Below is a reconciliation of (i) total segment profit (loss) to operating profit (loss) on the Consolidated Statements of Operations, and (ii) total segment assets to total assets on the Consolidated Balance Sheets. The sales from external customers represent the net sales on the Consolidated Statements of Operations.
The Company’s sales, substantially all of which are on an unsecured credit basis, are to various customers from its distribution centers in Texas, California, Arizona, Washington and Nevada. The Company evaluates credit risks on an individual basis before extending credit to its customers and it believes the allowance for doubtful accounts adequately provides for loss on uncollectible accounts. During the six months ended June 30, 2005 and 2004, no single customer accounted for more than 10% of net sales, although sales to environmental contractors were approximately 45% and 42% of consolidated net sales in those periods, respectively. A reduction in spending on environmental projects could significantly impact sales.
Although no vendor accounted for more than 10% of the Company’s sales, three product classes accounted for greater than 10% of sales for the first six months of 2005. The first product class accounted for approximately 17% and 16% of net sales in the first six months of 2005 and 2004, respectively. A major component of these products is petroleum. Increases in oil prices or shortages in supply could significantly impact sales and the Company’s ability to supply its customers with certain products at a reasonable price. The second product class accounted for approximately 14% and 12% of net sales in the first six months of 2005 and 2004, respectively. A majority of these products are produced internationally. Although political climates could impact our ability to sell these products, sourcing of these products is available from many countries and many vendors, none of which control the market.
The Company was named in several class action lawsuits. These complaints generally allege that defendants violated the Securities and Exchange Act of 1934 by allegedly making a series of materially false and purportedly misleading statements concerning Abatix’s business agreement with the Goodwin Group LLC and, as a result, the price of the Abatix stock was allegedly artificially inflated causing plaintiff and other members of the class to allegedly suffer damages.
All of the lawsuits were transferred to one Federal District Court in the Northern District of Texas, Dallas Division (“Federal Court”) and have been consolidated into a single case under Cause No. 3-04CV-872-D; Family Medicine Specialists, et al v. Abatix, et al. (“Class Action”).
On May 27, 2004, the officers and directors of Abatix Corp. were named as defendants in a lawsuit filed in the District Court of Dallas County, Texas, 162nd Judicial District (“State District Court,” and when combined with the Federal Court as “Courts”) styled Daniel M. Johnson Plaintiff v. Terry Shaver; Frank Cinatl IV; Gary L Cox; Donald N. Black; Eric A. Young; and A. David Cook; Defendants v. Abatix Corp. Nominal Defendant (Cause No. 2004-04-4841) (“Derivative Suit”), although Plaintiff has dismissed A. David Cook from this case. This suit is a stockholder derivative action that alleges that all of the defendants breached certain fiduciary duties and abused their control of Abatix. Further, the plaintiff seeks contribution and indemnification. In addition, this petition alleges that Donald Black, an outside board of director of Abatix, breached his fiduciary duties by selling securities based on allegedly material, non-public information and by allegedly misappropriation of information.
On May 6, 2005, the Company executed a Stipulation and Agreement of Settlement to settle the Class Action (“Class Stipulation”) now pending in the Federal Court. On May 9, 2005, the Company executed a Stipulation of Compromise and Settlement to settle the Derivative Suit (“Derivative Stipulation,” and with the Class Stipulation, “Stipulations”) now pending in the State District Court. While the Company was prepared to vigorously defend itself and the officers and directors against the allegations, the Company agreed to settle the Class Action for $900,000 in cash and will adhere to certain corporate governance provisions to settle the Derivative Suit, so that management and its employees can concentrate their full attention on growing the business by eliminating the distraction of further protracted litigation. In addition, the Company agreed to the Stipulations in order to eliminate the litigation risk and expense. The settlement funds are expected to be covered by the Company’s insurance policy. Accordingly, there are no expected charges against the Company’s earnings related to this matter. These proposed settlements expressly provide that the Company and its officers or directors do not admit or concede any violation of law or wrongdoing of any kind.
On May 16, 2005, the State District Court signed the Order Regarding Proposed Derivative Action Settlement, Settlement Hearing and Notice Thereof which allows the notification of the proposed settlement to the stockholders of record as of May 9, 2005. In addition, August 11, 2005 was established as the date for, among other things, determining whether the proposed settlement is fair, reasonable and in the best interest of the nominal defendant, the Company, and its stockholders and whether it should be approved by the State District Court.
On May 17, 2005, the Federal Court signed the Preliminary Order for Notice and Hearing in Connection with Settlement Proceedings which allows the notification of the proposed settlement to the class. In addition, August 11, 2005 was established as the date for, among other things, determining whether the proposed settlement is fair, reasonable and adequate.
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It is the understanding of the Company that the counsel for the plaintiffs in both the Class Action and the Derivative Suit have complied with the applicable procedures to notify the appropriate parties. It is also the Company’s understanding that one class member has opted out of the proposed settlement in the Class Action and that no members of the Class Action or the Derivative Suit have objected to the proposed settlement. The proposed settlement remains subject to final approval by the Courts. Members of the class are defined as purchasers of Abatix common stock from 5:05 p.m. Eastern Standard Time on April 14, 2004 through and including April 30, 2004.
Other than the applicable policy deductible and the fees and expenses incurred prior to provision of notice to the insurance carrier, the insurance company has paid for the defense costs related to the Class Action and Derivative Suit. At this time, it is not possible to predict whether the Company will have any additional liability or to estimate additional costs that may be incurred with such actions that may not be covered by any applicable insurance policy.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Introduction
The following information should be read in conjunction with the Management’s Discussion and Analysis of Financial Condition and Results of Operations included in the Company’s Form 10-K for the year ended December 31, 2004.
The Company is a supplier of mainly safety related products and tools to workers involved in the manufacturing, construction and homeland security markets. From seven fully-stocked distribution facilities/sales offices in the western and southwestern part of the United States, the Company primarily distributes commodity products to the local geographic areas surrounding its facilities.
IESI, the Company’s wholly-owned subsidiary, imports disposable clothing from China. IESI sells their product throughout the United States through the Abatix distribution channels, as well as through other distributors.
The Company’s management believes that hiring additional sales staff, controlling costs, geographic expansion, diversification of customer base and responding effectively to competitive challenges are important to the long-term success of the Company.
• | Sales Staff – We sell our products based on relationships, among other things. Our ability to hire, train and retain staff, especially in the sales and customer service area is critical to our long-term success. Our current competitive compensation and benefits, including updating these items when necessary, as well as a good work-life balance are critical to this area. |
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• | Controlling Costs – To maintain our competitive position by providing competitively priced products while also maintaining our profitability, we must control our costs and effectively utilize our assets. As we did in 2004, we are continuing to review our selling, general and administrative costs and making adjustments where appropriate. Our ability to control costs can be affected by outside factors, such as the price of oil or increases in interest rates. In addition, the cost to initially comply with Section 404 of the Sarbanes-Oxley Act by the end of 2006 is expected to be $500,000, approximately 3% of our annualized selling, general and administrative expenses. This cost would negate most of our cost reduction efforts to date. |
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• | Geographic Expansion – The Company needs to leverage our infrastructure and knowledge over a larger revenue base. While the Company intends to focus on growing revenues in its existing locations, the Company will also explore geographic expansion. This expansion could come in the form of opening a new location in a new geographic market or acquiring an existing company in a market where we currently do not operate. Both of these possibilities require significant planning time and financial resources. |
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• | Customer Base – While no customer represents 10% or more of the Company’s revenues, there are several large customers, especially at IESI. The loss of one or more of those customers would have a severe impact on our business. The Company intends to pursue additional customers and cultivate current customers in an attempt to lessen the impact of any one customer. While we intend to sell our customer service in an attempt to obtain higher margins than just, obtaining market share generally has a negative effect on product margins. |
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• | Competitive Environment – Past results and future prospects are significantly affected by the competitive environment in which we operate. We experience intense competition for sales of our products in all of our markets. Our competition ranges from small owner-operator distributors to large national retail chains selling to the construction industry and large national companies selling to the construction and industrial industries. Typically, the smaller companies are built around very strong relationships which make it hard to penetrate, while the larger companies have a distinct geographic and price advantage. |
Other than historical and factual statements, the matters and items discussed herein are forward-looking statements that involve risks and uncertainties. Actual results of the Company may differ materially from the results discussed herein. Certain, but not all, factors that could contribute to such differences are discussed throughout this report, but are more fully discussed in our report on Form 10-K for the year ended December 31, 2004. We do not undertake any obligation to publicly update forward-looking statements to reflect events or circumstances after the date on which the statement is made or to reflect the occurrence of unanticipated events, except as required by law or regulation.
Results of Operations and Related Information
Second Quarter 2005 Compared With 2004
Net Sales
Consolidated net sales increased 29% to $16,028,000 from 2004. The Abatix operating segment net sales increased 27% to $15,105,000, while the IESI operating segment net sales increased 59% to $923,000.
• | The increase in sales at the Abatix operating segment resulted from: |
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| • | increased sales to the environmental market primarily as a result of weather related events in California, |
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| • | increased sales to the industrial manufacturing and construction markets, as spending has increased due to the current growth in the U.S. economy. |
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• | The increase in sales at the IESI operating segment resulted from market penetration by a few key customers. |
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Gross Profit
Consolidated gross profit of $4,389,000 increased 31% from 2004. Expressed as a percentage of sales, gross profit was 27% in both 2005 and 2004. The increase in gross profit dollars is a result of:
• | higher sales volume to the restoration, industrial and construction markets at the Abatix segment, and |
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• | higher sales volume at the IESI segment. |
Selling, General and Administrative (“S,G&A”) Expenses
S,G&A expenses of $3,740,000 increased 3% from 2004. The significant changes are:
• | higher labor costs as a result of higher selling volume, |
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• | higher freight expenses as a result of higher selling volume and higher fuel costs, and |
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• | higher bad debt expense as a result of the increased write-offs, |
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• | partially offset by lower legal expenses. |
Expressed as a percentage of sales, S,G&A expenses were 23% and 29% for 2005 and 2004, respectively, as the general and administrative costs did not increase at the same rate as the growth in revenues.
Additional Statement of Operations Commentary
• | Operating profit of 4.1% of sales for 2005 improved from an operating loss of (2.2%) of sales in 2004. The Abatix segment operating profit of 2.8% of sales for 2005 improved from an operating loss of (3.2%) of sales in 2004. The IESI segment operating profit of 23.8% of sales in 2005 improved from 17.2% in 2004. |
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| • | The improvement at both the Abatix and IESI segments is a result of higher sales volumes without a corresponding increase in general and administrative costs. |
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• | Interest expense of $75,000 increased approximately $22,000 from 2004 primarily due to higher interest rates, partially offset by lower average line of credit balances. |
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• | Our effective tax rate was 39% in 2005 and 2004. |
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• | Net earnings of $350,000 or $.20 per share increased approximately $553,000 from net losses of ($203,000) or ($.12) per share in 2004. The increase in net earnings is primarily due to the higher operating profit. |
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First Six Months 2005 Compared With 2004
Net Sales
Consolidated net sales increased 26% to $30,754,000 from 2004. The Abatix operating segment net sales increased 24% to $28,841,000, while the IESI operating segment net sales increased 62% to $1,913,000.
• | The increase in sales at the Abatix operating segment resulted from: |
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| • | increased sales to the environmental market primarily as a result of weather related events in California, |
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| • | increased sales to the industrial manufacturing and construction markets, as spending has increased due to the current growth in the U.S. economy. |
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• | The increase in sales at the IESI operating segment resulted from market penetration by a few key customers. |
Gross Profit
Consolidated gross profit of $8,531,000 increased 30% from 2004. Expressed as a percentage of sales, gross profit was 28% and 27% in 2005 and 2004, respectively. The increase in gross profit dollars is a result of:
• | higher sales volume to the restoration, industrial and construction markets at the Abatix segment, and |
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• | higher sales volume at the IESI segment. |
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• | The increase in the gross profit rate is primarily a result of better purchasing decisions. |
S,G&A Expenses
S,G&A expenses of $7,492,000 increased 8% from 2004. The significant changes are:
• | higher labor costs as a result of higher selling volume, |
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• | higher freight expenses as a result of higher selling volume and higher fuel costs, and |
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• | higher bad debt expense as a result of the increased write-offs, |
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• | partially offset by lower legal expenses. |
Expressed as a percentage of sales, S,G&A expenses were 24% and 28% for 2005 and 2004, respectively, as the general and administrative costs did not increase at the same rate as the growth in revenues.
Additional Statement of Operations Commentary
• | Operating profit of 3.4% of sales for 2005 improved from an operating loss of (1.5%) of sales in 2004. The Abatix segment operating profit of 1.8% of sales for 2005 improved from an operating loss of (2.5%) of sales in 2004. The IESI segment operating profit of 25.7% of sales in 2005 improved from 15.4% in 2004. |
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| • | The improvement at both the Abatix and IESI segments is a result of higher sales volumes without a corresponding increase in general and administrative costs. |
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• | Interest expense of $137,000 increased approximately $38,000 from 2004 primarily due to higher interest rates, partially offset by lower line of credit balances. |
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• | Our effective tax rate was 39% in 2005, which compared with 32% in 2004. The effective rate in 2004 is lower than normal as the expected tax benefit as a result of the losses was partially offset by a $20,000 additional tax expense resulting from an adjustment to the 2001 tax year. |
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• | Net earnings of $548,000 or $.32 per share increased approximately $871,000 from net losses of ($323,000) or ($.19) per share in 2004. The increase in net earnings is primarily due to the higher operating profit. |
Liquidity and Capital Resources
Cash used in operations during 2005 of $220,000 compared to cash used in operations during 2004 of $1,342,000.
• | Gross inventory increased 18% over 2004 year-end. Inventory for the comparable period in 2004 also increased 15% over 2003 year-end. The increase in 2005 is a result of: |
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| • | an increase in stocking levels ahead of price increases on several products, and |
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| • | inventory stock up in anticipation of the normally busy summer months, which is also hurricane season. |
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• | Gross accounts receivable increased 4% since December 2004 as sales in the second quarter of 2005 were 9% higher than the first quarter 2005 and 14% higher than the fourth quarter of 2004. |
Cash requirements for investing activities during 2005 of $211,000 increased by $70,000 when compared to 2004. These requirements were primarily the purchase of corporate vehicles and computer hardware and software. Purchases for the remainder of 2005 are estimated to be approximately $300,000 and will primarily include replacement of vehicles and computers, and potentially some additional productivity software.
The Company has an $8,000,000 working capital line of credit and a $500,000 capital equipment credit facility at one financial institution.
• | Based on the borrowing formula calculated as of June 30, 2005, the Company had the capacity to borrow up to the maximum of $8,000,000 on its working capital line. |
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• | As of August 3, 2005, there are advances of $6,030,000 outstanding on the working capital credit facility. |
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• | As of August 3, 2005 there are advances of $23,000 outstanding on the capital equipment credit facility. |
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• | Both credit facilities are payable on demand and bear a variable rate of interest tied to the prime rate. |
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• | The majority of the Company’s credit facilities are at one financial institution and are payable on demand. A risk exists that these credit facilities would be called by the financial institution and the Company would be unable to secure other facilities. |
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Contractual Obligations
The following table presents the Company’s total contractual obligations as of June 30, 2005 for which future cash flows are fixed or determinable (in thousands).
| | 2005 | | 2006 | | 2007 | | 2008 | | 2009 | | 2010 | | Total | |
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Contractual obligations: | | | | | | | | | | | | | | | | | | | | | | |
Operating leases | | $ | 543 | | $ | 532 | | $ | 348 | | $ | 132 | | $ | 118 | | $ | 69 | | $ | 1,742 | |
Working capital line of credit | | | 5,869 | | | — | | | — | | | — | | | — | | | — | | | 5,869 | |
Equipment notes | | | 26 | | | 37 | | | 20 | | | 8 | | | 5 | | | 1 | | | 97 | |
Employment contracts | | | 292 | | | 584 | | | — | | | — | | | — | | | — | | | 876 | |
Open purchase orders | | | 1,597 | | | — | | | — | | | — | | | — | | | — | | | 1,597 | |
Other obligations | | | 22 | | | 28 | | | 7 | | | 7 | | | 4 | | | — | | | 68 | |
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Total contractual obligations | | $ | 8,349 | | $ | 1,181 | | $ | 375 | | $ | 147 | | $ | 127 | | $ | 70 | | $ | 10,249 | |
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Commentary:
• | The amounts for 2005 represent the approximate contractual obligations for the remainder of 2005. |
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• | The Company’s working capital line of credit agreement includes a feature that allows the bank to call the debt; therefore, the debt is classified as a current liability on the Consolidated Balance Sheets and included above. This line of credit contains no defined payment schedule. In addition, the Company uses letters of credit to periodically facilitate the purchase of goods from outside the United States. As of June 30, 2005, the Company had one outstanding letter of credit for approximately $19,000, which is included in the above table. |
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• | The Company’s equipment notes are comprised of term notes of 36 to 60 months in length. While these term notes are listed above in accordance with their scheduled payments, certain of these term notes have a call feature, and are therefore classified as current liabilities on the Consolidated Balance Sheets. |
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• | The employment agreements with the Chief Executive, Operating and Financial Officers expire on December 31, 2006. |
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• | The open purchase orders represent amounts the Company anticipates will become payable within the next year for saleable product. |
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New Accounting Standards
In June 2005, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“Statement”) 154, “Accounting Changes and Error Corrections” a replacement for Accounting Principles Board (“APB”) Opinion No. 20 and FASB Statement 3. Statement 154 applies to all voluntary changes in accounting principle and changes the requirement for accounting for and reporting of a change in accounting principle. It also applies to changes required by an accounting pronouncement in the unusual instance that the pronouncement does not include specific transition provisions. When a pronouncement includes specific transition provisions, those provisions should be followed. APB Opinion No. 20 required that most voluntary changes in accounting principle be recognized by including in net income of the period of the change the cumulative effect of changing to the new accounting principle. Statement 154 establishes that unless impracticable, retrospective application is the required method for reporting a change in accounting principle in the absence of explicit transition requirements specific to the newly adopted accounting principle. While the correction of an error is not an accounting change, Statement 154 requires the restatement of previously issued financial statements. The Company does not expect the adoption of Statement 154 to have a material impact on its financial statements.
In June 2005, the Emerging Issues Task Force (“EITF”) reached a tentative conclusion on Issue No. 04-13, “Accounting for Purchases and Sales of Inventory With the Same Counterparty.” The first issue surrounds the recognition of a nonmonetary transaction at fair value rather than at recorded amounts. The second issue surrounds the classification of two or more nonmonetary transactions being viewed as a single nonmonetary transaction. With respect to the first issue, the Company does, on occasion, purchase and sell finished goods inventory to other companies within the same line of business. These transactions have been recognized at the recorded amount in accordance with the EITF tentative conclusion. With respect to the second issue, the EITF created a list of indicators that would trigger two or more nonmonetary transaction be accounted for as a single transaction. Based on the criteria established, the Company does not expect any impact to its financial statements from the EITF conclusion.
In June 2005, the EITF reached a final conclusion on Issue No. 05-06, “Determining the Amortization Period for Leasehold Improvements.” The EITF concluded that leasehold improvements placed in service significantly after and not contemplated at, or near, the beginning of the lease term, should be amortized over the lesser of the useful life of the assets or a term that includes renewals that are reasonable assured at the date the leasehold improvements are purchased. This consensus applies only to purchase of significant leasehold improvements as a result of a single capital investing decision. The Company does not expect any impact to its financial statements from the EITF conclusion.
In June 2005, the Financial Accounting Standards Board issued an Exposure Draft containing a joint proposal with the International Accounting Standards Board to improve and align the accounting for business combinations. The proposed standard would replace the existing requirements of Statement of Financial Accounting Standards (“Statement”) 141, Business Combinations. The Company has yet to determine the impact of the Exposure Draft, if adopted in its current state, would have on its financial statements.
In June 2005, the FASB issued an Exposure Draft containing a joint proposal with the International Accounting Standards Board that proposes noncontrolling interests be classified as equity within the consolidated financial statements and the acquisitions of noncontrolling interests be accounted for as equity transactions. The Company has yet to determine the impact of the Exposure Draft, if adopted in its current state, would have on its financial statements.
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Business Outlook
Our goal for 2005 is to produce revenue growth, exclusive of the non-recurring revenues in Florida in 2004, as it is vital to our long-term success.
• | We are anticipating the industrial manufacturing and construction markets to remain steady as the general economy and, in particular, the real estate market, have stabilized. However, recent increases in interest rates could negatively impact the economy. |
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• | We anticipate growth in the environmental market, and in particular, the restoration subset of that market. However, year over year growth will be difficult as the third and fourth quarters of 2004 include the positive impact on our business from the 2004 hurricanes in Florida. |
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• | The homeland security segment is expected to continue to grow in 2005. The growth in this market to date has been with the public sector and generally is at lower margins than the remainder of the Company’s markets. We are hopeful the private sector will spend more money on homeland security products as the economy remains stable; however, there is not much evidence to support the private sector will begin to spend on our homeland security products. In response to these issues, the Company has lowered its cost structure to support this market. |
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• | Hiring of additional sales staff will be critical for long-term growth of the Company. |
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• | Diversification of our customer base, especially at the IESI segment, will also help provide more consistent results. Although no customer is more than 5% of our revenues, we have several large customers, the loss of which would impact our business. The growth at the IESI segment was primarily generated by two customers. We are focused on helping all of our customers grow, as well as adding to our customer base. |
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• | New locations and acquisitions will most likely be critical for the long-term growth of the Company. Although we are not certain if and when we will open new locations, we are currently evaluating certain markets as possibilities. We are not currently evaluating any acquisitions. |
Overall margins for 2005 are anticipated to remain at their current levels.
• | We are utilizing certain tools and reporting from our new computer system in an effort to enhance margins. In addition, these tools and reporting should allow us to identify issues that can be addressed more quickly, thereby minimizing possible margin erosion. |
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• | We continue to evaluate the consolidation of certain vendors to gain access to better pricing. |
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• | We are evaluating alternative methods for sourcing products to enhance our purchasing process. |
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• | However, further competitive pressures or changes in the customer or product mix could negatively impact any and all efforts by the Company to maintain or improve product margins. |
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The Company will need to further reduce costs to stay competitive and improve on its profitability.
• | We intend to continue evaluating costs, including labor related costs, rent, freight and depreciation which make up approximately 75% of our selling, general and administrative costs, to ensure our cost structure is in line with our revenue stream and supports our business model. We do anticipate our legal expenses in 2005 will be less than 2004. |
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• | The Company recently began its work to comply with Section 404 of the Sarbanes-Oxley Act of 2002. The Company currently estimates that it will incur approximately $500,000 in costs, most of which are external costs, related to this work. These costs will be incurred over 2005 and 2006. |
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• | If the recent growth in revenues continues or the current level of revenues is sustainable, our selling, general and administrative expenses should be in the 25% of sales range for 2005. |
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• | The Company’s credit facilities are variable rate notes tied to the lending institution’s prime rate. Increases in the prime rate could negatively affect the Company’s earnings. |
Depending on many factors, including the timing of sales, cash flow from operations for the entire year of 2005 is expected to be positive as the Company continues its receivables collection efforts, further improvements are made to inventory and purchasing and there is continued refinement in our cost structure.
• | Unless the Company employs a more aggressive growth strategy, management believes the Company’s current credit facilities, together with cash provided by operations, will be sufficient for its capital and liquidity requirements for the next twelve months. |
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• | The Company’s accounts receivable collection days have leveled off over the past year after increasing because of the sharp decrease in sales to restoration contractors in early 2003. The Company took steps to protect our interests in certain receivables and increased its bad debt expense. The Company believes its allowance for bad debts is sufficient to cover any anticipated losses. |
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• | The Company’s inventory turns have improved slightly over the past year after increasing because of the sharp decrease in sales to restoration contractors and the increase in inventory levels to support a customer of IESI. The improvement in sales overall and sales to IESI’s customer have helped the inventory turns. Further work in reducing inventory levels is needed. |
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• | A new location would require approximately $100,000 in fixed asset purchases, comprised of computers, office furniture, warehouse racking and potentially a delivery vehicle. In addition, cash will also be required to stock this location with product and to finance the customers’ purchases. Cash flow from operations and borrowings on our lines of credit will most likely be used to finance any new location. |
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• | Unless the Company’s stock could be used as currency, any acquisitions would most likely require the raising of capital as the borrowing capacity on the lines of credit and the cash flow from operations would most likely not be sufficient to support an acquisition of reasonable size. |
Information Concerning Forward-Looking Statements
Certain statements contained herein, among other things, are of a forward-looking nature relating to future events or the future business performance of Abatix. Such statements involve a number of risks and uncertainties including, without limitation, the occurrence and timing of weather related events, global, national and local economic and political conditions; changes in laws and regulations relating to the Company’s products and the import of such products; the outcome of litigation; market acceptance of new products, existence or development of competitive products the Company represents as a distributor that outperform current product lines or are priced more competitively; inability to hire and train quality people or retain current employees; changes in interest rates; the financial status of key customers and vendors; efforts to control and/or reduce costs; adverse weather conditions; significant changes in oil prices; or the Company’s success in the process of management’s assessment and auditor attestation of internal controls, as required by the Sarbanes-Oxley Act of 2002. We do not undertake any obligation to publicly update forward-looking statements to reflect events or circumstances after the date on which the statement is made or to reflect the occurrence of unanticipated events, except as required by law or regulation.
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Item 3. Quantitative and Qualitative Disclosures about Market Risk.
There have been no material changes from the information previously reported under Item 7A of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2004.
Item 4. Controls and Procedures.
Within the 90-day period prior to the date of this report, the Company evaluated, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Rule 13a-15 and 15d-15 of the Securities Exchange Act of 1934 (the “Exchange Act”). Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer conclude that the Company’s disclosure controls and procedures are effective in timely alerting them to material information relating to the Company (including its consolidated subsidiaries) required to be included in the Company’s Exchange Act filings.
There have been no significant changes in the Company’s internal controls over financial reporting or in other factors, which could significantly affect internal controls over financial reporting subsequent to the date the Company carried out its evaluation.
The Company is currently undergoing a comprehensive effort to ensure compliance with the new regulations under Section 404 of the Sarbanes-Oxley Act that take effect for the Company’s fiscal year ending December 31, 2006. This effort includes internal control documentation and review under the direction of senior management. In the course of its ongoing evaluation, management has identified certain areas requiring improvement, which the Company is addressing. Management routinely reviews potential internal control issues with the Company’s Audit Committee.
PART II – OTHER INFORMATION
Item 1. Legal Proceedings.
The Company was named in several class action lawsuits. These complaints generally allege that defendants violated the Securities and Exchange Act of 1934 by allegedly making a series of materially false and purportedly misleading statements concerning Abatix’s business agreement with the Goodwin Group LLC and, as a result, the price of the Abatix stock was allegedly artificially inflated causing plaintiff and other members of the class to allegedly suffer damages.
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All of the lawsuits were transferred to one Federal District Court in the Northern District of Texas, Dallas Division (“Federal Court”) and have been consolidated into a single case under Cause No. 3-04CV-872-D; Family Medicine Specialists, et al v. Abatix, et al. (“Class Action”).
On May 27, 2004, the officers and directors of Abatix Corp. were named as defendants in a lawsuit filed in the District Court of Dallas County, Texas, 162nd Judicial District (“State District Court,” and when combined with the Federal Court as “Courts”) styled Daniel M. Johnson Plaintiff v. Terry Shaver; Frank Cinatl IV; Gary L Cox; Donald N. Black; Eric A. Young; and A. David Cook; Defendants v. Abatix Corp. Nominal Defendant (Cause No. 2004-04-4841) (“Derivative Suit”), although Plaintiff has dismissed A. David Cook from this case. This suit is a stockholder derivative action that alleges that all of the defendants breached certain fiduciary duties and abused their control of Abatix. Further, the plaintiff seeks contribution and indemnification. In addition, this petition alleges that Donald Black, an outside board of director of Abatix, breached his fiduciary duties by selling securities based on allegedly material, non-public information and by allegedly misappropriation of information.
On May 6, 2005, the Company executed a Stipulation and Agreement of Settlement to settle the Class Action (“Class Stipulation”) now pending in the Federal Court. On May 9, 2005, the Company executed a Stipulation of Compromise and Settlement to settle the Derivative Suit (“Derivative Stipulation,” and with the Class Stipulation, “Stipulations”) now pending in the State District Court. While the Company was prepared to vigorously defend itself and the officers and directors against the allegations, the Company agreed to settle the Class Action for $900,000 in cash and will adhere to certain corporate governance provisions to settle the Derivative Suit, so that management and its employees can concentrate their full attention on growing the business by eliminating the distraction of further protracted litigation. In addition, the Company agreed to the Stipulations in order to eliminate the litigation risk and expense. The settlement funds are expected to be covered by the Company’s insurance policy. Accordingly, there are no expected charges against the Company’s earnings related to this matter. These proposed settlements expressly provide that the Company and its officers or directors do not admit or concede any violation of law or wrongdoing of any kind.
On May 16, 2005, the State District Court signed the Order Regarding Proposed Derivative Action Settlement, Settlement Hearing and Notice Thereof which allows the notification of the proposed settlement to the stockholders of record as of May 9, 2005. In addition, August 11, 2005 was established as the date for, among other things, determining whether the proposed settlement is fair, reasonable and in the best interest of the nominal defendant, the Company, and its stockholders and whether it should be approved by the State District Court.
On May 17, 2005, the Federal Court signed the Preliminary Order for Notice and Hearing in Connection with Settlement Proceedings which allows the notification of the proposed settlement to the class. In addition, August 11, 2005 was established as the date for, among other things, determining whether the proposed settlement is fair, reasonable and adequate.
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It is the understanding of the Company that the counsel for the plaintiffs in both the Class Action and the Derivative Suit have complied with the applicable procedures to notify the appropriate parties. It is also the Company’s understanding that one class member has opted out of the proposed settlement in the Class Action and that no members of the Class Action or the Derivative Suit have objected to the proposed settlement. The proposed settlement remains subject to final approval by the Courts. Members of the class are defined as purchasers of Abatix common stock from 5:05 p.m. Eastern Standard Time on April 14, 2004 through and including April 30, 2004.
Other than the applicable policy deductible and the fees and expenses incurred prior to provision of notice to the insurance carrier, the insurance company has paid for the defense costs related to the Class Action and Derivative Suit. At this time, it is not possible to predict whether the Company will have any additional liability or to estimate additional costs that may be incurred with such actions that may not be covered by any applicable insurance policy.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds. None
Item 3. Defaults upon Senior Securities. None
Item 4. Submission of Matters to a Vote of Security Holders.
| At the Annual Stockholders’ Meeting on May 26, 2005, the stockholders elected Terry W. Shaver, Gary L. Cox, Donald N. Black, Eric A. Young and A. David Cook as the Board of Directors for the Company until the next Annual Stockholders’ Meeting in 2006. A total of 1,675,604 votes were for the election Terry W. Shaver, A. David Cook and Eric A. Young as directors with 2,300 shares against their election and no shares withheld. A total of 1,676,704 votes were for the election Gary L. Cox and Donald N. Black as directors with 1,200 shares against their election and no shares withheld. |
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| In addition, the stockholders also ratified the appointment of KPMG LLP to serve as independent auditors of the Company for the year ending December 31, 2005. A total of 1,676,704 votes were for the ratification of the appointment of the auditors with 1,200 shares against and no shares withheld. |
Item 5. Other Information. None
Item 6. Exhibits.
| (a) Exhibits – (31)(a) – Certification of Chief Executive Officer * |
| (31)(b) – Certification of Chief Financial Officer * |
| (32)(a) – Certification of Chief Executive Officer * |
| (32)(b) – Certification of Chief Financial Officer * |
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| * Only included with the Company’s electronic filing with the SEC. |
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| ABATIX CORP. |
| (Registrant) |
| |
Date: August 3, 2005 | By: | /s/ FRANK J. CINATL, IV |
| |
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| | Frank J. Cinatl, IV |
| | Vice President and Chief Financial |
| | Officer of Registrant |
| | (Principal Accounting Officer) |
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