ABATIX CORP. AND SUBSIDIARY
Consolidated Statements of Cash Flows
(Unaudited)
| | Three Months Ended
March 31, | |
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| | 2006 | | 2005 | |
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Cash flows from operating activities: | | | | | | | |
Net earnings | | $ | 219,997 | | $ | 198,315 | |
Adjustments to reconcile net earnings to net cash provided by (used in) operating activities: | | | | | | | |
Depreciation and amortization | | | 118,871 | | | 105,010 | |
Deferred income taxes | | | (106,145 | ) | | 52,920 | |
Provision for losses on receivables | | | 83,842 | | | 151,199 | |
Provision for obsolescence of inventory | | | 34,260 | | | 43,752 | |
Loss (gain) on disposal of assets | | | 551 | | | (701 | ) |
Changes in operating assets and liabilities: | | | | | | | |
Receivables | | | 2,988,291 | | | 733,879 | |
Inventories | | | 684,257 | | | (766,863 | ) |
Prepaid expenses and other assets | | | 310,086 | | | 110,807 | |
Other assets, primarily deposits | | | (18,954 | ) | | 455 | |
Accounts payable | | | (627 | ) | | (47,185 | ) |
Accrued expenses | | | (593,276 | ) | | (120,708 | ) |
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Net cash provided by operating activities | | | 3,721,153 | | | 460,880 | |
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Cash flows from investing activities: | | | | | | | |
Purchase of property and equipment | | | (52,726 | ) | | (80,852 | ) |
Advances to employees | | | (363 | ) | | (530 | ) |
Collection of advances to employees | | | 1,022 | | | 2,630 | |
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Net cash used in investing activities | | | (52,067 | ) | | (78,752 | ) |
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Cash flows from financing activities: | | | | | | | |
Borrowings on notes payable to bank | | | 3,259,179 | | | 4,939,046 | |
Repayments on notes payable to bank | | | (7,218,231 | ) | | (5,306,970 | ) |
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Net cash used in financing activities | | | (3,959,052 | ) | | (367,924 | ) |
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Net (decrease) increase in cash | | | (289,966 | ) | | 14,204 | |
Cash at beginning of period | | | 790,097 | | | 338,443 | |
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Cash at end of period | | $ | 500,131 | | $ | 352,647 | |
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See accompanying notes to consolidated financial statements.
ABATIX CORP. AND SUBSIDIARY
Notes to Consolidated Financial Statements
(Unaudited)
(1) Basis of Presentation, General and Business
Abatix Corp. (“Abatix”) and subsidiary, (collectively, the “Company”) market and distribute personal protection and safety equipment, and durable and nondurable supplies to the environmental industry, the industrial safety industry, the homeland security industry and, combined with tools and tool supplies, the construction industry. At March 31, 2006, the Company operated seven sales and distribution centers in five states and a temporary facility in Louisiana. In response to the summer 2004 hurricanes in Florida, the Company operated a temporary facility in Tampa from August 2004 until February 2005.
The Company’s wholly-owned subsidiary, International Enviroguard Systems, Inc. (“IESI”) imports disposable protective clothing products sold through the Company’s distribution channels and through other distributors.
Note 1 of the Notes to Consolidated Financial Statements included in the Company’s Form 10-K for the year ended December 31, 2005 contains a description of the Company’s significant accounting policies. Since December 31, 2005, there have been no changes in our critical accounting policies and no significant changes to our assumptions and estimates related to them.
The accompanying consolidated financial statements are prepared in accordance with the instructions to Form 10-Q, are unaudited and do not include all the information and disclosures required by generally accepted accounting principles in the United States of America for complete financial statements. All adjustments that, in the opinion of management, are necessary for a fair presentation of the results of operations for the interim periods have been made and are of a recurring nature unless otherwise disclosed herein. The results of operations for such interim periods are not necessarily indicative of results of operations for a full year.
The preparation of the accompanying consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
The accompanying consolidated financial statements include the accounts of Abatix and IESI. All significant intercompany accounts and transactions have been eliminated in consolidation. Certain prior year amounts have been reclassified for consistency in presentation.
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(2) Earnings per Share
Basic earnings per share is calculated using the weighted average number of common shares outstanding during each period, while diluted earnings per share includes the effects of all dilutive potential common shares. For the three-month periods ended March 31, 2006 and 2005, there were no dilutive securities outstanding.
(3) Supplemental Information for Statements of Cash Flows
The Company paid interest of $104,771 and $64,274 in the three months ended March 31, 2006 and 2005, respectively. The Company paid income taxes of $537,700 and $220,954 in the three months ended March 31, 2006 and 2005, respectively.
(4) Segment Information
Identification of operating segments is based principally upon differences in the types and distribution channel of products. The Company’s reportable segments consist of Abatix and IESI. The Abatix operating segment includes the Company’s corporate operations, seven aggregated branches and the temporary facility, which are principally engaged in distributing environmental, safety, homeland security and construction equipment and supplies to contractors and industrial manufacturing facilities in the western half of the United States. The IESI operating segment, which consists of the Company’s wholly-owned subsidiary, International Enviroguard Systems, Inc., is engaged in the wholesale distribution of disposable protective clothing to companies similar to, and including, Abatix. The IESI operating segment distributes products throughout the United States and the Caribbean.
The accounting policies are consistent in each operating segment as described in Note 1 of the Notes to Consolidated Financial Statements included in the Company’s Form 10-K for the year ended December 31, 2005. The Company evaluates the performance of its operating segments based on operating profit after a charge for the carrying value of inventory and accounts receivable. Intersegment sales are at agreed upon pricing and intersegment profits are eliminated in consolidation.
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Summarized financial information concerning the Company’s reportable segments is shown in the following table. There are no other significant noncash items.
| | Abatix | | IESI | | Totals | |
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Three months ended March 31, 2006 | | | | | | | | | | |
Sales from external customers | | $ | 15,992,430 | | $ | 613,900 | | $ | 16,606,330 | |
Intersegment sales | | | — | | | 221,953 | | | 221,953 | |
Interest expense | | | 130,280 | | | — | | | 130,280 | |
Depreciation and amortization | | | 116,894 | | | 1,977 | | | 118,871 | |
Segment profit | | | 300,529 | | | 176,181 | | | 476,710 | |
Capital expenditures | | | 52,726 | | | — | | | 52,726 | |
Three months ended March 31, 2005 | | | | | | | | | | |
Sales from external customers | | $ | 13,736,038 | | $ | 990,727 | | $ | 14,726,765 | |
Intersegment sales | | | — | | | 143,312 | | | 143,312 | |
Interest expense | | | 62,584 | | | — | | | 62,584 | |
Depreciation and amortization | | | 103,215 | | | 1,795 | | | 105,010 | |
Segment profit | | | 100,182 | | | 272,379 | | | 372,561 | |
Capital expenditures | | | 79,150 | | | 1,702 | | | 80,852 | |
Segment Assets | | | | | | | | | | |
March 31, 2006 | | $ | 21,169,101 | | $ | 1,004,774 | | $ | 22,173,875 | |
December 31, 2005 | | | 25,158,984 | | | 1,355,270 | | | 26,514,254 | |
Below is a reconciliation of (i) total segment profit to operating profit on the Consolidated Statements of Operations, and (ii) total segment assets to total assets on the Consolidated Balance Sheets for all periods presented. The sales from external customers represent the net sales on the Consolidated Statements of Operations.
| | March 31, | |
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| | 2006 | | 2005 | |
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Profit for reportable segments | | $ | 476,710 | | $ | 372,561 | |
Elimination of intersegment profits | | | 9,768 | | | 16,471 | |
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Operating profit | | $ | 486,478 | | $ | 389,032 | |
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| | March 31,
2006 | | December 31,
2005 | |
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Total assets for reportable segments | | $ | 22,173,875 | | $ | 26,514,254 | |
Elimination of intersegment assets | | | (75,110 | ) | | (82,531 | ) |
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Total assets | | $ | 22,098,765 | | $ | 26,431,723 | |
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The Company’s sales, substantially all of which are on an unsecured credit basis, are to various customers from its permanent distribution centers in Texas, California, Arizona, Washington, Nevada and its temporary facility in Louisiana. 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 three months ended March 31, 2006 and 2005, no single customer accounted for more than 10% of net sales, although sales to environmental contractors were approximately 42% and 43% of consolidated net sales in those periods, respectively. A reduction in spending on environmental projects could significantly impact sales.
As a result of the hurricanes affecting the Gulf Coast region in 2005, several customers of Abatix purchased substantial amounts of product in the second half of 2005. These large purchases resulted in significant receivable balances from these customers during that period. The top ten companies owing money to the Company at December 31, 2005 represented approximately 41% of the total receivable balance. These same customers do non-disaster related work as well and represent approximately 20% of the receivable balance as of March 31, 2006. Most of these accounts have been customers of the Company for more than three years, with several being customers of the Company for more than ten years. As of March 31, 2006, the top 10 customers owing money to the Company represent approximately 26% of the total receivable balance. Non-payment by any one of these accounts would have a significant negative impact on the cash flows of the Company.
Although no vendor accounted for more than 10% of the Company’s sales, three product classes (groupings of similar products) accounted for greater than 10% of sales for the first three months of 2006 or 2005. |
• | The first product class, plastic sheeting and bags, accounted for approximately 19% and 16% of net sales in the first three months of 2006 and 2005, respectively. A major component of these products is petroleum. Further 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, disposable clothing, accounted for approximately 14% and 15% of net sales in the first three months of 2006 and 2005, respectively. A majority of these products are produced internationally, predominantly in China. Changes in political climates could impact our ability to obtain these products from our current source. |
• | The third product class, abatement and restoration equipment, accounted for approximately 9% and 11% of net sales in the first three months of 2006 and 2005 respectively. This product class is made up of many vendors with many dissimilar products. |
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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, 2005.
The Company is a supplier of mainly safety related products and tools to workers involved in the construction, manufacturing and homeland security markets. From seven fully-stocked distribution facilities/sales offices in the western and southwestern part of the United States, and one temporary facility in Louisiana to serve our customers helping with the aftermath of the hurricanes affecting the Gulf Coast region, the Company primarily distributes equipment and 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 and the Caribbean 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. Competitive compensation and benefits as well as a good work-life balance are critical to this area. |
| • | 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. We continuously review our general and administrative costs making adjustments where appropriate. Our ability to control costs can be affected by outside factors, such as the price of oil or other raw materials or increases in interest rates. In addition, the cost to initially comply with Section 404 of SOX 404 is expected to total approximately $575,000 by December 31, 2007, of which approximately $125,000 has been spent through March 31, 2006. |
| • | 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. These possibilities require significant planning time and financial resources which could limit our ability to implement. |
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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 an impact on our revenue and profitability. The Company intends to pursue additional customers in an attempt to lessen the impact of any one customer and improve on existing customer relationships. While we intend to market our customer service in an attempt to obtain higher margins, obtaining market share generally has a negative effect on product margins. |
| • | 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. |
In addition to the above mentioned critical success factors, significant short-term boosts of revenue, like the hurricanes of 2004 and 2005, although positively impacting the sales and net income of the Company, also place strains on the Company’s resources as partially identified below:
• | Non-recurring revenues |
| • | Comparisons of financial results between periods are not always evident without reading the financial statements as a whole. |
| • | There is no reliable method to determine the amount of impact these events will have on the Company, nor is there a reliable method to determine how long the impact may last. |
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• | Accounts receivable |
| • | The sharp rise in non-recurring revenues from these events can cause significant balances owed to the Company by a few customers. Balancing this concentration risk with sales is a difficult process that involves significant judgment. |
| • | Much of the work performed by the Company’s customers is related to insurance claims. Occasionally, there is difficulty in getting the insurance company to pay the amount owed and can possibly delay when payment is received by Abatix. |
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• | Inventory |
| • | Certain products can be in short supply because the Company’s vendors are unable to ramp up production to meet the demand in the required time frame. |
| • | Damage caused by catastrophic events can affect the manufacturing and transportation of inventory, including raw materials used by others to manufacture products sold by the Company. |
| • | Products in demand in the affected areas can decimate inventory levels in other facilities and not allow us to serve all of our customers in a normal manner. |
| • | Potential shortages in product result in advanced purchases and maintenance of higher levels of safety stock. If there is little or no damage caused by a catastrophic event or if advance purchasing is too aggressive in estimating needs, the Company could be left with excess inventory. |
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• | Cash |
| • | Significant increases in revenues in a short period of time utilize the cash resources available to the Company as the inventory is purchased and paid for generally between 10 – 40 days, while the average collection period is generally more than 60 days. |
| • | Advance purchases in anticipation of increased sales and possible shortages in supply elongates the cash cycle. |
| • | If interest rates continue to rise, the higher borrowing levels normally associated with these events would translate to higher interest expense. |
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• | Human Resources |
| • | There is significant planning time involved in responding to these events that would normally be spent on other areas of the business. |
| • | Immediate response to these disasters is handled by currently employed personnel which can detract from the service levels provided to our customer base in our other facilities. |
| • | We have generally found a lack of sufficient human resource talent outside of the Company to meet the short-term needs demanded by our temporary facilities. |
| • | Significant amounts of time are spent managing and projecting the cash flows to ensure cash resources are available. |
| • | Fluctuations in financial results can result in extra requirements placed on the corporate staff as a result of comments, inquiries and compliance with regulatory agencies. |
Management has learned from our experience over the past two years and is working to improve our response to these types of events in an attempt to minimize the impact of the items mentioned above. However, each event has its own set of challenges that require significant estimates and judgments of the Company personnel involved.
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. 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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Overview of First Quarter 2006 Results
• | Net sales increased 13% when compared to 2005. |
• | Gross profit increased 12% when compared to 2005. |
• | Selling, general and administrative costs increased 11% when compared to 2005. |
• | Net income of $220,000 increased $22,000 when compared to 2005. |
This discussion and analysis of our results of operations and financial condition is intended to provide investors with an understanding of the Company’s recent performance, its financial condition and its prospects. We will discuss and provide our analysis of the following: |
• | Results of Operations and Related Information |
• | Liquidity and Capital Resources |
• | Critical Accounting Policies |
• | New Accounting Standards |
• | Business Outlook |
• | Information Concerning Forward-Looking Statements |
Results of Operations and Related Information
First Quarter 2006 Compared With 2005
Net Sales
Consolidated net sales increased 13% to $16,606,000 from 2005. The Abatix operating segment net sales increased 16% to $15,992,000, while the IESI operating segment net sales to external customers decreased 38% to $614,000. |
• | The increase in sales at the Abatix operating segment resulted from: |
| • | increased sales to the construction and industrial manufacturing markets, as spending has increased due to the current status of the U.S. economy, and |
| • | increased sales to the environmental market, partially due to the continued sales to the areas affected by the 2005 hurricanes. |
• | The decrease in sales to external customers at the IESI operating segment resulted from lower sales to its two largest customers. |
Gross Profit
Consolidated gross profit of $4,639,000 increased 12% from 2005. Expressed as a percentage of sales, gross profit was 27.9% and 28.1% in 2006 and 2005, respectively. The increase in gross profit dollars is primarily a result of: |
• | higher sales volume in the industrial, construction and environmental markets at the Abatix segment, |
• | partially offset by lower sales volume at the IESI segment. |
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Selling, General and Administrative (“S,G&A”) Expenses
S,G&A expenses of $4,153,000 increased 11% from 2005. The significant changes are: |
• | higher labor costs as a result of higher selling volume and normal annual increases in wages, and |
• | higher freight expenses as a result of higher selling volume and higher fuel costs, |
• | partially offset by lower legal expenses. |
Expressed as a percentage of sales, S,G&A expenses were 25.0% and 25.5% for 2006 and 2005, 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 2.9% of sales for 2006 improved from 2.6% of sales in 2005. The Abatix segment operating profit of 1.9% of sales for 2006 improved from 0.7% in 2005. The IESI segment operating profit of 21.1% of sales in 2006 declined from 24.0% in 2005. |
| • | The improvement at the Abatix segment is a result of higher sales volume without a corresponding increase in general and administrative costs. |
| • | The decline at the IESI segment is a result of lower sales volume. |
• | Interest expense of $130,000 increased approximately $68,000 from 2005 primarily due to higher interest rates and higher borrowed balances. |
• | Our effective tax rate was 39.0% in 2006 and 39.6% in 2005. |
• | Net earnings of $220,000 or $.13 per share increased approximately $22,000 from net earnings of $198,000 or $.12 per share in 2005 as a result of the higher operating profit, partly offset by higher interest expense. |
Liquidity and Capital Resources
Cash provided by operations during 2006 of $3,721,000 increased when compared to cash provided by operations during 2005 of $461,000. |
• | Accounts receivable |
| • | Gross accounts receivable decreased 24% since December 31, 2005 as the Company collected a majority of the money it was owed from customers that did hurricane related work in the Gulf Coast region. |
| • | Approximately 26% of the receivables balance is held by ten companies, with the largest company comprising approximately 8% of the receivables balance. While these companies are long-term customers of Abatix and payment in full is expected, non-payment or delays in payment of these balances owed would have a significant negative impact on the cash flows of the Company. |
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• | Gross inventory decreased 6% since December 31, 2005 as a result of: |
| • | increased sales volume, and |
| • | controlled purchasing. |
• | Cash provided by operations were partially offset by the: |
| • | repayments on the notes payable to the bank, |
| • | reduction in accrued expenses, and |
| • | purchase of fixed assets. |
Cash requirements for investing activities during 2006 of $52,000 decreased by $27,000 when compared to 2005. These requirements were primarily the purchase of computer hardware and software. Purchases for the remainder of 2006 are estimated to be approximately $580,000 and are expected to include the replacement of a vehicle and computers, capital expenses related to the relocation of certain facilities and potentially some additional productivity software.
The Company has a $12,000,000 working capital line of credit with its financial institution and a $500,000 capital equipment credit facility. |
• | Based on the borrowing formula calculated as of March 31, 2006, the Company had the capacity to borrow up to a maximum of $10,148,000 on its working capital line. |
• | As of May 5, 2006, there are advances of $5,468,000 outstanding on the working capital credit facility. |
• | As of May 5, 2006, there are advances of $65,000 outstanding on the capital equipment credit facility. |
• | Both credit facilities expire in October 2007 and bear a variable rate of interest tied to the prime rate. Although, the Company, at its option, can convert the loan to a Libor rate loan. |
• | The equipment facility is payable on demand. |
• | The majority of the Company’s credit facilities are at one financial institution. There is risk associated with having the majority of the Company’s relationship with one financial institution. |
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Contractual Obligations
The following table presents the Company’s total contractual obligations as of March 31, 2006 for which future cash flows are fixed or determinable (in thousands).
| | 2006 | | 2007 | | 2008 | | 2009 | | 2010 | | 2011 and
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Contractual obligations: | | | | | | | | | | | | | | | | | | | | | | |
Operating leases | | $ | 718 | | $ | 879 | | $ | 739 | | $ | 711 | | $ | 610 | | $ | 2,036 | | $ | 5,693 | |
Working capital line of credit | | | 5,871 | | | — | | | — | | | — | | | — | | | — | | | 5,871 | |
Equipment notes | | | 40 | | | 46 | | | 23 | | | 12 | | | 1 | | | — | | | 122 | |
Employment contracts | | | 608 | | | — | | | — | | | — | | | — | | | — | | | 608 | |
Open purchase orders | | | 1,304 | | | — | | | — | | | — | | | — | | | — | | | 1,304 | |
Office equipment leases | | | 14 | | | 19 | | | 19 | | | 9 | | | — | | | — | | | 61 | |
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Total contractual obligations | | $ | 8,555 | | $ | 944 | | $ | 781 | | $ | 732 | | $ | 611 | | $ | 2,036 | | $ | 13,659 | |
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Commentary: |
• | The amounts for 2006 represent the approximate contractual obligations for the remainder of 2006. |
• | Even though the Company’s working capital line of credit agreement has a maturity date of October 2007, there is no defined payment schedule. Therefore, this line of credit is classified as a current liability on the Consolidated Balance Sheets. In addition, the above amount does not include a contractual obligation related to the interest since the interest rate is variable and the working capital line of credit balance fluctuates, therefore making the interest component not fixed and determinable. |
• | The Company’s equipment notes are comprised of term notes of 24 to 60 months in length. Certain of these term notes also have a call feature, and are therefore classified as current liabilities on the Consolidated Balance Sheets. The other term notes with no call feature are properly classified between the current liabilities and non-current liabilities sections on the Consolidated Balance Sheets. |
• | The employment agreements with the Chief Executive, Operating and Financial Officers were effective on January 1, 2005 and expire on December 31, 2006. |
• | 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
On March 17, 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“Statement”) No. 156, “Accounting for Servicing of Financial Assets – an Amendment of FASB Statement No. 140.” This Statement, which amends Statement No. 140: (1) Requires an entity to recognize a servicing asset or servicing liability each time it undertakes an obligation to service a financial asset by entering into a servicing contract in certain situations; (2) Requires all separately recognized servicing assets and servicing liabilities to be initially measured at fair value; (3) Permits an entity to choose either the amortization method or the fair value measurement method for each class of separately recognized servicing assets and servicing liabilities; (4) At its initial adoption, permits a one-time reclassification of available-for-sale securities under Statement 115 under certain conditions; and (5) Requires separate presentation of servicing assets and servicing liabilities subsequently measured at fair value in the balance sheet and additional disclosures for all separately recognized servicing assets and servicing liabilities. This Statement is effective as of the beginning of the first fiscal year that begins after September 15, 2006. The Company does not expect any impact to its financial statements from this Statement.
On March 31, 2006, the FASB issued an Exposure Draft, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans.” The ED proposes requiring companies to: (1) Recognize in its balance sheet the over funded or under funded status of a defined benefit postretirement plan measured as the difference between the fair value of plan assets and the benefit obligation; (2) Recognize as a component of other comprehensive income, net of tax, the actuarial gains and losses and the prior service costs and credits that arise during the period but pursuant to FAS 87 and 106 are not recognized as components of net periodic benefit cost; (3) Recognize as an adjustment to the opening balance of retained earnings, net of tax, any transition asset or transition obligation remaining from the initial application of FAS 87 or 106; (4) Measure defined benefit plan assets and defined benefit plan obligations as of the date of the employer’s statement of financial position; (5) Disclose additional information in the notes to financial statements about certain effects on net periodic benefit cost in the upcoming fiscal year that arise from delayed recognition of the actuarial gains and losses and the prior service costs and credits. This Statement is effective for fiscal years ending after December 15, 2006. The Company does not expect any impact to its financial statements from this Exposure Draft.
Business Outlook
Our goal for 2006 is to produce revenue growth, exclusive of the non-recurring revenues in the Gulf Coast region in 2005, as it is vital to our long-term success. |
• | We are anticipating the industrial manufacturing and construction markets to remain steady or improve slightly as the general economy and, in particular, the real estate market, have stabilized. However, recent increases in interest rates and the cost of materials for real estate projects could negatively impact those segments and the economy in general. |
• | We anticipate growth in the environmental market, and in particular, the restoration subset of that market. However, year over year growth in 2006 will be difficult because of the positive impact on our business, estimated at approximately $9,000,000, from the hurricanes in 2005. |
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• | We do not expect much growth in the homeland security market. However, we will continue to seek both public and private sector opportunities. |
• | Continued shortages in supplies of product, in particular the equipment necessary to respond to catastrophic events and plastic sheeting and bags used in environmental cleanup, could impact the Company’s ability to serve the customers. In addition, (i) price increases attributable to increased raw materials cost, (ii) decrease in supply of product caused by damage from the weather events or (iii) increases in demand for product caused by the weather events could cause increases in product costs which could impact sales. |
• | Hiring of additional sales staff will be critical for long-term growth of the Company. |
• | 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 sales and profitability. 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. |
• | 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. |
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Overall margins for 2006 are anticipated to be in the 27 – 28% range. |
• | 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. |
• | We continue to evaluate the consolidation of certain vendors to gain access to better pricing. |
• | Alternative methods for sourcing products are also being evaluated to enhance our purchasing process. |
• | 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 and freight 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. |
• | In 2005, the Company began its work to comply with SOX 404 and has spent approximately $125,000 through March 31, 2006. The Company currently estimates that it will incur in excess of $575,000 in costs, most of which are external costs, related to this work. |
• | As was the case in Florida in February 2005, if the revenue stream for the temporary office in Ponchatoula does not support the continued operation of that facility, we are prepared to close it. Depending on the timing, a decision to close the facility could result in a charge to earnings. |
• | Unless revenues improve significantly and are sustainable, S,G&A expenses are estimated to be in the 24 – 25% range for 2006. |
• | The Company’s credit facilities are variable rate notes tied to the lending institution’s prime or Libor rates. Increases in these rates have already and could continue to negatively affect the Company’s earnings. |
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Depending on many factors, including the timing of sales and the effects of hurricanes in 2006, if any, cash flow from operations for the entire year of 2006 is expected to be positive as the Company collected a significant amount of the receivables from the sales increase in the last half of 2005, improvements are made to inventory and purchasing and there is further 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. |
• | The Company does not expect a significant change in its accounts receivable collection days and also believes its allowance for bad debts is sufficient to cover any anticipated losses. |
• | The Company’s inventory turns have decreased slightly over the past twelve months. The decline is primarily a result of the inventory levels in anticipation of continued sales in the areas impacted by the hurricanes in 2005 or for future water restoration business. Continued work in reducing inventory levels is still needed; however, the Company believes its allowance for inventory obsolescence is sufficient to cover any valuation issues. |
• | 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 would most likely be used to finance any new location. |
• | 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. |
• | The Company currently estimates that it will incur approximately $450,000 in additional costs through 2007 related to the implementation of SOX 404. |
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, timing and property devastation of disasters; 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; market acceptance of new products; existence or development of competitive products the Company represents 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 and relationships with key customers and vendors; efforts to control and/or reduce costs; fluctuations 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 SOX 404. 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, 2005.
Item 4. Controls and Procedures.
Evaluation of Disclosure Controls and Procedures
As of March 31, 2006, 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 were 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.
Internal Control over Financial Reporting
The Company is currently undergoing a comprehensive effort to ensure compliance with the regulations under SOX 404 that take effect for the Company’s fiscal year ending December 31, 2007. 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.
Changes in Internal Control
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.
Limitations on the Effectiveness of Controls
Our management, including the Chief Executive Officer and the Chief Financial Officer, does not expect that our disclosure controls and procedures or our internal control over financial reporting will prevent all error and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met.
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Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake.
The design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies and procedures. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.
PART II – OTHER INFORMATION
Item 1. Legal Proceedings. None
Item 1A. Risk Factors. There has been no material change from the risk factors previous disclosed in the Company’s Form 10-K for the year ended December 31, 2005.
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. None
Item 5. Other Information. None
Item 6. Exhibits.
| (31.1) | | Certification of Chief Executive Officer required by Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), filed herewith. |
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| (31.2) | | Certification of Chief Financial Officer required by Rule 13a-14(a) or Rule 15d-14(a) of the Exchange Act, filed herewith. |
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| (32.1) | | Certification of Chief Executive Officer required by Rule 13a-14(b) or Rule 15d-14(b) of the Exchange Act and Section 1350 of Chapter 63 of Title 18 of the United States Code, filed herewith. |
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| (32.2) | | Certification of Chief Financial Officer required by Rule 13a-14(b) or Rule 15d-14(b) of the Exchange Act and Section 1350 of Chapter 63 of Title 18 of the United States Code, filed herewith. |
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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) |
| | |
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Date: May 8, 2006 | 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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