1
EXHIBIT 99.2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
As described in Note 2 of the Notes to Supplemental Consolidated Financial
Statements, in fiscal 1996 and 1997 the Company entered into business
combinations with Moore Electric Supply, Inc., Florida Pipe & Supply Company,
Electric Laboratories and Sales Corporation and ELASCO Agency Sales, Inc.
(collectively, "ELASCO"), Panhandle Pipe & Supply Co., Inc. ("PPSC"), Sunbelt
Supply Co. ("Sunbelt") and Metals, Incorporated, Stainless Tubular Products,
Inc. and Metals, Inc. -- Gulf Coast Division (collectively, the "Metals Group")
which were accounted for as poolings of interests. Accordingly, all financial
data in this discussion and analysis is reported as though the companies have
always been one.
NINE MONTHS ENDED OCTOBER 31, 1996 AND 1995
Net Sales
Net sales for the nine months ended October 31, 1996 were $1,150.7 million,
a 23% increase over the nine months ended October 31, 1995. Newly acquired and
opened wholesale outlets provided 10 percentage points of the 23% increase.
Management expects commercial construction activity to continue at current
levels. These favorable conditions coupled with the Company's acquisition
program should result in continued sales growth.
Gross Margin
Gross margin for the nine months ended October 31, 1996 was 20.5% compared
to 20.1% for the nine months ended October 31, 1995. Expansion of product
offerings to lines with better margins, efficiencies created with central
distribution centers, increased volume and concentration of supply sources have
contributed to the improvement.
Operating Expenses
Operating expenses for the nine month period ended October 31, 1996 were
$191.0 million, a 21% increase over the prior year period. Approximately
one-half of this increase is attributable to recent acquisitions and
newly-opened wholesale outlets.
Non-Operating Income and Expenses
Interest and other income increased $.8 million for the nine months ended
October 31, 1996 over the prior year period. The increase is primarily
attributable to gain on sales of property and equipment, and increased
collection of service charges due on delinquent accounts receivable.
Interest expense was $9.6 million for the nine months ended October 31,
1996 compared to $7.1 million for the nine months ended October 31, 1995. The
increase is primarily the result of higher borrowing levels as interest rates
have been essentially unchanged. Expansion through business acquisitions has
been partially funded by debt financing.
Income Taxes
The effective tax rates for the nine months ended October 31, 1996 and 1995
were 37.8% and 33.1%, respectively. Prior to the merger on April 26, 1996 with
ELASCO and January 24, 1997 with Metals, Incorporated and Stainless Tubular
Products, Inc., all three entities were Subchapter S corporations and,
therefore, not subject to corporate income tax. Each entity's Subchapter S
corporation status terminated upon the merger with the Company. As a result, the
Company's effective tax rate will be higher for the year ending January 31, 1997
than for the year ended January 26, 1996.
1
2
Net Income
For the nine months ended October 31, 1996, net income reached $25.1
million, a 39% increase over the nine months ended October 31, 1995. Fully
diluted earnings per share for the nine months ended October 31, 1996 and 1995
were $2.45 and $2.12, respectively. This increase of 16% was on 20% more shares
outstanding.
FISCAL 1996, 1995 AND 1994
Net Sales
The Company exceeded the one billion dollar mark with net sales of $1.2
billion in fiscal 1996. Net sales increased by 25% over fiscal 1995 net sales of
$994.8 million. Fiscal 1994 net sales totaled $827.3 million. Newly-opened and
acquired wholesale outlets accounted for approximately 60% of the increase in
fiscal 1996 and 40% of the increase in fiscal 1995.
The Company's strategy of expanding and diversifying into more construction
markets (commercial and industrial, as well as geographic) has contributed to
these strong sales gains along with same store sales growth. Although fiscal
1996 and 1995 residential construction activity has been slower following a
strong fiscal 1994, commercial and industrial construction activity rebounded in
fiscal 1995 and continued through fiscal 1996.
Gross Margin
Gross margins have been improving steadily over the past few years. Gross
margins increased to 20.4% in fiscal 1996 compared to 19.9% in fiscal 1995 and
19.7% in fiscal 1994. The improvement has resulted from several factors,
including expansion of product offerings to lines with better margins,
efficiencies created with central distribution centers, increased volume and
concentration of supply sources as part of the Company's preferred vendor
program.
Operating Expenses
Operating expenses in fiscal 1996 were $213.9 million, a 25% increase over
fiscal 1995. Newly-opened wholesale outlets and recent acquisitions accounted
for approximately 50% of the increase. The remainder of the increase is due
primarily to personnel and transportation costs associated with the growth in
sales. Similarly, the $24.9 million increase in fiscal 1995 compared to fiscal
1994 is attributed primarily to newly-opened wholesale outlets and acquisitions
(approximately 45%) and costs, such as personnel, transportation and insurance,
associated with sales growth.
Non-Operating Income and Expenses
Interest and other income increased to $5.0 million in fiscal 1996 compared
to $3.2 million in fiscal 1995 and $3.7 million in fiscal 1994. This increase is
primarily the result of improved collection of service charge income on
delinquent accounts receivable. In addition, gain realized on sales of property
and equipment (primarily transportation equipment) was $.3 million higher in
fiscal 1996.
Interest expense increased by $3.0 million in fiscal 1996 over fiscal 1995.
Higher interest rates and higher average borrowing levels were equally
responsible for the increase. Fiscal 1995 interest expense was only $.4 million
higher than fiscal 1994, which was attributable to higher interest rates
partially offset by lower borrowing levels due primarily to the conversion of
approximately $23 million of subordinated debentures.
Net Income
Net income in fiscal 1996 increased 46% to $23.2 million from $15.9 million
in fiscal 1995, while fully diluted earnings per share increased 36% to $2.70 in
fiscal 1996 compared to $1.98 in fiscal 1995. These results followed fiscal 1995
increases of 63% and 48%, respectively, in net income and fully diluted earnings
per share. Net income and fully diluted earnings per share in fiscal 1994 were
$9.7 million and $1.34, respectively.
2
3
These improved results reflect operating leverage that has been achieved
through the Company's acquisition and internal growth program. Operating margins
(operating income as a percentage of net sales) have steadily improved to 3.2%
in fiscal 1996, compared to 2.7% and 2.0% in fiscal 1995 and 1994, respectively.
Liquidity and Capital Resources
Working capital at October 31, 1996 amounted to $303 million compared to
$217 million, $197 million and $162 million in fiscal years ended 1996, 1995 and
1994, respectively. The working capital ratio increased to 2.86 to 1 at October
31, 1996 compared to 2.59 to 1, 2.65 to 1 and 2.87 to 1 for fiscal years ended
1996, 1995 and 1994, respectively. During expansionary periods when sales
volumes are increasing, the Company is required to carry higher levels of
inventories and receivables to support the growth. The Company strives to
maintain inventories at levels that support current sales activity but are not
excessive through increased use of central distribution facilities and with
investments in resources to improve the efficiency and service capability of
these facilities.
For the nine months ended October 31, 1996, net cash provided by operations
was $8.0 million. In fiscal 1996, net cash provided by operations was $17.3
million compared to $3.7 million in fiscal 1995 and cash used in operations of
$1.0 million in fiscal 1994. These changes are due primarily to fluctuations in
accounts receivable, inventories and accounts payable. Because additional
amounts of cash were generated in fiscal 1996, net borrowing under short-term
debt decreased to $15.4 million compared to $26.8 million and $17.8 million in
fiscal 1995 and 1994, respectively.
Expenditures for property and equipment were $11.8 million for the nine
months ended October 31, 1996 compared to $9.7 million for the nine months ended
October 31, 1995. The Company invested $90.0 million for property and equipment
in fiscal 1996. Cash payments for business acquisitions totaled $89.9 million
and $10.0 million for the nine months ended October 31, 1996 and the fiscal year
ended January 26, 1996, respectively. Capital expenditures for property and
equipment, not including amounts for business acquisitions, are expected to be
approximately $14 million in fiscal 1997.
As discussed in Note 11 of the Notes to the Supplemental Consolidated
Financial Statements, in May 1996 the Company issued 1,486,989 shares of common
stock in a public offering (generating net proceeds of approximately $48
million, after all expenses) and issued $98 million of senior notes in a private
placement in connection with the purchase of substantially all of the assets,
properties and business of PVF Holdings, Inc. ("PVF"). In addition to funding
the PVF acquisition, the net proceeds of these offerings were used to reduce
indebtedness outstanding under the Company's bank debt.
Management believes that the acquisitions of PVF, Sunbelt and the Metals
Group provide the Company with several strategic benefits, including: (i) a
well-established position in the stainless steel and specialty alloy sector of
the pipe, valve and fitting products market; (ii) a higher gross margin product
group than the Company's other product groups; (iii) greater focus on targeted
industrial and replacement markets; (iv) a strong management team; and (v) new
opportunities for additional acquisitions. Additional growth opportunities for
the Company related to these acquisitions include incremental sales of
complimentary valve products (which had represented only 2% of PVF's fiscal 1995
net sales) and new branch openings.
Principal reductions on long-term debt were $14.3 million for the nine
months ended October 31, 1996 compared to $5.4 million for the prior year nine
months. The increase resulted primarily from paying off debt of recent business
acquisitions. Dividend payments were $4.5 million and $3.9 million during the
nine months ended October 31, 1996 and 1995, respectively. Dividend payments
included $2.4 million and $2.6 million in cash dividends of pooled companies
during the nine months ended October 31, 1996 and 1995, respectively.
In October 1996, the Company's revolving credit and line of credit
agreement with a group of banks was amended. The agreement now permits the
Company to borrow up to $150 million ($160 million previously). With this
facility, the Company has sufficient borrowing capacity to take advantage of
growth and business acquisition opportunities. The Company's financial condition
remains strong and the Company believes that it has the resources necessary,
with approximately $63 million of unused debt capacity (subject to borrowing
3
4
limitations under long-term debt covenants) as of October 31, 1996, to fund
ongoing operating requirements. Future expansion will continue to be financed on
a project-by-project basis through additional borrowing, or, as circumstances
allow, through the issuance of common stock.
Business Acquisitions
In addition to the business combinations with ELASCO, PPSC, Sunbelt, and
the Metals Group accounted for as poolings of interests as mentioned previously,
during the first nine months of fiscal 1997 the Company acquired several
wholesale distributors for approximately $127 million ($90 million in cash and
$37 million in stock). In fiscal 1996, consideration for acquisitions was
approximately $13 million ($10 million in cash and $3 million in stock). Outlays
for acquisition of wholesale distributors in fiscal 1995 totaled $21 million
($11 million in cash, $4 million in stock and $6 million in other
consideration), while fiscal 1994 expenditures were $4 million in cash. These
acquisitions were accounted for as either purchases or immaterial poolings and
the results of operations of these businesses from their respective dates of
acquisition are included in the Company's supplemental consolidated financial
statements. As a result of these acquisitions, the Company had 266 branches in
24 states as of October 31, 1996, compared to 226 branches in 20 states at last
year end.
Inflation and Changing Prices
The Company is aware of the potentially unfavorable effects inflationary
pressures may create through higher asset replacement costs and related
depreciation, higher interest rates and higher material costs. The Company seeks
to minimize these effects through economies of purchasing and inventory
management resulting in cost reductions and productivity improvements as well as
price increases to maintain reasonable profit margins. Management believes,
however, that inflation (which has been moderate over the past few years) and
changing prices have not significantly affected the Company's operating results
or markets in the three most recent fiscal years.
4