10-Q 1 a2048918z10-q.txt 10Q 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 ENDED MARCH 31, 2001 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: 001-13931 PENTACON, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 76-0531585 (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.) 10375 RICHMOND AVENUE, SUITE 700 HOUSTON, TEXAS 77042 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE) (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE): (713) 860-1000 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 (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Number of shares of common stock of the Registrant, par value $.01 per share, outstanding at April 30, 2001 was 16,839,898. PENTACON, INC. FORM 10-Q FOR THE THREE MONTHS ENDED MARCH 31, 2001 INDEX Part I - Financial Information Item 1 - Financial Statements Consolidated Balance Sheets as of March 31, 2001 and December 31, 2000............................. 3 Consolidated Statements of Operations for the Three Months ended March 31, 2001 and 2000........ 4 Consolidated Statements of Cash Flows for the Three Months ended March 31, 2001 and 2000........ 5 Notes to Consolidated Financial Statements............. 6 Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations................. 9 Part II - Other Information Item 6 - Exhibits and Reports on Form 8-K....................... 12 Signature....................................................... 12 2 PENTACON, INC. PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS PENTACON, INC. CONSOLIDATED BALANCE SHEETS

The accompanying notes are an integral part of these statements. 3 PENTACON, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

The accompanying notes are an integral part of these statements. 4 PENTACON, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

The accompanying notes are an integral part of these statements. 5 PENTACON, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 2001 (UNAUDITED) 1. BASIS OF PRESENTATION The consolidated financial statements of Pentacon, Inc. (the "Company") included herein have been prepared without audit pursuant to the Rules and Regulations for reporting on Form 10-Q. Accordingly, certain information and footnotes required by generally accepted accounting principles for complete financial statements are not included herein. The Company believes all adjustments necessary for a fair presentation of these statements have been included and are of a normal and recurring nature. There has been no significant change in the accounting policies of the Company during the periods presented. The statements should be read in conjunction with the financial statements and related notes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 2000. The balance sheet at December 31, 2000 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. RECENTLY ISSUED ACCOUNTING STANDARDS: In June 1998, the Financial Accounting Standards Board issued Statements of Financial Accounting Standards No. 133, ACCOUNTING FOR DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES ("SFAS No. 133"). SFAS No. 133 requires that all derivatives be recognized as assets and liabilities and measured at fair value. The accounting for changes in the fair value of a derivative depends on the intended use of the derivative and the resulting designation. The Company adopted this standard in the quarter ended March 31, 2001. The adoption had no impact on net income because of the Company's minimal use of derivatives. 2. CREDIT FACILITY AND LONG-TERM DEBT In March 1999, the Company sold $100 million of Senior Subordinated Notes (the "Notes") due April 1, 2009. The net proceeds of $94.2 million, after the original issue discount and paying underwriter's commissions, from the offering of the Notes were used to repay indebtedness under the Company's credit agreement (the "Bank Credit Facility"). The Notes accrue interest at 12.25% which is payable on April 1 and October 1 of each year. The Notes are publicly registered and subordinated to all existing and future senior subordinated obligations and will rank senior to all subordinated indebtedness. The indenture governing the Notes contains covenants that limit the Company's ability to incur additional indebtedness, pay dividends, make investments and sell assets. At March 31, 2001, the Company was in compliance with the covenants. Each of the Company's subsidiaries, all of which are wholly owned, fully, unconditionally and jointly and severally guarantees the Notes on a senior subordinated basis. Separate financial statements of the guarantors are not presented because management has determined that they would not be material to investors. Effective September 30, 1999, the Company amended its Bank Credit Facility to provide a revolving line of credit of up to $100 million (subject to a borrowing base limitation) to be used for general corporate purposes, future acquisitions, capital expenditures and working capital. The Bank Credit Facility is secured by Company stock and assets. Advances under the Bank Credit Facility bear interest at the banks' prime rate. At the Company's option, the loans may bear interest based on a designated London interbank offered rate plus a margin of 200 basis points. Commitment fees of 25 to 37.5 basis points per annum are payable on the unused portion of the line of credit. The Bank Credit Facility contains a provision for standby letters of credit up to $20 million. The Bank Credit Facility prohibits the payment of dividends by the Company, restricts the Company's incurring or assuming other indebtedness and requires the Company to comply with certain financial covenants including a minimum 6 net worth and, under certain circumstances, a minimum fixed charge ratio. At March 31, 2001, the Company was in compliance with the covenants. Borrowings under the Bank Credit Facility are classified as current liabilities in accordance with EITF 95-22 BALANCE SHEET CLASSIFICATION OF BORROWINGS OUTSTANDING UNDER REVOLVING CREDIT AGREEMENTS THAT INCLUDE BOTH A SUBJECTIVE ACCELERATION CLAUSE AND A LOCK-BOX ARRANGEMENT. The Bank Credit Facility will terminate and all amounts outstanding thereunder, if any, will be due and payable September 30, 2004. At March 31, 2001, the Company had approximately $22.5 million available under the Bank Credit Facility. 3. EARNINGS PER SHARE Basic and diluted net income per share is computed based on the following information:

4. INCOME TAXES The provision for income taxes included in the Consolidated Statement of Operations assumes the application of statutory federal and state income tax rates and the non-deductibility of goodwill amortization. Interim period income tax provisions are based upon estimates of annual effective tax rates and events may occur which will cause such rates to vary. 5. COMMITMENTS AND CONTINGENCIES The Company is involved in various legal proceedings that have arisen in the ordinary course of business. While it is not possible to predict the outcome of such proceedings with certainty, in the opinion of the Company, all such proceedings are either adequately covered by insurance or, if not so covered, should not ultimately result in any liability which would have a material adverse effect on the financial position, liquidity or results of operations of the Company. 7 6. SEGMENT INFORMATION The Company has two principal operating segments: the Industrial Group and the Aerospace Group. The Industrial Group serves a broad base of industrial manufacturers producing items such as diesel engines, locomotives, power turbines, motorcycles, telecommunications equipment, and refrigeration equipment. The Aerospace Group serves the aerospace and aeronautics industries. Financial information by industry segment follows:

(1) Goodwill and related amortization has been excluded from segment operating income. The prior year has been restated to conform to the 2001 presentation. 7. SUBSEQUENT EVENTS On April 25, 2001, the Company announced that Mark E. Baldwin had resigned the positions of Chairman and Chief Executive Officer, and that Robert L. Ruck, President of the Company's Aerospace Group, was elected Chief Executive Officer and a Board member, and Cary M. Grossman, an outside director and co-founder of the Company, was elected Chairman. The Company also announced that it would be closing its corporate office in Houston, Texas and relocating those functions to Chatsworth, California, where its Aerospace Group is headquartered. In addition, the Company announced that it had decided to offer up to $10 million of slower moving Aerospace Group inventory at substantially discounted prices. The Company is in the process of identifying the specific inventory and will take a non-cash charge for the estimated loss in the second quarter. 8 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS INTRODUCTION The following discussion should be read in conjunction with the financial statements of the Company and related notes thereto and management's discussion and analysis of financial condition and results of operations related thereto which are included in the Company's Annual Report on Form 10-K for the year ended December 31, 2000. This discussion contains forward-looking statements that are subject to certain risks, uncertainties and assumptions. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated, estimated or projected. Key factors that could cause actual results to differ materially from expectations include, but are not limited to: (1) estimates of costs or projected or anticipated changes to cost estimates relating to entering new markets or expanding in existing markets; (2) changes in economic and industry conditions; (3) changes in regulatory requirements; (4) changes in interest rates; (5) levels of borrowings under the Company's Bank Credit Facility; (6) accumulation of excess inventories; and (7) volume or price adjustments with respect to sales to major customers. These and other risks and assumptions are described in the company's Annual Report of Form 10-K for the year ended December 31, 2000. RESULTS OF OPERATIONS Quarterly results may be materially affected by the timing and magnitude of assimilation costs, costs of opening new facilities, gain or loss of a material customer and variation in product mix. Accordingly, the operating results for any three-month period are not necessarily indicative of the results that may be achieved for any subsequent three-month period or for a full year. THREE MONTH PERIODS ENDED MARCH 31, 2001 AND 2000 The following table sets forth certain selected financial data and the related amounts as a percentage of revenues for the periods indicated:

REVENUES Revenues decreased $3.1 million, or 4.2%, to $71.3 million for the three months ended March 31, 2001 from $74.4 million for the three months ended March 31, 2000. The decrease in revenues was attributable to a 15.8% revenue decline in the Industrial Group offset by a 12.1% revenue increase in the Aerospace Group. The Aerospace Group increase primarily relates to the new contract business signed in the year 2000. The reduction in the Industrial Group revenues was primarily the result of a decline in sales to the heavy-duty truck market that began in the third quarter of 2000. In addition, the Company experienced softening sales to the telecommunications customers. However, strong revenue growth was experienced in the power generation sector of the business. 9 COST OF SALES Cost of sales decreased $1.6 million, or 3.1%, to $50.0 million for the three months ended March 31, 2001 from $51.6 million for the three months ended March 31, 2000. As a percentage of revenues, cost of sales increased from 69.4% for the three months ended March 31, 2000, to 70.1% for the three months ended March 31, 2001. As a result of the implementation of the new contracts in the Aerospace Group, gross margins declined from the comparable year 2000 period. Contract business in the Aerospace Group typically carries a lower margin than bid and buy business because the working capital investment is lower. Gross margins for the quarter in the Industrial Group increased in the current year quarter compared to the prior year quarter as a result of a change in sales mix. OPERATING EXPENSES Operating expenses decreased $0.4 million, or 2.5%, to $15.8 million for the three months ended March 31, 2001 from $16.2 million for the three months ended March 31, 2000. As a percentage of revenues, operating expenses increased from 21.7% for the three months ended March 31, 2000, to 22.1% for the three months ended March 31, 2001. The Company continues to realize the operating efficiency benefits of the consolidation of its information technology systems and facilities in the Aerospace Group. In addition, the fourth quarter 2000 decision to exit certain non-core and under-performing businesses contributed to the reduction in operating expenses in the first quarter of 2001. The increase in operating expenses in the Industrial Group as a percentage of revenue was largely due to the decline in revenues as operating expenses in absolute dollar terms were lower in the current year quarter than in the prior year quarter. OPERATING INCOME Due to the factors discussed above, operating income decreased $1.0 million to $4.7 million for the three months ended March 31, 2001 from $5.7 million for the three months ended March 31, 2000. As a percentage of revenues, operating income decreased to 6.6% for the three months ended March 31, 2001 from 7.7% for the three months ended March 31, 2000. NON-OPERATING COSTS AND EXPENSES Interest expense for the three months ended March 31, 2001, totaled $4.6 million compared to $4.8 million for the three months ended March 31, 2000. The decrease in interest expense resulted from both lower debt levels and lower interest rates. PROVISION FOR INCOME TAXES The provision for income taxes for the three months ended March 31, 2001 was $20 thousand (an effective rate of 19.6%) compared with $0.5 million (an effective rate of 54.7%) for the three months ended March 31, 2000. The lower effective tax rate in the current year primarily relates to anticipated Aerospace Group inventory disposals at substantially discounted prices. The higher effective tax rate for the three-months ended March 31, 2000 primarily related to nondeductible goodwill amortization. LIQUIDITY AND CAPITAL RESOURCES The Company provided $3.3 million of net cash from operating activities during the three months ended March 31, 2001; this cash was used for debt reduction and capital expenditures. Net cash used in investing activities was $0.8 million for capital expenditures. Net cash used in financing activities was $2.5 million for the three months ended March 31, 2001 and consisted of repayments of debt. At March 10 31, 2001, the Company had cash of $0.1 million, working capital of $69.5 million and long-term debt of $99.7 million. In March 1999, the Company sold $100 million of Senior Subordinated Notes due April 1, 2009. The net proceeds of $94.2 million, after the original issue discount and paying underwriter's commissions, from the offering of the Notes were used to repay indebtedness under the Company's Bank Credit Facility. The Notes accrue interest at 12.25% which is payable on April 1 and October 1 of each year. The Notes are publicly registered and subordinated to all existing and future senior subordinated obligations and will rank senior to all subordinated indebtedness. The indenture governing the Notes contains covenants that limit the Company's ability to incur additional indebtedness, pay dividends, make investments and sell assets. At March 31, 2001, the Company was in compliance with the covenants. Each of the Company's subsidiaries, all of which are wholly owned, fully, unconditionally and jointly and severally guarantees the Notes on a senior subordinated basis. Effective September 30, 1999, the Company amended its Bank Credit Facility to provide a revolving line of credit of up to $100 million (subject to a borrowing base limitation) to be used for general corporate purposes, future acquisitions, capital expenditures and working capital. The Bank Credit Facility is secured by Company stock and assets. Advances under the Bank Credit Facility bear interest at the banks' prime rate. At the Company's option, the loans may bear interest based on a designated London interbank offered rate plus a margin of 200 basis points. Commitment fees of 25 to 37.5 basis points per annum are payable on the unused portion of the line of credit. The Bank Credit Facility contains a provision for standby letters of credit up to $20 million. The Bank Credit Facility prohibits the payment of dividends by the Company, restricts the Company's incurring or assuming other indebtedness and requires the Company to comply with certain financial covenants including a minimum net worth and, under certain circumstances, a minimum fixed charge ratio. At March 31, 2001, the Company was in compliance with the covenants. Borrowings under the Bank Credit Facility are classified as current liabilities in accordance with EITF 95-22 BALANCE SHEET CLASSIFICATION OF BORROWINGS OUTSTANDING UNDER REVOLVING CREDIT AGREEMENTS THAT INCLUDE BOTH A SUBJECTIVE ACCELERATION CLAUSE AND A LOCK-BOX ARRANGEMENT. The Bank Credit Facility will terminate and all amounts outstanding thereunder, if any, will be due and payable September 30, 2004. At March 31, 2001, the Company had approximately $22.5 million available under the Bank Credit Facility. The Company's Industrial Group is implementing the J.D. Edwards' One World Enterprise Application Solution as its common information system. The total expenditures for this information system are expected to be approximately $5.5 million during the years 2000 and 2001. The majority of these expenditures are capitalized as computer hardware and software and depreciated over the estimated useful life of the assets. The total expenditures for this system were $4.7 million through March 31, 2001. Funding for these expenditures and future capital expenditures will be provided by operating cash flows. In April 2001, the Company announced that it had decided to offer up to $10 million of slower moving Aerospace Group inventory at substantially discounted prices. The Company is in the process of identifying the specific inventory and will take a non-cash charge for the estimated loss in the second quarter. The disposal of this inventory will allow the Company to improve its inventory mix, obtain refunds of previously paid taxes and eliminate the current year tax liability. SEASONALITY AND INFLATION The Company experiences seasonal declines in the fourth quarter due to declines in its customers' activities in that quarter. The Company's volume of business may be adversely affected by a decline in projects as a result of regional or national downturns in economic conditions. Inflation has not had a material impact on the Company's results of operations. 11 PART II -OTHER INFORMATION ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) EXHIBITS None. (b) REPORTS ON FORM 8-K The Company filed a report on Form 8-K dated April 26, 2001 which included a copy of a press release announcing among other things the resignation of Mark E. Baldwin, Chairman and Chief Executive Officer. 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. PENTACON, INC. Dated: May 11, 2001 By: /s/ JAMES C. JACKSON -------------------- JAMES C. JACKSON Vice President & Controller (Principal Financial & Accounting Officer) 12

PENTACON INC 10-Q