (1) a $50.0 million Credit Facility (including letters of credit of
up to $20 million) and (2) a $75.0 million term loan (Term Loan A) to fund
acquisitions with an outstanding balance of $56.3 million at December 20, 2002
and no capacity to borrow additional funds under that facility.

The Credit Facility matures December 30, 2005. Commitment fees on the
unused portion of the Credit Facility of 0.375% to 0.050% are payable quarterly
in arrears. At December 31, 2002, the Company had $13.4 million outstanding and
$34.6 million in available borrowings under the Credit Facility (net of
approximately $2.0 million outstanding letters of credit). The Company's
effective interest rate for its borrowings under the Credit Agreement was 5.7%
and 7.1%, for the year ended December 31, 2002 and 2001, respectively.

Borrowings under the revolving Credit Facility are available on a revolving
basis and may be used for general corporate purposes, excluding, however, loans,
advances and investments, including acquisitions, by the Company other than
specified exceptions. Scheduled quarterly repayments of $75.0 million
outstanding under Term Loan A began on September 30, 2001 and through September
30, 2002 the Company had repaid $18.3 million of the amount outstanding under
that facility. Prior to December 20, 2002, the Company was to continue to make
scheduled quarterly repayments through December 31, 2003 to 50% of the $75.0
million

F-15

SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

amount drawn under the Term Loan A. The scheduled amortization for 2003 was
$15.0 million. The remaining 50% was scheduled to be repaid in equal quarterly
payments through December 30, 2005.

On December 20, 2002 the Company amended its Credit Agreement and
refinanced $45.1 million of the $56.3 Term Loan A outstanding balance with a new
six year, $47.5 million Term B facility. The Term Loan B includes a $2.4 million
discount (representing a fee) which will be amortized through interest expense
over the life of the facility. Term Loan B will mature December 30, 2007.
Scheduled principal repayment under the Term Loan B facility for the years
ending December 31, 2003 through 2006 will be $0.5 million per year payable
quarterly. The remaining balance under Term Loan B will be repaid in 2007. We
have three scheduled quarterly payments in 2007 at the same rate of $0.5 million
per year and a final payment due for the balance outstanding at December 31,
2007. There is no scheduled amortization for the $11.1 million outstanding under
the Term Loan A facility for the years ending December 31, 2003 and 2004. The
remaining $11.1 million drawn under Term Loan A will be repaid in 2005. The most
significant effects of the amendment are:

- restoration of the full availability of the $50.0 million Credit Facility
by eliminating a previously existing covenant to maintain borrowing
availability under our Credit Facility (a) of at least $10.0 million at
all times prior to December 31, 2002 and (b) of at least $12.5 million
from January 1, 2003,

- amendment of the financial covenants to decrease the restrictiveness of
those covenants for the quarter ended December 31, 2002 and each of the
fiscal quarters prospectively beginning with first quarter of 2003,

- elimination of the fixed charge ratio covenant beginning December 31,
2002, which was replaced by an asset coverage ratio covenant under which
the Company must maintain at the end of each fiscal quarter a ratio
(determined by the sum of accounts receivable, inventory and property,
plant and equipment divided by total amount advanced, including
outstanding letters of credit, under the Credit Agreement) greater than
1.25 to 1,

The following effects of previous amendments are still in effect under the
current amended Credit Agreement:

- a limitation on the use of advances under the Credit Facility for, among
other things, acquisitions and investments in non-guarantor, offshore
entities,

- prohibition of any significant acquisitions unless only capital stock is
used as the purchase consideration and no indebtedness is assumed or
acquired, and

- a decrease in the Company's permitted levels of capital expenditures and
indebtedness outside the credit facilities.

Borrowings under the Credit Agreement bear interest at the Company's option
at a rate per annum equal to either (1) the higher of (a) the current base rate
as offered by JPMorgan Chase or (b) 1/2 of 1% per annum above the federal funds
rate plus, in either case, an applicable margin or (2) a Eurodollar rate plus an
applicable margin. The applicable margin varies by facility. For amounts drawn
under the Term Loan A and Credit Facility the Eurodollar margin is 3.75% and the
base rate margin is 2.75%. For amounts drawn under the Term Loan B facility, the
Eurodollar margin is 4.50% and the base rate margin is 3.50%. Amounts
outstanding under the Credit Facility, Term Loan A and Term Loan B bear
interest, payable quarterly in the case of base rate advances and payable at the
end of the relevant interest period of one, two, three or six months (or
quarterly in certain cases) for all Eurodollar advances. The Company's credit
ratings do not affect the interest rates for the Company's borrowings under our
Credit Agreement.

The Credit Agreement contains covenants that, among other things, restrict
the ability to incur additional indebtedness, dispose of assets, repay or amend
other indebtedness, pay dividends, or make other changes in

F-16

SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

the business conducted by the Company or its subsidiaries. In addition the
Credit Agreement requires compliance with specific financial ratios and tests,
as defined in the Credit Agreement. The Credit Facility, Term Loan A and Term
Loan B are secured by substantially all of the assets of the Company and its
subsidiaries including pledges of the common stock of the Company's
subsidiaries. In addition, the Credit Facility, Term Loan A and Term Loan B are
guaranteed by the Company's subsidiaries. Some of these guarantees and pledges
are in support of only offshore advances, if any, under the Credit Facility. No
additional borrowings are available under Term Loan A or Term Loan B.

The Company's Singapore-based sales office has a facility providing for
borrowings up to approximately $1.1 million in U.S. dollars and secured by a
letter of credit. Interest is payable at United States prime plus 1.0%. At
December 31, 2002, approximately $0.8 million was drawn on the facility.

At December 31, 2002, the Company has $13.4 million drawn under the Credit
Facility, and approximately $2.0 million of outstanding letters of credit. At
December 31, 2002, the Company had approximately $34.6 million of borrowing
availability under the Credit Facility.

ACQUISITION NOTES PAYABLE

In connection with an acquisition, the Company had a $1.0 million note
payable to the seller that has a maturity date of June 30, 2003. The note
accrues interest at a rate of 8.5% payable on each June 30. At December 31,
2002, $0.3 million was outstanding under the note payable. In connection with
its acquisition of IMPAG, the Company will pay $1.3 million in consideration in
three installments. Approximately $0.3 million was paid in January 2002. The
Company will pay approximately $0.5 million in January 2003 and January 2004,
respectively.

ANNUAL MATURITIES

Annual maturities of the Company's long-term debt are as follows at
December 31, 2002:

2003........................................................ $ 2,041
2004........................................................ 975
2005........................................................ 24,951
2006........................................................ 475
2007........................................................ 45,600
2008 and thereafter......................................... 150,000
--------
224,042
Less: un-amortized discounts................................ (3,148)
--------
Total long-term debt........................................ $220,894
========

F-17

SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

9. INCOME TAXES

The components of the provision for income taxes are as follows for the
years ended December 31, 2002, 2001 and 2000:

The reconciliation of income tax expense computed at the U.S. federal
statutory tax rates to income tax expense (benefit), inclusive of tax benefits
on extraordinary items, is as follows for the years ended December 31, 2002,
2001 and 2000:

F-18

SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities are as follows:

10. RETIREMENT PLANS

The Company sponsors a defined benefit pension plan covering certain
salaried employees of one subsidiary of the Company. The plan is frozen to new
participants. Participants in the plan were given credit for prior years of
service.

The Company has a pension plan covering all union employees of a different
subsidiary. The Company's funding policy has been to contribute annually at
least the minimum required by ERISA. The Plan provides monthly benefits under a
benefit formula.

None of the plan assets of either pension plan are invested in equity of
the Company or equity investments in any related party.

F-19

SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The following tables set forth the Company's two defined benefit plans:

The Company sponsored several defined contribution savings plans (IRS
qualified 401(k) plans) for employees of their U.S. based subsidiaries.
Participation in the plans is available to all salaried and hourly employees of
the Company. Participating employees contribute to the 401(k) plans based on a
percentage of

F-20

SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

their compensation which are matched, based on a percentage of employee
contributions by the Company. The Company recorded expense under these plans of
$1,674, $1,583 and $1,177 for the periods ended December 31, 2002, 2001 and
2000, respectively.

No significant Company sponsored employee savings plans were provided to
non-U.S. employees during 2002 or 2001.

11. MANAGEMENT INCENTIVE PLANS

The Company has implemented certain management incentive plans.

STOCK OPTION PLAN

The Company's Stock Option Plan (the Plan), provides incentives to key
employees and directors (including non-employee directors) of the Company by
granting them nonqualified stock options of up to 299,950 shares of the
Company's common stock. The Plan is administered by a committee of the Board of
Directors which has the authority to determine the employees to whom options
will be granted, the number of options, and other terms and conditions of the
options. The committee increased the number of options available for grant from
240,713 to 299,950 in 2002. Options are granted at not less than the fair value
on the date of grant. Options granted from the Plan are subject to a five year
maximum vesting period and expire ten years from the date of grant. Options
available for grant are 18,000 at December 31, 2002. Options to date have been
granted only to employees and one director. At December 31, 2002, 90,300 options
were exercisable by participants at $129.50 and 3,000 options were exercisable
at $115.00. No options have been exercised at December 31, 2002. The weighted
average remaining contractual life and weighted average exercise price of the
options at December 31, 2002 are 8.5 years and $124.74 per option share,
respectively.

The Company has stock options outstanding as follows:

As permitted under the provisions of SFAS No. 123, "Accounting for
Stock-Based Compensation," as amended by SFAS No. 148, the Company will continue
to apply APB Opinion No. 25 and related interpretations in accounting for the
options under the Company's Plan. Accordingly, compensation expense has only
been recognized for options with an exercise price below the market value at the
date of grant. Had the provisions of SFAS 123 been used in the calculation of
compensation expense (calculated using the

F-21

SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

minimum value method for non-public companies), pro forma net loss would have
been as follows for the three years ended December 31, 2002:

The fair value of each award is estimated on the date of award using the
Minimum Value award-pricing model with risk free interest rates ranging from
5.1% to 6.4% and expected award lives of up to ten years for 2002. The Company
has not paid and does not anticipate paying dividends; therefore, the expected
dividend yield is assumed to be zero.

Because the Company's options have characteristics significantly different
from those of traded stock options, and because changes in subjective input
assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its awards.

In January 2003, the Company offered to any participant in the stock option
plan who so elected, the opportunity to voluntarily surrender all existing
option grants, both vested and unvested, and agreed to reissue new options to
those participants approximately 181 days after the existing options have been
surrendered. The strike price of the new grants will be the greater of $115.00
or the fair market value of the Company's stock on the date of reissuance. As of
February 19, 2003, all of the participants holding options at $129.50 per share
have elected to surrender all such options and receive a like number of options
at the strike price to be determined as described above.

EMPLOYEE STOCK PURCHASE PLAN

The Company's employees purchased 7,045 Class A common shares at fair
market value under an Employee Stock Purchase Plan offered during the first
quarter of 2000.

12. OPERATING LEASES

The Company leases buildings, machinery and equipment under operating
leases which expire on various dates through 2014. Rent expense for all
operating leases was $1,892, $1,849 and $873 for the years ended December 31,
2002, 2001 and 2000, respectively. Future minimum lease payments under
non-cancelable operating leases with terms in excess of one year are as follows:

2003........................................................ $1,327
2004........................................................ 965
2005........................................................ 742
2006........................................................ 722
2007........................................................ 720
2008 and thereafter......................................... 5,050
------
$9,526
======

F-22

SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

13. CAPITAL LEASES

Property under capital leases included within property, plant, and
equipment are as follows:

Future minimum lease payments under capital leases at December 31, 2002,
together with the present value of the minimum lease payments are as follows:

2003........................................................ $ 764
2004........................................................ 718
2005........................................................ 749
2006........................................................ 737
2007........................................................ 737
2008 and thereafter......................................... 399
------
Total minimum payments...................................... 4,104
Less: Amounts representing interest......................... 1,206
------
Present value of minimum payments........................... 2,898
Less: Current portion....................................... 402
------
Total long-term portion..................................... $2,496
======

14. ENVIRONMENTAL MATTERS

The Company is subject to various federal, state, local, and foreign
environmental laws and regulations pertaining to the discharge of materials into
the environment, the handling and disposal of solid and hazardous wastes, the
remediation of contamination, and otherwise relating to health, safety, and
protection of the environment. These laws and regulations provide for
substantial fines and criminal sanctions for violations and impose liability for
the costs of clean up, and for certain damages resulting from past spills,
disposals, or other releases of hazardous substances. In connection with its
acquisitions of businesses, the Company has conducted substantial investigations
to assess potential environmental liabilities. The investigations, performed by
independent consultants of all facilities, found that certain facilities have
had or may have had releases of hazardous materials that require or may require
remediation. In addition, certain subsidiaries have been named as potentially
responsible parties under the Comprehensive Environment Response, Compensation,
and Liability Act (CERCLA) and/or similar environmental laws for cleanup of
multiparty waste disposal sites.

The Company has negotiated contractual indemnifications from previous
owners of acquired businesses, which, supplemented by commercial insurance
coverage designed for each acquisition, is currently expected to adequately
address a substantial portion of known and foreseeable environmental
liabilities. The Company does not currently believe that potential additional
expenses for environmental liabilities will have a material adverse effect on
the financial condition or results of operations of the Company.

F-23

SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

15. SEGMENT REPORTING

The Company has two reportable segments: the Commercial segment and the
Construction segment. Applications sold by the Commercial segment consist
primarily of flexible packaging adhesives and coatings for a number of
applications, high performance, specialty adhesives and coatings for automotive,
aerospace, manufactured housing and textile applications. Through the
Construction segment, the Company manufactures and sells housing repair,
remodeling and construction sealants and adhesives used in exterior and interior
applications.

The Company evaluates performance and defines segment profit based upon
operating income. The reportable segments' accounting policies are the same as
those described in the summary of significant accounting policies (see Note 2.)
Segment profit is calculated as a reportable segment's operating income. Total
segment profits exceed consolidated operating profits to the extent of
unallocated corporate expenses included in selling, general and administrative
expenses. Unallocated corporate expenses were $12.5 million, $9.7 million and
$6.8 million for the years ended December 31, 2002, 2001 and 2000, respectively.

The reportable segments are each managed and measured separately primarily
due to the differing customers, production processes, products sold and
distribution channels. The reportable segments are as follows:

F-24

SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

A reconciliation of the reportable segments to consolidated net sales,
operating income and consolidated assets are as follows:

There is no significant inter-segment revenue or cost of sales to be
eliminated. Other significant items as disclosed within the reportable segments
are reconciled to the consolidated totals as follows:

F-25

SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Revenues and long-lived assets by geographic area are determined by the
location of the Company's facilities as follows:

16. SUPPLEMENTAL CASH FLOW INFORMATION

The following table provides supplemental cash flow data in addition to the
information provided in the consolidated statements of cash flows for the years
ended December 31, 2002, 2001 and 2000:

17. SELECTED QUARTERLY DATA (UNAUDITED)

Operating income for the fourth quarter of 2002 includes a $4.1 million
provision for plant closure costs relative to the planned closures of two of the
Company's manufacturing facilities in 2003 (see Note 3).

18. EXTRAORDINARY ITEM

On March 6, 2000, the Company repurchased its $125.0 million 9 1/2 Senior
Subordinated Notes for an aggregate purchase price of $127.4 million. The
transaction was financed through borrowings from the Company's Credit Agreement.
In connection with this transaction, the Company recognized an extraordinary
loss of $4.8 million, net of an income tax benefit of $3.2 million. The
extraordinary loss resulted from a 1%

F-26

SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

premium on the repurchase of the 9 1/2% Senior Subordinated Notes and the
write-off of unamortized deferred financing costs related to the 9 1/2% Senior
Subordinated Notes.

19. OTHER FINANCIAL INFORMATION

The Company is a holding company with no independent assets or operations.
Full separate financial statements of its guarantor subsidiaries have not been
presented as the guarantors are wholly owned subsidiaries of the Company.
Management does not believe that inclusion of such financial statements would be
material to investors. The financial statement data as of December 31, 2002,
2001 and 2000, respectively of the Guarantor Subsidiaries and the Non-Guarantor
Subsidiaries are below.

The following sets forth the financial data at December 31, 2002 and for
the year then ended.

F-27

SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

F-28

SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The following sets forth the financial data at December 31, 2001 and for
the year then ended.

F-29

SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The following sets forth the financial data for the year ended December 31,
2000.

F-30

SOVEREIGN SPECIALTY CHEMICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

F-31

ANNUAL REPORT ON FORM 10-K

ITEMS 14(A) AND 14(C)

EXHIBIT INDEX

E-1

E-2

- ---------------

+ Incorporated by reference to the Company's Registration Statement on Form S-4,
as amended (Registration No. 333-39373)

E-3

SOVEREIGN SPECIALTY CHEMICALS, INC.

SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS

- ---------------

(1) Accounts written off, net of recoveries.

(2) Balances added relative to acquisitions.

S-1