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PLATFORM SPECIALTY PRODUCTS CORP - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations

May 7, 2014

Forward-Looking Information

From time to time, Platform may make or publish forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements reflect Platform's current views with respect to, among other things, future events and performance. These statements may discuss, among other things, our adjusted earnings per share, expected or estimated revenue, the outlook for Platform's markets and the demand for its products, estimated sales, segment earnings, net interest expense, income tax provision, restructuring and other charges, cash flows from operations, consistent profitable growth, free cash flow, future revenues and gross operating and adjusted EBITDA margin improvement requirement and expansion, organic net sales growth, bank debt covenants, the success of new product introductions, growth in costs and expenses, the impact of commodities and currencies and Platform's ability to manage its risk in these areas, and the impact of acquisitions, divestitures, restructuring and other unusual items, including Platform's ability to successfully complete as well as integrate and obtain the anticipated results and synergies from its consummated and future acquisitions. Platform generally identifies forward-looking statements by words such as "anticipate," "estimate," "expect," "intend," "project," "plan," "predict," "believe," "seek," "continue," "outlook," "may," "might," "will," "should," "can have," "likely" or the negative version of these words or comparable words. Forward-looking statements are based on beliefs and assumptions made by management using currently available information. These statements are only predictions and are not guarantees of future performance, actions or events. Forward-looking statements are subject to risks and uncertainties. If one or more of these risks or uncertainties materialize, or if management's underlying beliefs and assumptions prove to be incorrect, actual results may differ materially from those contemplated by a forward-looking statement. Factors that can cause actual results to differ materially from those reflected in the forward-looking statements include, among others, those discussed in Part I, Item 1A, "Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, 2013, filed with the SEC on March 21, 2014, and elsewhere in this report. You should understand that it is not possible to predict or identify all such factors. Consequently, you should not consider any such list to be a complete set of all potential risks or uncertainties, and we urge you not to place undue reliance on any forward looking statements, which reflect management's analysis, judgment, belief or expectation only as of the date hereof. The Company expressly disclaims any obligation to update or revise any forward-looking statement, whether as a result of new information, future events or otherwise. Historical results are not necessarily indicative of the results expected for any future period. You are advised, however, to consult any further disclosures we make on related subjects in the Company's Forms 10-K, 10-Q and 8-K reports to the SEC. The following "Overview" section is a brief summary of the significant items addressed in Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A"). Investors should read the relevant sections of this MD&A for a complete discussion of the items summarized below. Unless the context otherwise requires, all references in this section to "Platform", the "Company,""we", "us", "our", and "Successor" refer to Platform Specialty Products Corporation and its subsidiaries, collectively, for all periods subsequent to the MacDermid Acquisition (as defined below). All references in this quarterly report on Form 10-Q to our "Predecessor" refer to MacDermid, Incorporated, a Connecticut corporation ("MacDermid") and its subsidiaries for all periods prior to the MacDermid Acquisition (as defined below).



Overview

We were initially incorporated with limited liability under the laws of the British Virgin Islands on April 23, 2013 under the name Platform Acquisition Holdings Limited. We were created for the purpose of acquiring a target company or business with an anticipated enterprise value of between $750 million and $2.50 billion. We completed our initial public offering in the United Kingdom on May 22, 2013, raising approximately $881 million net proceeds and were listed on the London Stock Exchange. On October 31, 2013, we indirectly acquired substantially all of the equity of MacDermid Holdings, LLC ("MacDermid Holdings"), which, at the time, owned approximately 97% of MacDermid (the "MacDermid Acquisition"). As a result, we became a holding company for the MacDermid business. We acquired the remaining 3% of MacDermid (the "MacDermid Plan Shares") on March 4, 2014, pursuant to the terms of an Exchange Agreement, dated October 25, 2013, between us and the fiduciaries of the MacDermid, Incorporated Profit Sharing and Employee Savings Plan (the "MacDermid Savings Plan"). Concurrently with the closing of the MacDermid Acquisition, we changed our name to Platform Specialty Products Corporation. On January 22, 2014, we changed our jurisdiction of incorporation from the British Virgin Islands to Delaware (the "Domestication"), and on January 23, 2014, our shares of common stock, par value $0.01 per share ("Common Stock"), began trading on the New York Stock Exchange ("NYSE") under the ticker symbol "PAH". The total consideration for the MacDermid Acquisition and the Exchange Agreement was approximately $1.80 billion (including the assumption of approximately $756 million of indebtedness), plus (i) up to $100 million of contingent consideration tied to achievement of EBITDA and stock trading price performance metrics over a seven-year period following the closing of the MacDermid Acquisition and (ii) an interest in certain MacDermid pending litigation. The consideration for the MacDermid Acquisition was paid in both equity interests and cash. Certain sellers elected to receive common stock in our wholly owned subsidiary Platform Delaware Holdings, Inc. ("PDH") representing approximately $97.0 million of the total consideration. Holders of PDH common stock have the right to exchange such shares for shares of our Common Stock, on a one-for-one basis, at 25% per year, after the earlier of October 31, 2014 or a change of control of Platform. 25

-------------------------------------------------------------------------------- We are a global producer of high technology specialty chemical products and provider of technical services. As our name "Platform Specialty Products Corporation" implies, we continually seek opportunities to act as an acquirer and consolidator of specialty chemical businesses on a global basis, particularly those meeting Platform's "asset lite, high touch" philosophy, which involves dedicating extensive resources to research and development and highly technical, post-sale customer service, while limiting our investments in fixed assets and capital expenditures. To date, Platform has completed one acquisition, the MacDermid Acquisition, on October 31, 2013. Currently, our business involves the manufacture of a broad range of specialty chemicals, which we create by blending raw materials, and the incorporation of these chemicals into multi-step technological processes. These specialty chemicals and processes together encompass the products we sell to our customers in the electronics, metal and plastic plating, graphic arts, and offshore oil production and drilling industries. We refer to our products as "dynamic chemistries" due to their delicate chemical compositions, which are frequently altered during customer use. Our dynamic chemistries are used in a wide variety of attractive niche markets and we believe that the majority of our operations hold strong positions in the product markets they serve. We generate revenue through the manufacture and sale of our dynamic chemistries and by providing highly technical post-sale service to our customers through our extensive global network of specially trained service personnel. Our personnel work closely with our customers to ensure that the chemical composition and function of our dynamic chemistries are maintained as intended. As an example, a customer will engage us to manufacture and sell a product consisting of a process composed of eight successive chemical baths, each of which is made up of our specialty chemicals, in order to enhance the overall performance of that customer's circuit boards. In addition to providing such product, a member of our professional service team would visit the customer's manufacturing facilities on a regular basis post-sale to ensure that the process sold maintains the correct chemical balance and can be used effectively in the manner and for the purpose desired. While our dynamic chemistries typically represent only a small portion of our customers' costs, we believe that they are critical to our customers' manufacturing processes and overall product performance. Further, operational risks and switching costs make it difficult for our customers to change suppliers and allow us to retain customers and maintain our market positions.



We report our business in two operating segments: a Performance Materials segment and a Graphic Solutions segment.

Performance Materials-Our Performance Materials segment manufactures and markets dynamic chemistry solutions that are used in the electronics, automotive and oil and gas production and drilling industries. We operate in the Americas, Asia and Europe. Our products include surface and coating materials and water-based hydraulic control fluids. In conjunction with the sale of these products, we provide extensive technical service and support to ensure superior performance of their application. The regional sales mix in this segment has shifted over the past several years from more industrialized nations towards emerging markets, such as Asia and South America. To better serve customers in these markets, we have developed state-of-the-art facilities in SÃo Paulo, Brazil and Suzhou, China. We have over 600 personnel and three manufacturing facilities in Asia and remain focused on further increasing our presence in the region. Graphic Solutions-Our Graphic Solutions segment primarily produces and markets photopolymers through an extensive line of flexographic plates that are used in the commercial packaging and printing industries. We manufacture photopolymers used to produce printing plates for transferring images onto commercial packaging, including packaging for consumer food products, pet food bags, corrugated boxes, labels and beverage containers. In addition, we also produce photopolymer printing plates for the flexographic and letterpress newspaper and publications markets. Our products are used to improve print quality and printing productivity. Flexography is a printing process that utilizes flexible printing plates made of rubber or other flexible plastics. Photopolymers are molecules that change properties upon exposure to light. Our business mix in this segment is focused on high innovation, higher cash flow businesses by offering new products. We believe growth in this segment will be driven by consumer demand and advertising. 26 -------------------------------------------------------------------------------- Both of our operating segments include significant foreign operations. There are certain risks associated with our foreign operations. See Part I, Item 1A Risk Factors - "Our substantial international operations subject us to risks not faced by domestic competitors, including unfavorable political, regulatory, labor, tax and economic conditions in other countries that could adversely affect our business, financial condition and results of operations" included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2013. We sell our products into three geographic regions: the Americas, Asia and Europe. Because the Performance Materials segment utilizes shared facilities and administrative resources and offers products that are distinct from those within the Graphic Solutions segment, we make decisions about how to manage our operations by reference to each segment and not with respect to the underlying products or geographic regions that comprise each segment.



For financial information about our operating segments, see Note 17 to our condensed consolidated financial statements included herein.

The following is a discussion of our financial condition and results of operations during the three months ended March 31, 2014 (the "Successor Period") and the three months ended March 31, 2013 (the "Predecessor Period"). We did not own MacDermid for the Predecessor period. Consequently, these results may not be indicative of the results that we would expect to recognize for future periods.



Net Sales

Net sales of approximately $183.7 million in the Successor Period increased by $1.6 million, or 0.9%, compared to the Predecessor Period. Net sales for the Successor Period were not materially impacted by foreign currency translation as compared to the Predecessor Period. We believe that net sales of products that we have identified as new products, which represent opportunities to enter markets adjacent to those we currently serve, was $21.3 million for the Successor Period, compared to $17.9 million for the Predecessor Period. We not only periodically introduce new products to market, but also continuously modify our existing products, often at the request of, or in collaboration with, customers. The impact of new product sales is a recurring factor to our results of operations. Net sales in the Performance Materials segment increased by $4.3 million, or 3.1%, as compared to the Predecessor Period. The increase in net sales is primarily attributable to higher demand for electronic products in Asia during the Successor Period. These increases were partially offset by lower sales of offshore fluids as compared to the Predecessor Period. Net sales in the Graphic Solutions segment decreased by $2.7 million, or 6.2%, as compared to the Predecessor Period. The decrease in net sales is primarily attributable to lower demand for newspaper plating products. By region, net sales in the Americas, Asia and Europe in the Successor Period were $65.6 million, $49.9 million and $68.2 million, respectively. In the Predecessor Period, net sales in the Americas, Asia and Europe were $69.1 million, $49.0 million and $64.0 million, respectively. Sales volumes were lower in the Americas in the Successor Period primarily from the Graphic Solutions segment as previously discussed which was more than offset by an increase in European sales mainly attributable to higher demand for our core industrial products.



Changes in the average selling prices of the Company's products did not have a material impact on net sales for the Successor Period compared to the Predecessor Period.

Cost of Sales

Cost of sales increased $10.7 million, or 12.0%, in the Successor Period compared to the Predecessor Period. The increase is primarily due to the $12.0 million elimination of manufacturer's profit in inventory charged to cost of sales related to the purchase accounting fair value adjustments to inventory associated with the MacDermid Acquisition. Excluding this charge, cost of sales as a percentage of net sales for the Successor Period was 47.7% as compared to 48.8% in the Predecessor Period.



Gross Profit

Gross profit decreased in the Successor Period by $9.1 million, or 9.7%, as compared to the Predecessor Period. The decrease in gross profit is primarily attributable to the elimination of manufacturer's profit in inventory charged to cost of sales in connection with the MacDermid Acquisition. Excluding this charge, our gross margin was 52.3% in the Successor Period as compared to 51.2% for the Predecessor Period with the increase primarily due to favorable changes in product mix. 27

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Selling, Technical, General and Administrative Expense

Selling, technical, general and administrative expense increased in the Successor Period by $18.1 million, or 32.2%, as compared to the Predecessor Period. The increase in selling, technical, general and administrative expense is primarily attributable to a fair value adjustment to the long-term contingent consideration liability of $13.0 million in addition to incremental amortization expense on newly valued intangible assets associated with the MacDermid Acquisition of approximately $6.6 million. Excluding these adjustments, selling, technical, general and administrative expense as a percentage of net sales was 29.6% in the Successor Period as compared to 30.7% for the Predecessor Period.



Research and Development Expense

Research and development expense increased in the Successor Period by $0.2 million, or 4.1%, as compared to the Predecessor Period. The slight increase is due to higher investments made to support certain strategic projects in the Successor Period. As a percentage of net sales, research and development expense was 3.4% and 3.3% for the Successor and Predecessor Periods, respectively.



Operating Profit (Loss)

Operating profit for the Performance Materials segment in the Successor Period decreased by $12.6 million, or 58.8%, as compared to the Predecessor Period. The decrease in operating profit is primarily attributable to the increase in costs and expenses as described above of approximately $12.5 million associated with the MacDermid Acquisition. Partially offsetting these decreases are increases from higher margins on electronics industry products sold in Asia. Operating profit for the Graphic Solutions segment in the Successor Period decreased by $13.2 million, or 158.2%, as compared to the Predecessor Period. The decrease in operating profit is primarily attributable to the increase in costs and expenses as described above of approximately $12.5 million associated with the MacDermid Acquisition. The remaining reduction in operating profit is due to the lower segment sales volume in the Successor Period.



Restructuring Expense

Restructuring expense in the Predecessor Period was $1.6 million and was primarily associated with restructuring charges related to the elimination of certain positions in the Graphic Solutions segment in the Americas. There were no restructuring charges in the Successor Period.



Interest Expense, net

Interest expense, net decreased in the Successor Period by $4.0 million, or 33.9%, as compared to the Predecessor Period. The decrease in interest expense is primarily attributable to lower interest rates on, as well as the make-up of, debt balances outstanding in the Successor Period as compared to the Predecessor Period.



Other (Expense) Income, net

Other income decreased by $3.5 million in the Successor Period as compared to the Predecessor Period. The decrease was primarily due to a reduction of mark to market gains on foreign currency debt of $4.1 million that occurred in the Predecessor Period.



Income Tax Expense

Income tax expense was $2.1 million in the Successor Period compared to $6.3 million in the Predecessor Period. For the Successor and Predecessor Periods, the Company's effective tax rate was (54.9%) and 29.1%, respectively. The tax expense for the Successor Period was increased by the full tax impact of the fair value adjustment to the long term contingent consideration liability. The tax expense was increased by $3.4 million to reflect the non-deductible portion of this adjustment. The Predecessor tax expense includes incremental benefits principally from the imposition of foreign taxes at different tax rates of ($1.1 million) and a decrease in the valuation allowance for foreign tax credits of ($0.6 million). The tax impact of the year to date fair value adjustment to the long term contingent consideration liability was fully recorded in the interim period as a reliable estimate of the full year adjustment could not be reasonably made.



Liquidity and Capital Resources

Our primary sources of liquidity in the Successor Period were cash raised from the initial equity offering, the Warrant Exchange Offer and cash generated from operations. Our primary uses of cash and cash equivalents are raw material purchases, salary expense, acquisitions, capital expenditures and debt service obligations. We believe that our cash and cash equivalent balance and cash generated from operations will be sufficient to meet our working capital needs, capital expenditures and other business requirements for at least the next twelve months. At March 31, 2014, we had $317 million in cash and cash equivalents in addition to an unused line of credit of approximately $46 million. 28 -------------------------------------------------------------------------------- Of our $317 million of cash and cash equivalents at March 31, 2014, $56.1 million was held by our foreign subsidiaries. The majority of the cash held by foreign subsidiaries is generally available for the ongoing needs of our operations. The laws of certain countries may limit our ability to utilize cash resources held in those countries for operations in other countries. However, these laws are not likely to impact our liquidity in any material way. The operations of each foreign subsidiary generally fund such subsidiary's capital requirements. In the event that other foreign operations or operations within the United States require additional cash, we may transfer cash between and among subsidiaries as needed so long as such transfers are in accordance with law. As of March 31, 2014, we had the ability to repatriate $12.6 million of cash at our discretion from the foreign subsidiaries and branches while the remaining balance of $43.5 million was held at subsidiaries in which earnings are considered permanently reinvested. Repatriation of some of these funds could be subject to delay and could have potential tax consequences, principally with respect to withholding taxes paid in foreign jurisdictions. If cash is repatriated from jurisdictions in which earnings are considered permanently reinvested we will be required to accrue and pay U.S. income taxes on such repatriations. The following is a summary of our cash flows provided by (used in) operating, investing and financing activities during the periods indicated ($ in thousands): Three Months Ended Three Months Ended March 31, 2014 March 31, 2013 (amounts in thousands) Successor Predecessor Cash and cash equivalents, beginning of the period $ 123,040 $ 143,351 Cash provided by operating activities 21,065 23,116 Cash provided by (used in) investing activities 2,802 (2,621 ) Cash provided by (used in) financing activities 170,259 (20,024 ) Exchange rate impact on cash and cash equivalents (562 ) (781 ) Cash and cash equivalents, end of the period $ 316,604 $ 143,041 Operating Activities During the Successor Period, we generated $21.0 million in cash from operating activities primarily due to a net loss of $5.9 million that included non-cash charge add-backs for depreciation and amortization of $16.9 million, a fair value adjustment to the long-term contingent consideration liability of $13.0 million and the elimination of the final portion of the manufacturer's profit in inventory in connection with the MacDermid Acquisition of $12.0 million. These favorable changes were partially offset by lower accrued expenses of $7.9 million primarily from payments of deferred compensation made during the Successor Period in addition to higher inventories of $1.9 million due to an increase in finished goods in anticipation of second quarter sales. Also impacting cash from operating activities were unfavorable changes in other assets and liabilities and accounts receivable of $1.8 million and $1.0 million, respectively. During the Predecessor Period, we generated $23.0 million in cash from operating activities primarily due to net income of $15.3 million, the non-cash charge add-back for depreciation and amortization of $9.9 million and favorable changes in accrued expenses of $7.2 million mainly due to higher accrued interest on debt facilities. These increases were partially offset by unfavorable changes in inventories and accounts receivable of $5.8 million and $4.3 million, respectively.



Investing Activities

During the Successor Period, we generated cash from investing activities of approximately $2.8 million primarily from cash received for the working capital adjustment of $8.5 million in connection with the MacDermid Acquisition partially offset by cash payments made in connection with the 401(k) exchange settlement of $2.6 million and capital expenditures of $2 million.



During the Predecessor Period, we used cash from investing activities of approximately $3 million primarily for capital expenditures of $1.3 million.

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Financing Activities

During the Successor Period, we generated cash from financing activities of $170.3 million primarily from proceeds received from the issuance of common shares resulting from warrant exercises of approximately $172.5 million.

During the Predecessor Period, we used cash from financing activities of $20.0 million primarily for the repayment of long-term borrowings of $19.9 million.

We review accounts receivable on a consolidated basis on a business-by-business level. These quarterly reviews focus primarily on the seasonality and collectability of accounts receivable. As a result of these reviews, the Company determined that the composition of accounts receivable did not change in any material respect during either the Successor or Predecessor Period. The Company's management uses days sales outstanding ("DSO") to measure how efficiently it manages the billing and collection of accounts receivable. We calculate DSO by dividing the product of 360 and its accounts receivable balance by its annualized net sales. At March 31, 2014 and December 31, 2013, DSO was 69 days and 73 days, respectively. The primary components of the Company's inventory are finished goods, raw materials and supplies and equipment. We review our inventories quarterly on a consolidated basis on a business-by-business level for obsolescence and excess quantities and to evaluate the appropriateness of the composition of its inventory at any given time. The Company's management uses days in inventory ("DII") to calculate its efficiency at realizing inventories, which is calculated by dividing the product of 360 and its inventory balance, net of reserves, by its annualized cost of sales, excluding any intercompany sales. At March 31, 2014 and December 31, 2013, DII was 82 days and 88 days (inclusive of finished goods step-up adjustment of $35.9 million and related recognition of two-thirds of the inventory step-up in the November and December 2013 of $23.9 million in connection with the MacDermid Acquisition) , respectively. Its products generally have shelf lives that exceed one year.



Financial Borrowings

Credit Facilities

We are party to the Existing Credit Agreement consisting of (i) a $755 million first lien credit facility (which we refer to as our "first lien credit facility") and (ii) a $50.0 million revolving credit facility (which we refer to as our "revolving credit facility", and together with our first lien credit facility, our "credit facilities"). A portion of our revolving credit facility not in excess of $15.0 million is available for the issuance of letters of credit. As of March 31, 2014, we had approximately $749 million of indebtedness outstanding under our first lien credit facility and there were no borrowings under our revolving credit facility, other than stand-by letters of credit issued in the amount of $3.8 million which reduce the borrowings available under our revolving credit facility. Our credit facilities contain various covenants, including limitations on additional indebtedness, dividends and other distributions, entry into new lines of business, use of loan proceeds, capital expenditures, restricted payments, restrictions on liens, transactions with affiliates, amendments to organizational documents, accounting changes, sale and leaseback transactions and dispositions. In addition, the revolving credit facility requires us to comply with certain financial covenants, including consolidated leverage and interest coverage ratios and limitations on capital expenditures if funding under the revolving credit facility exceeds $12.5 million at the end of any fiscal quarter. As of March 31, 2014, the Company was in compliance with the debt covenants contained in our credit facilities.



Off-Balance Sheet Transactions

We use customary off-balance sheet arrangements, such as operating leases and letters of credit, to finance our business. None of these arrangements has or is reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors.


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