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Article by DailyStocks_admin    (04-03-08 05:42 AM)

Filed with the SEC from Mar 20 to Mar 26:

Industrial Distribution Group (IDGR)
Luther King Capital Management may consider making a competing acquisition proposal for IDGR. Last month, Industrial Distribution agreed to be acquired for $10.30 a share by an affiliate of Platinum Equity Advisors, in a deal worth about $113 million. LKCM reviewed the "adequacy of the offer" made by Platinum, particularly in light of significant margin expansion it believes IDGR will realize in future periods from management's recently implemented information-technology-in frastructure enhancements; strategic-pricing initiatives; and ongoing facility rationalization. Based on its review, LKCM said that it's considering strategic plans and proposals that, if effected, could result in a competing acquisition proposal. LKCM owns about 1.43 million shares (14.9%).

COMPENSATION

(1) The dollar value of stock options set forth in this table is equal to the compensation cost recognized for financial statement purposes in accordance with FAS 123R. This valuation method values stock options granted during 2006 and previous years. A discussion of the assumptions used in calculating the compensation cost is set forth in Note 10 of the Notes to Consolidated Financial Statements of the 2006 Annual Report. These amounts reflect the Company’s accounting expense for these awards and do not correspond to the actual value that will be recognized by the Directors.

(2) Includes the following benefits paid by the Company on behalf of Mr. Seigel: (a) medical benefits in the amount of $12,901, (b) executive healthcare benefits in the amount of $8,906, (c) legal expense in the amount of $486 for the required director Securities Exchange Act Section 16 filings with the Securities and Exchange Commission and (d) payments in the amount of $812 for various industry-related subscriptions.

(3) Includes the following benefits paid by the Company on behalf of Mr. Barth: (a) medical benefits in the amount of $12,901, (b) executive healthcare benefits in the amount of $17,099, (c) legal expense in the amount of $486 for the required director Securities Exchange Act Section 16 filings with the Securities and Exchange Commission and (d) payments in the amount of $812 for various industry-related subscriptions.

(4) Mr. Burkland’s term as director expired at the 2006 Annual Meeting.

(5) Includes the following benefits paid by the Company on behalf of Mr. Fenoglio: (a) medical benefits in the amount of $9,415, (b) executive healthcare benefits in the amount of $13,177, (c) legal expense in the amount of $486 for the required director Securities Exchange Act Section 16 filings with the Securities and Exchange Commission and (d) payments in the amount of $812 for various industry-related subscriptions.

(6) Includes the following benefits paid by the Company on behalf of Mr. Parr: (a) medical benefits in the amount of $9,415, (b) executive healthcare benefits in the amount of $12,625, (c) legal expense in the amount of $486 for the required director Securities Exchange Act Section 16 filings with the Securities and Exchange Commission and (d) payments in the amount of $812 for various industry-related subscriptions.

(7) Includes the following benefits paid by the Company on behalf of Mr. Sachs: (a) medical benefits in the amount of $9,415, (b) executive healthcare benefits in the amount of $4,168, (c) legal expense in the amount of $486 for the required director Securities Exchange Act Section 16 filings with the Securities and Exchange Commission and (d) payments in the amount of $812 for various industry-related subscriptions.

(8) Includes the following benefits paid by the Company on behalf of Mr. Shearer: (a) medical benefits in the amount of $12,901, (b) executive healthcare benefits in the amount of $10,371, (c) legal expense in the amount of $16,809 for the required director Securities Exchange Act Section 16 filings with the Securities and Exchange Commission and (d) payments in the amount of $812 for various industry-related subscriptions. The legal expense paid on behalf of Mr. Shearer was due to the filings required as a result of the pre-arranged stock trading plan, effective May 31, 2006, adopted under Rule 10b5-1 under the Securities Exchange Act.

The compensation elements set forth above were established during the Company’s inception in 1997, and have been reviewed periodically by the Board in order to ensure that they are appropriate and competitive in light of market circumstances and prevailing corporate governance “best practices.” The Nominating and Corporate Governance Committee evaluated the compensation of the Board in 2006. Based on that evaluation, the Board determined that all future compensation to the non-employee directors would be in the form of cash and equity securities. Directors may have access to the Company’s group health policy; however, they must pay all of the premiums associated with that plan. The Board also agreed to eliminate the executive healthcare benefits for the directors. As a result, below is the 2007 compensation for non-employee directors.

For the year 2007, equity compensation will be valued at $35,000 in restricted shares of the Company’s Common Stock, based on the closing price of the first trading day of the fiscal year.

Each director is entitled to reimbursement for his or her reasonable out-of-pocket expenses incurred in conjunction with travel to and from, and attendance at, meetings of the Board of Directors or its committees and related activities, including director education courses and materials.

In addition, each director is provided membership in the National Association of Corporate Directors and subscriptions to periodicals and newsletters that will assist with continuing education.

Base Salaries

Base salaries are established based upon several factors, including comparable market conditions, past performance of the senior executive, and years in current position. Because the economic profit incentive plan pursuant to which our executives may earn performance bonuses has no upper boundaries of payment (i.e. is not capped), our base salary compensation to our management tends to be between the 50th and 75th percentile of companies with similar market structures and end customers. Periodically, the Compensation Committee will hire outside consultants to review the compensation of executives. The last such independent study, looking at base salary for all executives, was performed in 2003; in late 2006, an independent assessment was undertaken of the compensation for the Company’s Chief Executive Officer, and the Compensation Committee received the consultant’s report in February 2007.

On December 1, 2006, the base salary of the Chief Executive Officer was raised to $400,000; prior to that time it was $300,000. On March 1, 2006, the base salary of the Chief Financial Officer was set at $275,000; prior to that time it was $250,000. These amounts are based upon the executives’ experience and market conditions.

The Company performed a similar analysis with respect to other senior management. For the Senior Vice President and Chief Information Officer, it was determined that a reasonable base salary for 2006 is $200,000.

Management Incentive Program (MIP)

The Management Incentive Program (MIP) is currently a formula-based, economic profit driven, incentive compensation program. The Company’s base formula for economic profit is: net operating profit after tax, less a cost of capital, which is then used to set varied performance levels at which incentive compensation in varying amounts may be earned. Each year at its third quarter meeting, the Compensation Committee reviews the cost of capital calculation for the Company to determine if a modification to the rules for the MIP is required. In addition, the Compensation Committee reviews the estimated tax rate applied to make sure that it is consistent with the tax profile of the Company.

The rules for the MIP include provisions that encourage continuous improvement that promote sustainable long-term operating successes and seek to guard against accelerated results in one year that sacrifice sustainability or improvement in the next year’s performance. An important element to achieving that long-term focus is the rules’

so-called “banking” provision, which provides for 25% of each year’s bonus earned to be held in reserve and not paid to the recipient, so that it is put at risk against the following year’s results. Under the economic profit formula, the economic profit of the Company may rise or fall in a given year. When economic profit rises, then up to 30% of the increase in economic profit is available to be divided among senior management participants. Each executive receives his or her share of the pool total, but is only paid 75% of his or her bank, and the other 25% of the cumulative pool remains in the bank. If economic profit declines in any year, then a “negative bonus” is earned, and one-half of 30% of the decline is allocated against the bank to senior management participants. After the “negative bonus” is applied to the outstanding bank then if the total bank is a positive amount, 75% of the bank is paid to the executive. If the remaining bank is negative, then this is carried forward into future years. Bonuses are only paid when a positive amount is in the executive’s bank.

The Company believes that this formula, which includes a focus on current earnings balanced with a return on invested capital, provides the proper incentives and ensures that management will make the correct long-term decisions for the Company. In addition to the disincentive to maximize bonus potential in one year to the detriment of future years, the plan also penalizes management for poor performance.

The Management Incentive Program is presently allocated among the Chief Executive Officer, the Chief Financial Officer, and the Executive Vice President of Sales and Marketing, although the Compensation Committee (and the Board) has the authority to designate other participants. The allocation percentages among those three officers are determined by the Compensation Committee and approved by the full Board of Directors at a meeting prior to the commencement of the current fiscal year. The economic profit program does not contain a maximum amount that may be earned in any given year, and accordingly rewards management as it produces results. However, the Compensation Committee has the right to negate the effect of unusual or non-recurring items. The MIP represents 100% of the cash bonus paid for the Chief Executive Officer, the Chief Financial Officer and the Executive Vice President of Sales and Marketing’s cash compensation.

Currently, because of the significant impact of the information technology (IT) system conversion on the Company as the IT structure is still being modernized, the Chief Information Officer has an objectives-based compensation program, based upon meeting objectives established by the Chief Executive Officer. These objectives for 2006 included the systems integration and improvements in IT quality, including telecommunication initiatives. The Compensation Committee approved the criteria prior to the commencement of the current year and deemed the criteria to be appropriate. The criteria included management’s assessment of the IT conversion, as well as certain other IT related initiatives the Company currently has in progress.

Equity Compensation

The Company’s long-term incentive plan is also tied to an economic profit model. Each senior executive, including the Chief Executive Officer, the Chief Financial Officer, the Chief Information Officer, and the Executive Vice President of Sales and Marketing, is eligible for a restricted stock award under the long-term incentive stock plan in an amount equal to 40% of their cash bonus paid. The plan provides for 40% of the compensation paid to be converted to restricted shares of Common Stock under the Company’s long-term incentive stock plan, based upon a formula, which is computed as 40% of compensation paid divided by the closing price of the Company’s Common Stock on the day the Board approved the cash bonus award. These shares vest upon the third anniversary of their issuance, but in order to be eligible to receive these restricted shares, the executive must buy an equal amount of shares under this plan on the Company’s listed exchange, currently NASDAQ, and commit to hold those plan shares for at least one year. Once the executive purchases shares in the open market, up to that number of shares will be awarded to the executive under the plan with a three-year cliff vesting provision from the date of purchase. Shares purchased on the open market pursuant to this plan will meet the ownership requirement for future years if the participant agrees to subject those shares to the holding requirements. The executives must purchase shares under the plan prior to the second quarter after the Board of Directors’ meeting to be eligible for the plan.

Management believes that the long-term incentive program has several benefits for both participants and the Company’s stockholders. For the participants, it provides an incentive, which is tied to current performance, in that the shares are issued based upon current earned cash bonus payments. For the stockholders, it is performance-based as well, as it serves as an additional “retention” incentive for management, since they will only receive the shares upon the third anniversary of the date of grant.

Other Equity Compensation

In late 2006, the Compensation Committee retained Mercer Consulting, a human resource and compensation consulting firm, to review the Company’s long-term equity compensation program for our Chief Executive Officer. As a result of Mercer Consulting’s research, the Compensation Committee is developing a plan that will compensate the Chief Executive Officer with awards of restricted shares that will be performance based. The performance criteria will be based upon sales growth, improvement in operating margin and improvement in earnings per share. The Compensation Committee has not finalized the plan, because the number of shares that will be required (an aggregate of 185,000) exceeds the amount currently available under the 1997 Stock Incentive Plan. If the stockholders approve the 2007 Stock Incentive Plan at the Annual Meeting as recommended by the Board and discussed elsewhere in this proxy statement, we expect the Compensation Committee will finalize the contemplated equity compensation program for our Chief Executive Officer at the first quarter Board of Directors meeting.

Health Benefits and Disability Insurance

The Company currently provides its senior management with the same health plan afforded to all associates of the Company. In addition, they participate in an executive health plan, which reimburses the executives for certain additional out-of-pocket health costs not covered by the Company’s self funded plan. This additional health plan is administered by a third party and is tax deductible to the Company. The Company also affords its senior management with additional disability insurance benefits. The disability benefit is based upon meeting certain medical underwriting requirements, and provides for additional disability income in excess of what the Company provides its associates generally.

Management believes that the additional health benefits and disability insurance afforded senior management is reasonable and competitive in the marketplace.

Retirement Plans

All executive officers of the Company participate in the Company’s 401(k) savings plan. The provisions afforded senior management are identical to those given to all associates of IDG.

Auto Allowance

The executive officers of the Company receive a $1,200 per month taxable automobile allowance. The Company believes that the allowance is necessary to be competitive in the marketplace.

MANAGEMENT DISCUSSION FROM LATEST 10K

The following discussion and analysis should be read in conjunction with Item 6: Selected Financial Data and our financial statements and supplementary data included elsewhere in this Report. In addition, in the following discussion, most percentage and dollar amounts have been rounded to aid presentation; as a result, all such figures are approximations. References to approximations have generally been omitted.
Overview and Certain Trends
In conjunction with distributing a full line of MROP products to meet the needs of manufacturers and other industrial users, we offer our customers a wide range of specialized business process outsourcing services through our FPS programs that relate to product selection and application based upon the customer’s production processes that affect the utilization and costs of MROP supplies. We also offer our customers general sales of MROP products from stock or on a special order (non-stock) basis. The revenue and cost components, and the overall pricing structures, associated with FPS sales and General MROP sales differ in some respects. As our sales mix shifts in the future, the different pricing structures of our FPS and General MROP sales may impact our financial results.
Analysis of FPS and General MROP Revenue/Cost Structures
In FPS arrangements in which we become the exclusive or primary supplier of a large volume of MROP products to a customer (as occurs with a storeroom management contract), our revenues typically include a component for management fee revenues that are designed to cover our administrative and overhead costs along with product revenues. These additional revenue sources from FPS arrangements will tend to yield higher profitability relative to General MROP sales involving the same level of product volume as FPS sales have lower selling and administrative costs. We often offer volume discounts on products to the customer as part of the overall FPS arrangement, in order to achieve mutually beneficial results for the customer and us. In FPS arrangements where we derive a portion of our revenues from management fees, the mix of product sales versus management fee and gain sharing revenues may cause our gross margin as a percentage of net sales to be higher, even if our product sales are lower. However, more often than not product discounts yield a lower gross margin from FPS sales as product volume increases relative to service and gain sharing revenues. General MROP customers purchase products at higher rates due to the amount of overhead cost we incur, which results in higher gross margin.

The additional revenue sources from FPS arrangements will tend to increase gross margins if product volume under these arrangements remains the same relative to General MROP sales. Currently, our FPS arrangements typically yield a lower gross margin as a percentage of sales (due to increased product volume at lower prices) than General MROP sales. On the other hand, however, our FPS arrangements yield higher profitability than General MROP sales because our selling, general and administrative expenses are lower and more variable in FPS arrangements.
At our storeroom management sites, many of our procurement support functions are performed at the customer’s facility. We therefore incur relatively low fixed selling, general and administrative costs as a percentage of total costs at storeroom management sites in comparison to our General MROP business, which has a higher fixed cost structure due to absorbing 100% of the overhead cost. In addition, the costs of our associates are billed to our customers at most of our storeroom management sites. Because our selling, general and administrative expenses at storeroom management arrangements are variable, we can control them relative to the volume and activity of the site. This control over expenses leads to higher profitability in storeroom management arrangements.
As a result of our cost structures, management believes that our FPS business is more profitable than our General MROP and Specialty businesses. Once all company overhead has been allocated we believe that the General MROP operations are unprofitable with the company profit being driven by the FPS and Specialty businesses.
Summary Comparison of FPS and General MROP Sales Results
The following summary of our sales and gross profit for the past three years reflects the trend we see with respect to the demand for FPS services among our MROP customers, which we believe supports our recognition of a similar trend within the industry in general.
Our total sales for 2007, 2006, and 2005 were $537.5 million, $547.9 million, and $538.8 million, respectively. Of these amounts, FPS sales (including sales pursuant to storeroom management arrangements) have increased steadily, both in dollar value and as a percentage of total sales, as reflected in the following table. We expect the upward trend in FPS sales to continue for the foreseeable future.

Results of Operations

2007 Compared to 2006
Net Sales
Net sales decreased $10.4 million or 1.9%, to $537.5 million from $547.9 million in the prior year. There was one additional selling day in the current year. Total FPS revenue increased $6.7 million, or 2.0%, to $332.0 million from $325.4 million in 2006. Our FPS revenue comprised 61.8% of total revenue, compared to 59.4% in the prior year. As of December 31, 2007 we had 319 FPS sites, of which 98 were storeroom management sites, as compared to 352 sites as of December 31, 2006, 101 of which were storeroom management sites. Driving the overall improvement in FPS revenue was existing customer growth, primarily from sites implemented in 2006 that began to run at full capacity in 2007. This increase was partially offset by the decrease in the number of FPS sites during 2007. Our average annual FPS revenue per site increased 12.6%, or $0.1 million in 2007.
General MROP revenue decreased $17.0 million, or 7.6%, to $205.5 million from $222.5 million in 2006. The most significant impact was the overall downturn in the production levels in the automotive and transportation industry. Lower production levels for recreational vehicles, made up $4.9 million of the decline as consumer demand slowed in 2007. In addition, in late 2006 we had an influx of orders related to the heavy truck industry, as purchases were being made in advance of the industry implementing new trucking emission standards. This buying pattern was not repeated in 2007, and its absence led to $1.8 million of the variance from 2006. Additionally, an estimated $6.8 million of revenue was lost as a result of attrition of our smaller customer base due to service issues encountered in conjunction with our ERP systems conversion in 2006 and the new pricing model implemented in early 2007.
Cost of Sales
Cost of sales decreased $12.3 million or 2.9%, to $414.5 million from $426.8 million in 2006. As a percentage of sales, cost of sales decreased to 77.1% as compared to 77.9% in the prior year. The decline in cost of sales resulted in a 0.8 percentage point increase in gross profit margin. General MROP margin improved by 2.0 percentage points (or 200 basis points) primarily as a result of company-wide efforts to implement better pricing practices and improve sales associate training. FPS margin improved by 0.1 percentage points (or 10 basis points) due to maintenance of profitability standards on FPS contracts as well as the improvement of recovery rates on service billings. Partially offsetting these improvements was a decline in rebate income combined with an increase of inbound freight charges both of which had a negative impact on total gross margin of 0.2 percentage points (or 20 basis points).
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased $6.4 million, or 5.9%, to $114.6 million from $108.2 million in 2006. As a percentage of sales, total selling, general and administrative expenses increased to 21.3% from 19.8% in the prior year. Salaries and benefits increased $4.3 million, which is the most significant component of the variance and was due to several factors including: (i) an increase of $2.5 million in personnel costs associated with storeroom management sites, (ii) an increase of $1.1 million for temporary labor and overtime required by our associates in the earlier part of 2007 in order to manage the increased transactional requirements from the IT system conversion completed in 2006, (iii) an increase in our self-insured healthcare expense of $0.6 million due to higher claims activity, and (iv) other items such as severance costs, which include non-compete agreements, related to the reorganization of certain processes were $0.4 million higher than prior year. These were partially offset by a reduction in management bonus expense due to financial performance.
Other items which attributed to the rise in selling, general and administrative expense were: (i) $1.3 million of incremental expense related to the service and lease costs for our new ERP system as compared to the prior year, (ii) strategic alternatives review process expenses of $0.4 million primarily related to legal and other professional services, (iii) the prior year included a non-recurring gain on the sale of real property of $0.3 million, (iv) bank fees increased $0.2 million due to certain customer specific payment programs and (v) new initiatives to improve our pricing model resulted in incremental costs of $0.2 million. Partially offsetting these items was a reduction in travel expenses of $0.3 million due to cost containment efforts implemented in the latter half of 2007 as well as non-recurring conversion related travel expenses incurred in the prior year.
Operating Income
Operating income was $8.4 million, or 1.6% of sales, as compared to $12.8 million, or 2.3% of sales, in 2006. The decrease in operating income was the result of a reduction in sales volume combined with increased costs, primarily associated with conversion related activity and strategic alternative review costs. These impacts were only partially offset by improvements in gross profit.
Interest Expense
Interest expense increased $0.2 million, or 12.8%, to $1.6 million for the year. Our average annual debt balance increased to $20.0 million from $18.5 million in the prior year. In addition, our average annual interest rate increased to 7.2% from 7.0% in the prior year.
Provision for Income Taxes
The provision for income taxes decreased by $1.8 million to $2.8 million, from $4.7 million in the prior year, primarily due to a reduction in operating income. Our effective rate was 41.0% as compared to 40.7% for the prior year. The increase in the effective rate was driven by a larger portion of permanent tax differences for taxable income and an increase to our tax contingency reserve recorded in accordance with FASB Interpretation No. 48.

MANAGEMENT DISCUSSION FOR LATEST QUARTER

RESULTS OF OPERATIONS

Net sales
Net sales decreased $4.7 million or 3.4% to $134.3 million for the three months ended September 30, 2007 from $139.0 million for the three months ended September 30, 2006. There were the same number of selling days in both periods. Our FPS revenue comprised 61.9% of our total revenue for the three months of 2007, compared to 60.3% in the prior year quarter. As of September 30, 2007 we had 327 FPS sites, of which 101 were storeroom management arrangements, as compared to 339 sites as of September 30, 2006, 102 of which were storeroom management arrangements. Total FPS revenue decreased $0.6 million or 0.8% to $83.2 million as compared to $83.8 million in the prior year. The decline in revenue as compared to the prior year was primarily attributable to one-time inventory sales of $2.1 million, net, primarily associated with the exiting of certain storeroom management arrangements during the three months ended September 30, 2006. Comparing ongoing activities unrelated to these sales, total FPS revenue increased $1.4 million or 1.8% as compared to the prior year. The implementation of 13 new sites since September 30, 2006, more than offset lost revenue from former sites, generating an incremental $1.4 million of revenue for the three months ended September 30, 2007.
General MROP revenue decreased $4.0 million or 7.3% to $51.2 million for the three months ended September 30, 2007, from $55.2 million for the same period in 2006. Of the decline, $2.0 million was related to attrition of smaller customers due to the closure of two will-call facilities, competitive pricing and a delay in regaining business lost due to service issues encountered during our 2006 system conversion. Lower revenues are also attributed to a $1.3 million decline in the automotive and heavy duty truck manufacturing industries due to decreased production levels. An additional $0.7 million of the decline was related to a general decline in the recreational vehicle and manufactured housing markets in 2007 after the increase in production in prior year for FEMA related projects.
Cost of Sales
Cost of sales decreased $4.7 million or 4.4% to $102.9 million for the three months ended September 30, 2007, from $107.6 million for the three months ended September 30, 2006. As a percentage of sales, cost of sales decreased to 76.6% for the three months ended September 30, 2007, from 77.4% for the same period in 2006. FPS drove the overall favorable variance in gross margin. Since early 2006 our FPS team has worked to improve levels of profitability on new and renewed FPS contracts, including focusing on improved recovery on service billings. General MROP margin improved primarily as a result of our pricing initiatives which include modification of our pricing practices for smaller customers and enhanced sales associate training. In addition, renegotiation of supplier rebate programs and a resulting increase in rebate incentive dollars contributed 0.2% towards the improvement.
Selling, General, and Administrative Expenses Selling, general and administrative expenses increased $0.9 million or 3.2% to $28.8 million for the three months ended September 30, 2007, from $27.9 million for the three months ended September 30, 2006. As a percentage of sales, total selling, general and administrative expenses increased to 21.4% for the third quarter of 2007 from 20.1% for the third quarter of 2006. Salaries and benefits increased $1.1 million or 5.6% as compared to the prior year quarter. Several factors impacted the rise in wages, including: (i) an increase of $0.7 million due to staffing costs associated with storeroom management sites, (ii) an increase in our self-insured healthcare costs of $0.4 million as a result of higher claims, and (iii) compensation expense associated with severances of $0.3 million. Partially offsetting these events was the reduction of management incentives due to lower operating performance levels.
During the three months ended September 30, 2007, we incurred an additional $0.4 million in incremental expense as compared to the prior year related to the service and lease costs for our new ERP system. Partially offsetting this increase was the implementation of our plans to contain costs for which we have seen a favorable impact of $0.5 million from reductions in travel and other variable operating costs. Outbound freight also decreased $0.1 million due to a decline in sales volume.
Operating Income
Operating income was $2.6 million for the three months ended September 30, 2007, a decrease of $0.8 million from the three months ended September 30, 2006. As a percent of revenue, operating income decreased to 2.0% for the three months ended September 30, 2007 from 2.5% for the comparable period in 2006. The impact of lower sales volume and a slight rise in selling, general and administrative expenses more than offset improvement in other areas and led to the decline in overall operating profit.
Interest Expense
Interest expense declined by less than $0.1 million to $0.3 million for the three months ended September 30, 2007. This is the result of both lower LIBOR rates and lower average debt outstanding during the quarter. The average quarterly interest rate decreased to 7.3% from 7.6% and the quarterly average debt balance declined $3.7 million or 18.3%.
Provision for Income Taxes
The provision for income taxes decreased by $0.3 million, to a provision of $1.0 million for the three months ended September 30, 2007, compared to $1.3 million for the three months ended September 30, 2006. Our effective tax rate increased to 43.3% as compared to 42.1% due to an adjustment to accrue to the projected annual 2007 effective tax rate as well as an increase in non-deductible items as a percentage of pre-tax income.
NINE MONTHS ENDED SEPTEMBER 30, 2007 AND 2006

Net sales
Net sales declined $14.3 million or 3.4% for the nine months ended September 30, 2007 from $416.3 million for the nine months ended September 30, 2006 to $402.0 million. There were the same number of selling days in both periods. Our FPS revenue for the nine months ended September 30, 2007 increased $1.2 million from $244.8 million for the nine months ended September 30, 2006 to $246.0 million in the current period. FPS sales comprised 61.2% of total revenue for the current nine month period as compared to 58.8% in the prior year. The increase in revenue was attributable to an overall increase in volume at 13 new storeroom management sites implemented since September 30, 2006. The incremental revenue from these sites was $10.8 million. However, these new site revenues were partially offset by lost revenues associated with sites that were eliminated during the 12-month period due to plant closures, downsizing or customers transferred to other services, which had a negative impact of $8.3 million for the nine months ended September 30, 2007. Although, there was $1.4 million, net, of one-time inventory sales related to the exit of certain storeroom arrangements which primarily occurred in the prior year, we also experienced reduced production levels at existing FPS customers, primarily those in the automotive manufacturing industry. However, this was offset by delays in receipt and processing certain automated orders during the prior period as a result of interruption of our EDI transactions following the IT system conversion, which represented an estimated loss of $1.4 million to $1.6 million.
General MROP revenue declined $15.5 million or 9.1% for the nine months ended September 30, 2007 to $155.9 million from $171.5 million reported at September 30, 2006. Contributing to this decline was a reduction in revenue of $4.3 million related to the general decline in 2007 in the recreational vehicle and manufactured housing markets, primarily as a result of FEMA-driven demand related to the hurricane activity in the prior year, with the negative impact primarily in the first six months of the current year. Additionally, $3.9 million of this decline was related to decreased production levels in both the automotive and heavy duty truck manufacturing industries. The remainder of the General MROP decline in revenue was due to service issues encountered following our IT system conversion in 2006, including the interruption of our EDI transactions discussed above. As a result of these issues in 2006, we experienced attrition of numerous smaller customers who are more sensitive to such interruptions in service as well as changes in pricing, which has had a significant impact on revenue from our traditional lines of business as we work to regain General MROP market share.
Cost of Sales
Cost of sales decreased $15.3 million or 4.7% to $310.1 million for the nine months ended September 30, 2007, from $325.5 million for the nine months ended September 30, 2006. As a percentage of sales, cost of sales decreased to 77.2% for the nine months ended September 30, 2007, from 78.2% in 2006. FPS had a favorable variance in gross margin primarily through the maintenance of profitability standards on FPS contracts, and the improvement of recovery rates on service billings. Gross margin improvement in General MROP was due to our company-wide efforts to implement better pricing practices and improved sales associate training as well as consolidating vendor spend with strategic growth suppliers that offer us the most favorable pricing.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased $4.3 million or 5.3% to $85.8 million for the nine months ended September 30, 2007, from $81.5 million for the nine months ended September 30, 2006. As a percentage of sales, total selling, general and administrative expenses increased to 21.3% for the first nine months of 2007 from 19.6% for the first nine months of 2006. Salaries and benefits drove the increase over the prior period with an increase of $3.4 million or 5.9%, which is due to several factors including: (i) an increase of $2.0 million in personnel costs associated with storeroom management sites, (ii) an increase of $0.9 million for temporary labor and overtime required by our associates in a continued effort to manage increased transactional requirements from the IT system conversion, (iii) an increase in incentives for certain associates of $0.5 million due to new commission and promotional programs, (iv) an increase in our self-insured healthcare expense of $0.4 million due to higher claims activity, and (v) the reorganization of certain processes and management which resulted in severance of $0.1 million. Partially offsetting the increased salaries and benefits was the reduction of management incentives as compared to the prior year period as a result of lower operating performance.
During the nine months ended September 30, 2007 we incurred an additional $1.1 million in incremental expense related to the service and lease costs for our new ERP system as compared to the prior period. The nine months ended September 30, 2006 also included $0.4 million of non-recurring benefits related to a gain on the sale of property and a franchise tax refund. Legal fees increased $0.3 million related to increased activity in the normal course of business as well as recent activity related to the strategic alternatives review process. New initiatives to bolster sales growth through marketing has also resulted in incremental costs of $0.2 million. Partially offsetting these increased costs was a reduction in property and casualty insurance reserves based upon lower claims which resulted in a favorable $0.4 million reduction of expense. In response to new initiatives to contain costs, travel and other variable operating costs declined by $0.4 million. Outbound freight also declined $0.4 million due to a reduction in sales volume.
Operating Income
Operating income was $6.1 million for the nine months ended September 30, 2007 and $9.3 million for the nine months ended September 30, 2006. As a percent of revenue, operating income decreased to 1.5% for the nine months ended September 30, 2007, from 2.2% in the prior period. The decline in operating income in the current year was the result of lower sales volume in conjunction with rising costs driven primarily by conversion related activity.
Interest Expense
Interest expense increased $0.3 million for the nine months ended September 30, 2007 and was $1.3 million as compared to $1.0 million for the same period for the prior year. This increase was the result of higher LIBOR rates in combination with the higher average debt outstanding in the first and second quarters of 2007 resulting in higher average year-to-date debt of $5.1 million as compared to the prior year. Our average interest rate year-to-date increased to 7.1% from 6.9%.
Provision for Income Taxes
The provision for income taxes decreased by $1.5 million, to a provision of $2.0 million for the nine months ended September 30, 2007, compared to $3.5 million for the nine months ended September 30, 2006. Our effective tax rate decreased to 41.2% as compared to 41.6% due to a decrease in non-deductible items as percentage of pre-tax income.
LIQUIDITY AND CAPITAL RESOURCES
Capital Availability and Requirements
At September 30, 2007, our total working capital was $86.7 million, which included $0.4 million in cash and cash equivalents. The amount outstanding under our Credit Facility as of September 30, 2007 was $13.0 million, which was $7.3 million less than September 30, 2006 and $11.4 million less than at December 31, 2006. We had an aggregate of $75.0 million of borrowing capacity under our Credit Facility at September 30, 2007. Based upon our current asset base (which serves as our collateral under the Credit Facility) and outstanding borrowings under the Credit Facility, we had borrowing availability under the Credit Facility of $60.8 million. We are in compliance with all applicable financial covenants under our Credit Facility.
Analysis of Cash Flows
Net cash provided by (used in) operating activities was $11.5 million and ($6.7 million) for the nine months ended September 30, 2007 and 2006, respectively. For the first nine months of 2007, net cash provided by operations was primarily attributable to a reduction of our accounts receivable balances due to improved collections and lower sales volume. Inventory levels have also declined over the nine months since purchases peaked at year end 2006 to meet various strategic growth supplier thresholds for rebate programs. We also used more cash during the nine months ended September 30, 2006 to fund a higher level of inventory relating to purchases in connection with new FPS site implementations. During the nine months ended September 30, 2006, net cash used in operations was primarily attributable to EDI billing process issues resulting from our IT system conversion, which delayed our receipt of payments from large customers.
Net cash provided by (used in) investing activities for the nine months ended September 30, 2007 and 2006 was $0.2 million and ($0.3 million), respectively. During the nine months ended September 30, 2007, cash was provided by entering into a sale-leaseback arrangement for certain warehouse related assets in conjunction with facility consolidations. In the prior year, our net cash was primarily attributable to the sale of real property, and was partially offset by increased capital purchases in connection with the IT system consolidation and asset purchases related to facility consolidations.
Net cash (used in) provided by financing activities was ($11.6 million) and $6.6 million for the nine months ended September 30, 2007 and 2006, respectively. Cash was used primarily for net repayments on our Credit Facility of $11.4 million and cash was provided by borrowings of $7.5 million for the nine months ended September 30, 2007 and 2006, respectively. During the first nine months of 2007 we used $0.5 million of cash to repurchase 50,800 shares pursuant to the stock repurchase plan. During the prior year, we used $2.2 million to repurchase 259,400 shares of common stock pursuant to the stock repurchase plan and we generated $1.0 million of cash primarily due to the issuance of stock options.
CERTAIN ACCOUNTING POLICIES AND ESTIMATES
Our consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires our management to make estimates and assumptions that affect: the reported amounts of assets and liabilities at the date of the financial statements; 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. Our management regularly evaluates its estimates and assumptions. These estimates and assumptions are based on historical experience and on various other factors that are believed to be reasonable under the circumstances and form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions, and these differences may be material.
While our significant accounting policies are described in Note 2 — Summary of Significant Accounting Policies in the Notes to Consolidated Financial Statements of our Annual Report on Form 10-K for fiscal 2006, we believe that the following accounting policies and estimates involve a higher degree of complexity and warrant specific description.
Allowance for Doubtful Accounts — Methodology
We have established an allowance for doubtful accounts based on our collection experience and an assessment of the collectability of specific accounts. We evaluate the collectability of accounts receivable based on a combination of factors. Initially, we estimate an allowance for doubtful accounts as a percentage of accounts receivable based on historical collections experience. This initial estimate is periodically adjusted when we become aware of a specific customer’s inability to meet its financial obligations (e.g., bankruptcy filing) or as a result of changes in the overall aging of accounts receivable. We do not believe our estimate of the allowance for doubtful accounts is likely to be adversely affected by any individual customer or group of customers, since our customers are geographically dispersed and do not service a concentrated industry, and none are individually significant. The table below depicts our allowance for doubtful accounts, bad debt expense incurred or recovered and write offs or recoveries during each quarter of 2007 and 2006. Write-offs of accounts receivable have no effect on either our results of operations or cash flows. Only charges to bad debt expense impact our earnings.



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