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| QEPC > SEC Filings for QEPC > Form 10-Q on 15-Oct-2008 | All Recent SEC Filings |
15-Oct-2008
Quarterly Report
Executive Overview
The Company is a worldwide leader in the manufacturing, marketing and distribution of a broad line of specialty tools and flooring related products, marketing over 3,000 specialty tools and related products used primarily for surface preparation and installation of ceramic tile, carpet, vinyl and wood flooring. The Company's products are sold to home improvement retailers, specialty distributors to the hardware, construction, flooring and home improvement trades, chain or independent hardware, tile and carpet retailers for use by the do-it-yourself consumer as well as the construction or remodeling professional, and original equipment manufacturers. The Company has executed a growth strategy intended to improve overall performance and profitability of operations that includes expanding product offerings and increasing penetration with its largest customers, expanding market share by obtaining new customers, introducing new and innovative products, and enhancing the cross selling of products among its channels of distribution.
For the second quarter of fiscal 2009, sales increased by approximately $3.8 million or 7% compared to the same period in the previous fiscal year. The sales increase was primarily in the Company's domestic operations due to the rollout of a national specialty tile tool program with the Company's largest home center customer.
For the six months ended August 31, 2008, sales decreased by $0.2 million or less than 1% compared to the same period in the previous year. The sales decrease was primarily related to declines in the Company's European operations of $1.7 million that were only partially offset by increased sales at the Company's North American and the favorable impact of changes in foreign currency exchange rates on the Company's foreign operations.
For the second quarter of fiscal 2009, gross profit increased by $1.4 million or 8% compared to the same period in the previous fiscal year. Gross profit as a percentage of sales, increased to 28.8% in the second quarter of fiscal 2009 from 28.3% in the second quarter of fiscal 2008, primarily due to favorable changes in product mix.
Gross profit for the six months ended August 31, 2008, increased by $0.9 million or 3% compared to the same period in the previous fiscal year. Gross profit as a percentage of sales, increased to 29.5% in the six months ended August 31, 2008 from 28.7% in the same period of the previous year due to favorable product mix.
For the second quarter of fiscal 2009, total operating expenses increased by $3.0 million or 24% compared to the second quarter of fiscal 2008. As a percentage of net sales, operating expenses were 26% in the second quarter of fiscal 2009 compared to 22% in the corresponding period in fiscal 2008. This increase is primarily due to additional shipping costs related to the additional sales and incremental shipping costs associated with the rollout of a national specialty tile tool program with the Company's largest home center customer. Additionally, the second quarter of fiscal 2008 included the one-time gain of $0.6 million on the sales of the Company's Stone Mountain operation.
For the six months ended August 31, 2008, operating expenses increased by $2.7 million or 10% compared to the same period in the previous year. As a percentage of sales, operating expenses were 26% for the six months ended August 31, 2008 compared to 23% for the six months ended August 31, 2007 due primarily to the additional shipping cost incurred in the second quarter of fiscal 2009.
Net income for the second quarter of fiscal 2009 was $0.8 million or $0.23 per diluted share compared to net income of $0.1 million or $0.02 per diluted share in the second quarter of fiscal 2008, an increase of $0.7 million or $0.21 per diluted share.
For the six months ended August 31, 2008, net income was $2.1 million or $0.59 per diluted share compared to net income of $0.9 million or $0.25 per diluted share for the six months ended August 31, 2007 due principally to the $1.4 million, non-tax deductible expense in fiscal 2008 relating to the settlement of the Company's put warrant obligation.
Critical Accounting Policies and Estimates
Revenue Recognition
Sales are recognized when merchandise is shipped and title has passed to the customer, the selling price is fixed and determinable and collectibility of the sales price is reasonably assured. Such revenue is recorded net of estimated sales returns, discounts and allowances. The Company establishes reserves for returns and allowances based on current and historical information and trends. Sales and accounts receivable have been reduced by such amounts.
The Company accounts for upfront consideration given to customers as a reduction to revenue at the earlier of the Company making payment or incurring an obligation to the customer, unless the Company has an agreement with the vendor in which the Company can control the benefit, in which case the incentive is recorded as a deferred cost asset and is expensed as a reduction to revenue over the term of the agreement. The Company evaluates the impairment of deferred cost assets on a quarterly basis.
Inventories
The Company records inventory at the lower of standard cost, which approximates actual cost, or market. The Company maintains reserves for excess and obsolete inventory based on market conditions and expected future demand. If actual market conditions were to be less favorable than those projected by management, additional inventory reserves could be required.
Accounts Receivable
The Company's accounts receivable are principally due from home centers or flooring accessory distributors. Credit is extended based on an evaluation of a customer's financial condition, and collateral is not required. Accounts receivable are due at various times based on each customer's credit worthiness and selling arrangement. The outstanding balances are stated net of an allowance for doubtful accounts. The Company determines its allowance by considering a number of factors, including the length of time trade accounts receivable are past due, the customer's previous loss history, the customer's ability to pay its obligations and the condition of the general economy and the industry as a whole.
Impairment Evaluations
The Company evaluates the recoverability of long-lived assets, including property, plant and equipment, and identifiable intangible assets, whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The Company performs indefinite-lived impairment tests on at least an annual basis and more frequently in certain circumstances. When the Company determines that the carrying amount of long-lived assets may not be recoverable based upon the existence of certain indicators, the assets are assessed for impairment based on the future undiscounted cash flows expected to result from the use of the asset. For goodwill and other indefinite-lived intangibles, impairment assessments are generally determined using the estimated future discounted cash flows of the asset's reporting unit using a discount rate determined by management to be commensurate with the risk inherent in the current business model. In both instances, if the carrying amount of the asset being tested exceeds its fair value, an impairment of the value has occurred and the asset may be written down. The Company performs an impairment test on goodwill during the second quarter of each fiscal year using information available at May 31st.
Income Taxes
The Company estimates income tax in each jurisdiction in which it operates. This process involves estimating the Company's current
tax obligations and its deferred income taxes to reflect the tax consequences in future years of differences between the tax basis of assets and liabilities and their financial reporting amounts each year-end. The Company must then consider the likelihood that any deferred tax assets will be recoverable from future taxable income and to the extent that it believes that recoverability is not likely, the Company establishes a valuation allowance.
The Company estimates the liability for unrecognized tax benefits associated with uncertain income tax positions. Any benefit ultimately recognized will reduce the Company's annual effective tax rate.
Results of Operations
Sales
Net sales for the second quarter of fiscal 2009 were $61.0 million compared to $57.2 million for the second quarter of fiscal 2008, an increase of $3.8 million or 7%.
Net sales at the Company's domestic operations increased by $5.2 million in the second quarter of fiscal 2009 compared to the second quarter of fiscal 2008. This increase was principally due to the increased sales penetration of existing products into new stores and the introduction of new products in existing stores at the Company's largest home center customer as a result of the rollout of a national specialty tile tool program with this customer. This increase offset lower sales to other domestic home center and distributor customers. Sales declined in certain of the Company's European operations by $1.2 million due to the general weakening in the economy. Currency translation gains contributed $0.9 million to the sales increase, primarily due to the strengthening of the Australian Dollar and the Euro compared to the U.S. Dollar.
Net sales for the six months ended August 31, 2008 were $113.9 million compared to $114.1 million for the six months ended August 31, 2007, a decrease of $0.2 million or less than 1%.
Net sales in certain of the Company's European operations declined by $1.7 million in the six months ended August 31, 2008 compared to the same period in the previous year. This decline was partially offset by increased sales at the Company's North America operations of $0.8 million. Currency translation gains increased sales by $2.7 million, primarily due to the strengthening of the Australian Dollar, Canadian Dollar and the Euro compared to the U.S. Dollar.
Sales from the Company's non-North American subsidiaries were 19% and 23% of total sales in the second quarter of fiscal 2009 and 2008, respectively. For the six months ended August 31, 2008 and 2007, sales from the Company's non-North American subsidiaries were 21% and 22% of total sales, respectively.
Gross Profit
Gross profit for the three months ended August 31, 2008 was $17.5 million compared to $16.2 million for the three months ended August 31, 2007, an increase of $1.4 million or 8%. As a percentage of net sales, gross profit increased to 28.8% in the second quarter of fiscal 2009 from 28.3% in the second quarter of fiscal 2008.
For the six months ended August 31, 2008, gross profit was $33.6 million compared to $32.7 million for the six months ended August 31, 2007, an increase of $0.9 million or 3%. As a percentage of sales, gross profit increased to 29.5% for the first six months of fiscal 2009 from 28.7% for the first six months of fiscal 2008.
The increase in gross profit in the three and six months ended August 31, 2008 compared to the same periods in the previous year was primarily attributable to the sales volume increases at the Company's domestic operations, offset somewhat by a decline in gross profit due to non-recurring costs in the Company's Australia/New Zealand operations. The increase in gross profit as a percentage of sales during the same period was due to favorable changes in product mix through a greater proportion of sales from higher margin
underlayment and specialty tile tool products. Foreign currency exchange rate changes contributed $0.3 million and $0.9 million in additional gross profit for the three and six months ended August 31, 2008, respectively, primarily due to the strengthening of the Australian Dollar, Canadian Dollar and the Euro compared to the U.S. Dollar.
Operating Expenses
Operating expenses for the three months ended August 31, 2008 were $15.6 million compared to $13.2 million for the three months ended August 31, 2007, an increase of $2.4 million or 18%. For the six months ended August 31, 2008, operating expenses were $29.3 million compared to $27.1 million for the six months ended August 31, 2007, an increase of 2.2 million or 8%.
Shipping expenses for the second quarter of fiscal 2009 were $7.2 million compared to $5.7 million in the second quarter of fiscal 2008, an increase of $1.5 million or 27%. Changes in customer mix, with a larger proportion of sales from higher freight cost customers, resulted in $0.7 million of the shipping expense increase. Additional freight expense and labor cost of approximately $0.6 million were incurred in the second quarter of fiscal 2009 associated with the rollout of a national specialty tile tool program. The second quarter of fiscal 2009 incremental costs resulted in shipping expenses for the six months ended August 31, 2008 of $12.8 million compared to $11.8 million in the same period of the previous year, an increase of $1.0 million or 9%. For the second quarter of fiscal 2009 and 2008, shipping expenses as a percentage of sales were 12% and 10%, respectively. For the six months ended August 31, 2008 and 2007, shipping expenses as a percentage of sales were 11% and 10%, respectively.
General and administrative expenses for the second quarter of fiscal 2009 were $4.6 million compared to $4.1 million in the second quarter of fiscal 2008, an increase of $0.5 million or 11%. The increase principally was due to a one-time severance charge of $0.2 million in the second quarter of fiscal 2009 at the Company's domestic operations and realized currency exchange gains of $0.2 million at the Company's foreign operations. For the six months ended August 31, 2008, general and administrative expenses were $9.0 million compared to $8.8 million in the same period of the previous year, an increase of $0.2 million or 3% due to the incremental cost in the second quarter of fiscal 2009. As a percentage of net sales, general and administrative expenses were 8% and 7% in the second quarter of fiscal 2009 and 2008, respectively. For the six months ended August 31, 2008 and 2007, general and administrative expenses were consistent at 8% of sales.
Selling and marketing expenses for the second quarter of fiscal 2009 were $3.8 million compared to $3.4 million in the second quarter of fiscal 2008, an increase of $0.4 million or 10%. This increase is due to the reorganization of certain of the Company's foreign distribution and sales operations. For the six months ended August 31, 2008, selling and marketing expenses were $7.4 million compared to $6.5 million in the same period of the previous year, an increase of $0.9 million or 13%. The reorganization within the Company's Australia/New Zealand distribution and sales operations resulted in $0.6 million additional sales expense. In addition, increased expenses for trade shows and other product promotion activities at the Company's domestic operations resulted in $0.3 million in additional marketing expenses. As a percentage of net sales, selling and marketing expenses were consistent at 6% in the second quarter of fiscal 2009 and 2008. For the six months ended August 31, 2008 and 2007, selling and marketing expenses were 7% and 6% of sales, respectively.
Other Income / Expense
During the three and six months ended August 31, 2008, the Company recorded royalty income of $0.1 million and $0.2 million respectively. In both periods this income was offset by a loss on sale of fixed assets at the Company's Australian subsidiary of $0.1 million.
For the three and six months ended August 31, 2007, the Company recorded other income of $0.7 million that primarily consisted of the gain on the sale of the Company's Stone Mountain operation in the second quarter of fiscal 2008.
Changes in the Put Warrant Liability
In the second quarter of fiscal 2008, the Company paid a cash settlement of its liability under the then outstanding Warrant Agreement between the Company and HillStreet Fund L.P. For the three and six months ended August 31, 2007, the Company's expense was $1.4 million related to the change in the fair value of the put warrant liability.
Interest Expense
Interest expense for the three and six months ended August 31, 2008 was $0.6 million and $1.0 million respectively. These amounts compare to $0.6 million and $1.3 million for the same periods in the previous fiscal year. Average borrowings in fiscal 2009 have generally increased compared to fiscal 2008, while decreases in average interest rates have offset the cost of additional borrowings.
Income Taxes
The Company recorded a provision for income taxes for the three and six months ended August 31, 2008, of $0.6 million and $1.4 million, respectively. This compares with a provision for income taxes of $1.5 million and $2.6 million for the same periods in fiscal 2008. The effective tax rate for the three and six months ended August 31, 2008, was 43% and 40%, respectively. The effective tax rate for the three and six months ended August 31, 2007, was 96% and 74%, respectively.
The provision for income taxes in the second quarter of fiscal 2009 includes $0.1 million of taxes on foreign deemed dividends and a valuation allowance of $0.2 million on foreign net operating losses, which the Company determined are unlikely to provide a future benefit. The provision for income taxes for the six months ended August 31, 2007, includes $0.4 million of US tax credits and $0.2 million of valuation allowances on foreign net operating losses. In all periods presented, the change in the put warrant liability is non-deductible for tax purposes.
The fiscal 2009 and 2008 provision was based upon the statutory tax rates available in every jurisdiction in which the Company operates as adjusted for tax contingencies.
Net Income
As a result of the above, principally the settlement of the put warrant obligation in fiscal 2008 and returning to a more normalized effective tax rate, net income for the second quarter of fiscal 2009 was $0.8 million or $0.23 per diluted share compared with net income of $0.1 million or $0.02 per diluted share in the second quarter of fiscal 2008, an increase of $0.7 million or $0.21 per diluted share. For the six months ended August 31, 2008, net income was $2.1 million or $0.59 per diluted share compared to net income of $0.9 million or $0.25 per diluted share in the same period of fiscal 2008, an increase of $1.2 million or $0.34 per diluted share.
Liquidity and Capital Resources
Working capital was $7.9 million as of August 31, 2008, compared to $9.1 million at February 29, 2008, a decrease of $1.2 million.
Net cash used in operating activities during the first six months of fiscal 2009 was $9.5 million compared to net cash provided by operating activities of $2.4 million for the comparable fiscal 2008 period. During the first six months of fiscal 2009, the Company used net cash of $13.0 million associated with the increase in receivables, inventory, trade payables and other accrued liabilities principally related to the initial rollout of the national specialty tile tools program, and for the upfront consideration paid related to that program. For the same period in fiscal 2008, increases in inventory and accounts receivable used cash of $4.7 million and increases in trade payables and accrued liabilities provided cash of $2.1 million.
Net cash used in investing activities was less than $0.1 million in the first six months of fiscal 2009. This was comprised of the final
proceeds from the sale of the Company's O'Tool operation of $0.3 million that was offset by capital expenditures of $0.4 million. Cash provided by investing activities in the first six months of fiscal 2008 was $2.8 million, which was comprised of the initial proceeds from the sales of the Company's O'Tool operation and proceeds from the sale of the Stone Holding operation of $3.1 million that was partially offset by capital expenditures of $0.3 million.
Net cash provided by financing activities was $9.6 million in the first six months of fiscal 2009 as compared to cash used in financing activities of approximately $4.9 million for the same period in the previous year. During the first six months of fiscal 2009 the Company borrowed an additional $10.2 million on its lines of credit primarily to finance the working capital requirements associated with the rollout of the national specialty tile tools program. During the first six months of fiscal 2009, the Company repaid $1.1 million of long-term debt, borrowed an additional $0.5 million under its existing Canadian mortgage facility and repurchased $0.2 million of its own stock. For the comparable fiscal 2008 period, the Company repaid $1.5 million on its line of credit and $2.4 million of long-term debt, settled the Company's put warrant obligation of $2.3 million and refinanced $1.4 million of long-term debt associated with its Australian subsidiary.
During the second quarter of fiscal 2009, the Company entered into a purchase plan under which it may purchase up to $2,000,000 of the Company's common stock from time to time on the open market or in privately negotiated transactions. The Company funds the repurchases through the use of existing sources of liquidity, borrowings under the current credit facility or new borrowings. Refer to Item 2. Unregistered Sales of Equity Securities and Use of Proceeds for a discussion of the shares of common stock repurchased by the Company during the second quarter of fiscal 2009.
The Company uses several bank lines of credit to support the working capital requirements of its various operations. Refer to Note E to the notes to the consolidated financial statements for a discussion of the Company's credit facilities.
The Company believes that its existing cash balances, internally generated funds from operations and available bank lines of credit will provide the liquidity necessary to satisfy its working capital needs, including changes in working capital balances, and will be adequate to finance anticipated capital expenditures and debt obligations for the next twelve months. There can be no assurance, however, that the assumptions upon which the Company bases its future working capital and capital expenditure requirements and the assumptions upon which it bases its belief that funds will be available to satisfy such requirements will prove to be correct. If these assumptions are not correct, the Company may be required to raise additional capital through loans or the issuance of debt or equity securities that would require the consent of the Company's current lenders.
To the extent the Company were to raise additional capital by issuing equity securities or obtaining borrowings convertible into equity, ownership dilution to existing stockholders may result, and future investors may be granted rights superior to those of existing stockholders. Moreover, additional capital may be unavailable on acceptable terms to the Company, or may not be available at all.
Impact of Inflation and Changing Prices
During fiscal 2008 and continuing into fiscal 2009, the Company has experienced and the Company expects to continue to experience price increases in certain key commodities and in components related to the purchase of raw materials and finished goods. The Company believes that its level of gross profit as a percent of net sales is affected by these increases. Other than the changes described, the effect of inflation on our operations has been reasonably minimal.
Recently Issued Accounting Standards
Refer to Note L to the notes to the consolidated financial statements for a discussion of recent accounting pronouncements.
Forward-Looking Statements
This report contains certain forward-looking statements that are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements present the Company's expectations or forecasts of future events. These statements can be identified by the fact that they do not relate strictly to historical or current facts. They are frequently accompanied by words such as "believe", "intend", "expect", "anticipate", "plan", or "estimate" and other words of similar meaning, and include statements relating to the Company's liquidity sources and the adequacy of those sources to meet the Company's working capital needs, anticipated capital expenditures and debt obligations for the next twelve months; the Company's ability to successfully execute its growth strategy, including expanding its market share, capitalizing on new customers, cross-selling its products, introducing new and innovative products, expanding existing product lines, and increasing its sales and market penetration; expectations regarding payment of dividends; expectations regarding recently issued accounting standards; the Company's expectations regarding price increases in certain commodities and components related to the purchase of raw materials and finished goods; the expected impact of the outcome of any legal proceedings in which the Company is involved; the Company's implementation of various measures to address the identified material weaknesses and to improve the overall effectiveness of internal controls over financial reporting; the Company's expectation regarding its incurrence of amortization cost for trademarks and other intangibles in fiscal 2009; the amount and manner in which the Company may repurchase shares of its common stock and the source of funds for stock repurchases; the Company's expectation regarding the expensing of deferred costs in fiscal 2009; the Company's expectations regarding its future effective tax rate; the Company's expectation regarding the total amount of unrecognized tax benefits over the next 12 months; the cost of compliance with Environmental Laws and the Company's anticipated expenditures on monitoring of wells and other environmental activity for the next three years.
These forward-looking statements are based on currently available information and are subject to risks and uncertainties which could cause actual results to differ materially from those discussed in the forward-looking statements and from historical results of operations (See Item 1A-Risk Factors). Among the risks and uncertainties which could cause such a difference are the assumptions upon which the Company bases its assessments of its future working capital and capital expenditures; the Company's ability to comply with the ratios and covenants in the Company's credit facilities; the Company's ability to satisfy its working capital needs and to finance its anticipated capital expenditures; the Company's dependence upon a limited number of customers for a substantial portion of its sales and the continued success of initiatives with those customers; the state of the housing, residential and commercial construction and home improvement markets; the success of the Company's marketing and sales efforts; interruptions in supply or price changes in the items purchased by the Company; improvements in productivity and cost reductions; increased pricing pressures from customers and competitors and the ability to defend market share in the face of price competition; the Company's ability to maintain and improve its brands; the Company's reliance upon certain major foreign suppliers; the . . .
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