UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 _________________________________ FORM 10-Q [x] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarter period ended February 28, 1999 OR [ ] Transition Report Pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934 For the transition period from ______to______ ________________________________ Commission File Number 0-10796 ________________________________ VALLEN CORPORATION (Exact name of registrant as specified in its charter) Texas 74-1366847 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 13333 Northwest Freeway Houston, Texas 77040 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (713) 462-8700 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months and (2) has been subject to such filing requirements for the past 90 days. Yes X No ------ ------ Indicate the number of shares outstanding of each of the issuer's classes of common stock, exclusive of treasury shares, at April 14, 1999: 7,171,426 shares of Common Stock, $.50 Par Value Page 1 of 12 PART I Item 1. Financial Statements VALLEN CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Thousands of Dollars) MAY 31, 1998 ASSETS (Derived from February 28, 1999 Audited Financial (Unaudited) Statements) ----------------- ------------------ Current assets: Cash and cash equivalents $ 981 $ 1,041 Investment securities, at cost which approximates market 3,000 3,000 Accounts receivable, net 51,846 48,382 Inventories 38,365 42,340 Prepaid expenses and other current assets 5,245 4,211 -------- -------- Total current assets 99,437 98,974 -------- -------- Property, plant and equipment, at cost 40,007 37,825 Less accumulated depreciation and amortization 26,202 24,175 -------- -------- Net property, plant and equipment 13,805 13,650 Notes receivable, affiliate 476 557 Investment in foreign affiliates, net 16,116 13,138 Intangibles, net of accumulated amortization 6,621 6,919 Other 4,741 3,331 -------- -------- $141,196 $136,569 ======== ======== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Current maturities of long-term debt $ 950 $ 898 Accounts payable 9,380 14,316 Other accrued liabilities 7,128 5,178 Income taxes payable 1,253 789 -------- -------- Total current liabilities 18,711 21,181 Long-term debt, excluding current maturities 14,629 12,733 Deferred income taxes 1,028 973 Minority interest (167) (133) Other non-current liabilities 773 945 Shareholders' equity: Preferred stock $1.00 par value; 1,000,000 shares authorized and unissued Common stock $.50 par value; 20,000,000 shares authorized 9,758,075 shares issued and 7,176,426 outstanding at February 28, 1999 and 9,758,075 shares issued and 7,249,658 outstanding at May 31, 1998 4,879 4,879 Additional paid-in capital 6,653 6,544 Accumulated other comprehensive income (799) (776) Retained earnings 100,804 94,014 -------- -------- 111,537 104,661 Less cost of common shares held in treasury; 2,581,649 shares at February 28, 1999 and 2,508,417 at May 31, 1998 (5,315) (3,791) -------- -------- Total shareholders' equity 106,222 100,870 -------- -------- $141,196 $136,569 ======== ======== See accompanying Notes to Consolidated Financial Statements (Unaudited). Page 2 of 12 VALLEN CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF EARNINGS (UNAUDITED) (Thousands of Dollars Except for Per Share Amounts) Three Months Ended Nine Months Ended February 28, February 28, -------------------------------------- ----------------------------------------- 1999 1998 1999 1998 ---------------- ------------------- ------------------- ------------------- Net sales $77,389 $75,638 $229,774 $215,055 Cost of sales 58,166 57,329 173,748 162,645 ------- ------- -------- -------- Gross profit 19,223 18,309 56,026 52,410 Selling, general and Administrative expenses 17,051 15,785 49,605 44,799 ------- ------- -------- -------- Operating income 2,172 2,524 6,421 7,611 Earnings from foreign affiliates, net 903 1,052 2,978 2,393 Interest and dividend income 115 29 229 145 Interest expense 237 263 667 664 Other income (expense), net 27 76 206 252 ------- ------- -------- -------- Earnings before income taxes 2,980 3,418 9,167 9,737 Income taxes 795 974 2,376 2,950 ------- ------- -------- -------- Net earnings $ 2,185 $ 2,444 $ 6,791 $ 6,787 ======= ======= ======== ======== Net earnings per common share - basic $ 0.30 $ 0.33 $ 0.94 $ 0.93 ======= ======= ======== ======== Net earnings per common share - diluted $ 0.30 $ 0.33 $ 0.93 $ 0.92 ======= ======= ======== ======== Weighted average number of common shares outstanding - basic 7,182 7,273 7,200 7,278 Weighted average number of common shares outstanding - diluted 7,291 7,380 7,305 7,371 See accompanying Notes to Consolidated Financial Statements (Unaudited). Page 3 of 12 VALLEN CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (Thousands of Dollars) Nine months ended February 28, 1999 1998 - --------------------------------- ---- ---- OPERATING ACTIVITIES: Net earnings $ 6,791 $ 6,787 Adjustments to reconcile net earnings to net cash provided by operating activities: (Gain) loss on disposition of assets 21 (19) Depreciation and amortization 2,581 2,544 Change in deferred income taxes 55 (177) Undistributed earnings from foreign affiliates, net (2,978) (2,445) Undistributed loss from U.S affiliate, net 146 115 Undistributed earnings from U.S. partnership, net (244) (260) Change in minority interest of majority-owned foreign affiliate (33) - Decrease in trading securities - 1,050 Increase in accounts receivable, net (3,464) (8,652) (Increase) decrease in inventories 3,975 (7,635) Decrease in notes receivable - 500 Increase in prepaid expenses (1,034) (1,141) (Increase) decrease in other assets (215) 316 Increase (decrease) in accounts payable and other liabilities (2,694) 10,350 ------- ------- Net cash provided by operating activities 2,907 1,333 INVESTING ACTIVITIES: Proceeds from disposition of assets 68 - Net additions to property, plant and equipment (2,482) (3,925) Payments for purchase of, and investment in companies, net of cash acquired (1,013) (1,493) Decrease in notes receivable 81 - Investments in affiliates (129) (541) ------- ------- Net cash used by investment activities (3,475) (5,959) FINANCING ACTIVITIES: Additions to long-term debt 5,356 4,800 Repayments of long-term debt (3,409) (365) Treasury stock purchases (1,536) (995) Employee stock transactions 120 385 ------- ------- Net cash provided by financing activities 531 3,825 ------- ------- Net decrease in cash and cash equivalents (37) (801) Effect of exchange rate on cash and cash equivalents (23) - Cash and cash equivalents at beginning of period 1,041 801 ------- ------- Cash and cash equivalents at end of period $ 981 $ 0 ======= ======= SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Interest payments 656 623 Income tax payments 1,853 3,692 See accompanying Notes to Consolidated Financial Statements (Unaudited). Page 4 of 12 VALLEN CORPORATION AND SUBSIDIARIES NOTE TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Thousands of dollars) Note 1: Basis of Presentation and Significant Accounting Policies The accompanying unaudited consolidated condensed financial statements have been prepared in accordance with the Instructions to Quarterly Reports on Form 10-Q required to be filed with the Securities and Exchange Commission and do not include all information and footnotes required by generally accepted accounting principles for complete financial statements. However, the information furnished reflects all adjustments (consisting of normal recurring accruals) which are, in the opinion of management, necessary to fairly present the results for the interim periods. The results of operations for the nine months ended February 28, 1999 are not necessarily indicative of the results that will be realized for the fiscal year ending May 31, 1999. These financial statements should be read in conjunction with the audited financial statements and notes thereto included in Vallen Corporation's ("Vallen" or the "Company") Annual Report on Form 10-K for the fiscal year ended May 31, 1998. The accounting policies followed by the Company in preparing interim consolidated condensed financial statements are similar to those described in the "Notes to Consolidated Financial Statements" in the Company's Form 10-K Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934, for the fiscal year ended May 31, 1998. For interim reporting purposes, provisions for income taxes are recorded on the basis of the estimated annual effective tax rate. Certain prior year amounts have been reclassified to conform with present year presentation. Investments in the common stock of the foreign affiliated companies are accounted for by the equity method. The excess of cost of the stock of these affiliates over the Company's share of their net assets at the acquisition date is being amortized on a straight line basis up to 40 years. Net earnings per share were computed per the requirements of Statement of Financial Accounting Standards No. 128, "Earnings Per Share" ("SFAS 128"). SFAS 128 requires a dual presentation of basic and diluted earnings per share ("EPS"). Basic EPS was computed by dividing net earnings by the weighted average number of shares outstanding during the periods. Diluted EPS was calculated by dividing net earnings by the combination of weighted average number of shares outstanding and the impact of dilutive potential common shares outstanding during the period. The net earnings for both basic and diluted EPS were $2,185 and $2,444 for the three month periods ended February 28, 1999 and 1998, respectively, and were $6,791 and $6,787 for the nine month periods ended February 28, 1999 and 1998, respectively. The weighted average shares outstanding for the three and nine month periods ended February 28, 1999 and 1998 are as follows: Three Months Ended Nine Months Ended February 28, February 28, 1999 1998 1999 1998 --------- --------- --------- --------- Basic 7,182,000 7,273,000 7,200,000 7,278,000 Restricted stock grant 20,000 -0- 12,000 -0- Incremental shares from exercise of outstanding stock options 89,000 107,000 93,000 93,000 --------- --------- --------- --------- Diluted 7,291,000 7,380,000 7,305,000 7,371,000 ========= ========= ========= ========= Page 5 of 12 Note 2: Inventory costs are summarized as follows: February 28, 1999 May 31, 1998 ----------------------- -------------------- Raw materials $ 2,049 $ 1,897 Work-in-process 527 746 Finished Goods 35,789 39,697 ------- ------- Total inventories $38,365 $42,340 ======= ======= Note 3: Long-term Debt During the first quarter of fiscal year 1999, the Company's working capital facility with a major commercial bank was increased to $13.5 million from $12 million. The increase in size was necessary for additional business expansion and a larger letter of credit facility for international transactions. At February 28, 1999, the Company had drawn $11.8 million under the facility, which was classified as long-term debt. Of the $11.8 million borrowed, $4.8 million bore interest at 6.156%, $6 million bore interest at 5.77%, and $1 million bore interest at 5.69%. The Company's variable rate, tax exempt industrial development bonds of $2.75 million bore interest at 3.10% as of February 28, 1999. Note 4. Comprehensive Income In June 1997, the Financial Accounting Standards Board (FASB) issued SFAS No. 130, "Reporting Comprehensive Income". SFAS No. 130 requires the presentation of a Comprehensive Income Statement that is to be presented with other general financial statements. This statement is effective for the Company's fiscal year end 1999. The following table sets forth the calculation of comprehensive income for the following periods: Three Months Ended Nine Months Ended February 28, February 28, 1999 1998 1999 1998 --------- ------- -------- ------- Net earnings 2,185 2,444 6,791 6,787 Foreign currency translation gains/losses (11) -0- (23) -0- ----- ----- ----- ----- Total comprehensive income 2,174 2,444 6,768 6,787 ===== ===== ===== ===== Page 6 of 12 Item 2. Management's Discussion and Analysis of Results of Operations and Financial Condition RESULTS OF OPERATIONS THREE MONTHS ENDED FEBRUARY 28, 1999 COMPARED TO THREE MONTHS ENDED FEBRUARY 28, 1998: Net sales increased 2.3% to $77.4 million and gross profit increased by 5.0% to $19.2 million. The increase in net sales was negatively impacted by a sharp decrease in energy market spending; this market accounts for approximately 25% of the Company's total distribution sales in North America. Gross profit for the distribution business increased 4.5% over last year with help from its service based business that includes training, fire services and technical support. Gross profit for the manufacturing business increased 8.8% over 1998 as a result of a combination of increased sales, especially in the eye protection line of products, and reduced manufacturing costs. Selling, general and administrative expenses increased 8.0%, due to a combination of increased branch location occupancy costs under sales and leaseback agreements, increased costs of leasing vehicles and warehouse equipment, and expenses related to the Company's decision to carry out a restructuring in its field distribution operations, resulting in a consolidation of certain branches and removal of redundant costs. This process resulted in a charge of $483 thousand in the quarter. Interest expense was slightly lower in the third quarter of fiscal 1999 compared to the prior year as a result of lower interest rates. Other income increased primarily due to increased interest income from investment of excess cash. Earnings from foreign affiliates decreased to $903 thousand in fiscal year 1999 compared to $1.05 million in the same period of fiscal year 1998 primarily as a result of losses incurred by Century Sales, the Company's 50% owned Canadian affiliate. The Canadian affiliate's operations have been negatively affected by the downturn in the energy business in Western Canada, which includes many of its customers. The Canadian affiliate's earnings fell $145 thousand in fiscal year 1999 compared to fiscal year 1998, resulting in a $45 thousand loss for the 1999 period. The recent recovery of energy prices in March are expected to result in a resurgence of energy sector customer spending in the fourth quarter of 1999, which should benefit the operations of Century. The Company's 50% owned Mexican affiliate, Proveedora, earnings continue to be positively impacted by the continuation of its services contract with Pemex. Net earnings decreased 10.2% in the quarter ended February 28, 1999 to $2.19 million ($.30 per diluted share), compared to $2.44 million ($.33 per diluted share) in the previous year's third quarter. The decrease in earnings was a result of a combination of the charge for closing locations, $483 thousand ($.04 per diluted share), and the effect of a reduced level of energy market spending on the Company's domestic operations and its foreign affiliates. NINE MONTHS ENDED FEBRUARY 28, 1999 COMPARED TO NINE MONTHS ENDED FEBRUARY 28, 1998: Net sales increased 6.8% to $229.8 million. The increase is primarily due to increased sales by the distribution business as a result of increased service based business revenues and the acquisitions of Sheridan Safety, Inc. and Superior Supply, which occurred in the second quarter of FY 1998. Gross profit increased by $3.6 million, or 6.9%. Gross profit for the distribution business increased 6.5% over last year with help from its service based business. Gross profit for the manufacturing segment was 9.7% higher than last year as a result of improved sales that began in the second half of fiscal year 1998 and continued into fiscal year 1999, primarily in the eye protection product group. Page 7 of 12 Selling, general and administrative expenses increased 10.7% primarily for the same reasons as discussed above for the quarter. Earnings from foreign affiliates increased to $3.0 million for the nine months ended February 28, 1999 versus $2.4 million for the nine months ended February 28, 1998. The increase of $585 thousand was a result of an increase of $904 thousand for Proveedora partially offset by a decrease of $319 thousand for Century Sales primarily due to the same reasons as discussed above for the quarter. Net earnings for the nine months ended February 28, 1999 were essentially unchanged from the same period of fiscal year 1998. The growth in earnings experienced in the first six months of fiscal year 1999, due to increased growth of service business earnings and by Proveedora, was offset by the factors discussed above for the quarter ended February 28, 1999. FINANCIAL CONDITION Cash flows provided by operations for the nine months ended February 28, 1999 totaled $2.9 million, compared to $1.3 million for the nine months ended February 28, 1998. The increase in the current period compared to the same period of the prior year is primarily related to lower levels of inventories and accounts receivable partially offset by cash used to reduce accounts payable. The Company's restructuring actions have helped reduce onhand inventory levels necessary to meet customer demand. During the nine months ended February 28, 1999, the Company purchased 80,100 shares of its Common stock in open market transactions for $1.54 million. Since the inception of the stock purchase plan approved by the Company's Board of Directors in 1997, the Company has purchased a total of 140,100 shares for $2.73 million. The Company's financial position during fiscal year 1999 remains strong with working capital of $80.7 million and a current ratio of 5.3 to 1 compared to working capital of $77.8 million and a current ratio of 4.7 to 1 at May 31, 1998. As discussed in Note 3 to the financial statements, the Company's credit facility with a major commercial bank was increased from $12 million to $13.5 million. Management believes the Company's liquidity, working capital flows and borrowing capacity due to low current financial leverage levels are sufficient to meet capital expenditure and working capital needs in the future. Lion Vallen Partnership income is based upon a U.S. government let contract to supply clothing to a Department of Defense base. The contract was scheduled for renewal in March 1999 and has been extended through June 1999. The partnership, of which 50% is owned by a Vallen subsidiary, has submitted a proposal for renewal of the contract, however it is not known whether or not the partnership will be successful in renewing the contract. In the nine months ended February 28, 1999, the Company recognized equity income of $610 thousand compared to $550 thousand for the same period of fiscal year 1998. During the three months ended February 28, 1999, the Company purchased the business of Fire Protection Plus, Inc. of Pocatello and Boise, Idaho. This Company installs and services fire protection systems and portable extinguisher units. Also, during this period the Company acquired a 50% ownership interest in a newly formed joint venture in Chile. The joint venture, Vallen-Acetogen S.A., has been formed to distribute safety related products in Chile. YEAR 2000 ISSUE The Company's business is heavily dependent on its information systems. These systems are critical in providing users with information regarding: product pricing and availability; order status; warehouse operations; inventory purchases and management; financial reporting; and other operational functions. Page 8 of 12 Year 2000 issues exist when dates in computer programs are recorded using two digits, instead of four, and are then used for arithmetic operations, comparisons or sorting. A two-digit date recording may recognize a date using "00" as 1900 rather than 2000, and that could cause the Company's computer systems to perform inaccurate computations. The Company's Year 2000 issues relate not only to its own systems, but also to those of its customers and suppliers. The Company has conducted a comprehensive review of its internal computer systems and applications to identify those that might be affected by the year 2000 issue and has developed an implementation plan to resolve the year 2000 issue. The Company is in the process of correcting or replacing those systems and applications which are not currently year 2000 compliant. Conversion of the Company's business systems has been completed and tested. Those systems are now year 2000 compliant. Conversion of other internal computer systems is ongoing with completion expected to occur in June 1999. The Company believes it will be able to modify or replace the remaining affected systems and applications in time to avoid any material detrimental impact on its operations. The Company has incurred internal staff costs as well as consulting and other expenses related to infrastructure and facilities enhancements necessary to prepare its systems and applications for the year 2000 issue. Through February 28, 1999 approximately $200 thousand has been spent for year 2000 corrective and replacement activities. The expense estimate for the remaining year 2000 corrective and replacement activities ranges from $200 to $300 thousand. It is anticipated that all year 2000 compliance efforts will be complete by June 1999, including testing. However, if such modifications and conversions are not completed in a timely manner, the year 2000 issue may have a material impact on the operations of the Company. The Company is also working to ensure that products purchased by Vallen, as well as services utilized by Vallen, will be year 2000 compliant. However, no assurance can be given that such compliance will happen. Vallen has established a year 2000 business resumption planning committee to evaluate business disruption scenarios, coordinate the establishment of year 2000 contingency plans, and identify and implement preemptive strategies. Detailed contingency plans for critical business processes will be developed by April 1999. CAUTION REGARDING FORWARD-LOOKING STATEMENTS The information discussed herein includes "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933 as amended (the "Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as amended (The "Exchange Act"). All statements other than statements of historical facts included herein regarding planned capital expenditures, the Company's financial position, business strategy and other plans and objectives for future operations, are forward-looking statements (typically using words such as "expert," "plan," "anticipate," "believe," and similar expressions.) Although the Company believes that such forward-looking statements reasonably reflect expected outcomes, certain risks and assumptions are involved, and there is no conclusive evidence Page 9 of 12 that such expectations will ultimately prove correct. Factors which may come into play which could cause actual results to vary from anticipated results include acquisition programs involved in expansion strategies, market competition affecting operating margins, depressed business environments for the Company's customers, the Company's ability to compete successfully with other competitors for the same markets (some of whom may be larger and have greater resources than the Company), ability to obtain products needed to remain competitive over long periods of time, ability to continue to produce technically competitive products in its manufacturing segment, possible exchange rate fluctuations related to affiliates in other countries, and changes in regulatory requirements in its geographic markets. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Not Applicable Page 10 of 12 PART II OTHER INFORMATION Item 1. Legal proceedings - None Item 2. Changes in 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. (a) Exhibits: 3i. Restated Articles of Incorporation as amended. Incorporated by reference is Exhibit 3a to the Company's Form 10-K, as filed with the Securities and Exchange Commission on August 17, 1990. 3ii. Bylaws of the Company, as amended, through June 23, 1994. Incorporated by reference is Exhibit 3ii to the Company's Form 10-Q, as filed with the Securities and Exchange Commission on January 16, 1996. 27 - Financial Data Schedule, attached hereto. (b) Form 8-K - None Page 11 of 12 SIGNATURES 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 thereto duly authorized. VALLEN CORPORATION Registrant April 14, 1999 /s/ James W. Thompson - ------------------------- ------------------------------ Date James W. Thompson President April 14, 1999 /s/ Leighton J. Stephenson - ------------------------- ------------------------------ Date Leighton J. Stephenson Vice President - Finance, Secretary and Treasurer Page 12 of 12