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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
---------------
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _________ TO ___________
COMMISSION FILE NUMBER 0-21513
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DXP ENTERPRISES, INC.
(Exact name of registrant as specified in its charter)
TEXAS 76-0509661
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
7272 PINEMONT 77040
HOUSTON, TEXAS (Zip Code)
713/996-4700
(Registrant's telephone number, including area code)
---------------
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 [ ]
---------------
APPLICABLE ONLY TO CORPORATE ISSUERS:
Number of shares outstanding of each of the issuer's classes of common
stock, as of November 10, 2002:
Common Stock: 4,071,685
================================================================================
ITEM 1: FINANCIAL STATEMENTS
DXP ENTERPRISES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
SEPTEMBER 30, DECEMBER 31,
2002 2001
------------- ------------
UNAUDITED
ASSETS
Current assets:
Cash ............................................................. $ 640 $ 2,260
Trade accounts receivable, net of allowances for doubtful accounts
of $1,959 and $1,784, respectively ............................. 19,224 18,757
Inventories, net ................................................. 21,153 22,922
Prepaid expenses and other ....................................... 640 341
Deferred income taxes ............................................ 1,532 1,714
-------- --------
Total current assets ........................................... 43,189 45,994
Property, plant and equipment, net ................................. 8,206 8,820
Goodwill, net ...................................................... -- 2,469
Notes and accounts receivable from officers and employees .......... 1,303 1,301
Deferred income taxes .............................................. 425 --
Other assets ....................................................... 247 350
-------- --------
Total assets ................................................... $ 53,370 $ 58,934
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Trade accounts payable and accrued liabilities ................... $ 16,420 $ 16,979
Accrued wages and benefits ....................................... 1,395 1,033
Current portion of long-term debt ................................ 2,045 7,273
Other accrued liabilities ........................................ 1,406 866
-------- --------
Total current liabilities ...................................... 21,266 26,151
Long-term debt, less current portion ............................... 23,094 22,864
Deferred income taxes .............................................. -- 250
Equity subject to redemption:
Series A preferred stock -- 1,122 shares ......................... 112 112
Shareholders' Equity:
Series A preferred stock, 1/10th vote per share; $1.00 par value;
liquidation preference of $1.00 per share; 1,000,000 shares
authorized; 1,168 shares issued and outstanding ................ 1 2
Series B convertible preferred stock, 1/10th vote per share;
$1.00 par value; $100 stated value; liquidation preference of
$100 per share; 1,000,000 shares authorized; 17,700 shares
issued, 15,000 shares outstanding and 2,700 shares in
treasury stock ................................................. 18 18
Common stock, $.01 par value, 100,000,000 shares authorized;
4,257,760 shares issued and 4,071,685 shares are
outstanding and 186,075 shares in treasury stock ............... 41 41
Paid-in capital .................................................... 2,730 2,765
Retained earnings .................................................. 8,002 8,625
Treasury stock, at cost ............................................ (1,894) (1,894)
-------- --------
Total shareholders' equity ..................................... 8,898 9,557
-------- --------
Total liabilities and shareholders' equity ..................... $ 53,370 $ 58,934
======== ========
See notes to condensed consolidated financial statements.
2
DXP ENTERPRISES, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
THREE MONTHS ENDED NINE MONTHS ENDED
------------------------- -------------------------
SEPTEMBER 30, SEPTEMBER 30,
------------------------- -------------------------
2002 2001 2002 2001
-------- -------- --------- --------
Sales ......................................................... $ 38,422 $ 43,240 $ 113,184 $135,826
Cost of sales ................................................. 28,638 32,296 84,172 101,712
-------- -------- --------- --------
Gross profit .................................................. 9,784 10,944 29,012 34,114
Selling, general and administrative expenses .................. 8,726 9,914 25,873 30,808
-------- -------- --------- --------
Operating income .............................................. 1,058 1,030 3,139 3,306
Other income .................................................. 14 12 63 53
Interest expense .............................................. (395) (572) (1,251) (2,025)
-------- -------- --------- --------
Income before income taxes .................................... 677 470 1,951 1,334
Provision for income taxes .................................... 269 198 778 628
-------- -------- --------- --------
Income before cumulative effect of a change in
accounting principal ........................................ 408 272 1,173 706
Cumulative effect of a change in accounting
principle, net of tax ....................................... -- -- (1,729) --
-------- -------- --------- --------
Net income (loss) ............................................. 408 272 (556) 706
Preferred stock dividend ...................................... 23 23 68 68
-------- -------- --------- --------
Net income (loss) attributable to common shareholders ......... $ 385 $ 249 $ (624) $ 638
======== ======== ========= ========
Per share and share amounts before cumulative
effect of a change in accounting principle
Basic earnings per common share ............................. $ 0.09 $ 0.06 $ 0.27 $ 0.16
======== ======== ========= ========
Common shares outstanding ................................... 4,072 4,072 4,072 4,072
======== ======== ========= ========
Diluted earnings per share .................................. $ 0.09 $ 0.06 $ 0.26 $ 0.16
======== ======== ========= ========
Common and common equivalent shares outstanding ............... 4,540 4,586 4,554 4,505
======== ======== ========= ========
Cumulative effect of a change in accounting
principle per share -- basic and diluted .................... $ -- $ -- $ (0.42) $ --
======== ======== ========= ========
Net income (loss) per share -- basic and diluted .............. $ 0.09 $ 0.06 $ (0.15) $ 0.16
======== ======== ========= ========
Common and common equivalent shares outstanding ............... 4,540 4,586 4,072 4,505
======== ======== ========= ========
See notes to condensed consolidated financial statements.
3
DXP ENTERPRISES, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
NINE MONTHS ENDED
SEPTEMBER 30
-----------------------
2002 2001
--------- ---------
OPERATING ACTIVITIES:
Net (loss) income ................................................ $ (556) $ 706
Adjustments to reconcile net (loss) income to net
cash provided by operating activities
Cumulative effect of a change in accounting principal ........ 1,729 --
Depreciation and amortization ................................ 867 1,054
Provision for deferred income taxes .......................... 243 463
Loss on disposal of property and equipment ................... 4 --
Changes in operating assets and liabilities:
Trade accounts receivable .................................... (467) 3,713
Inventories .................................................. (172) (1,241)
Prepaid expenses and other ................................... (198) (734)
Accounts payable and accrued liabilities ..................... 343 483
--------- ---------
Net cash provided by operating activities ........................ 1,793 4,444
INVESTING ACTIVITIES:
Purchase of property and equipment ............................... (258) (672)
Net proceeds on the sale of certain electrical
contractor segment assets ...................................... -- 1,149
--------- ---------
Net cash (used in) provided by investing activities ............ (258) 477
FINANCING ACTIVITIES:
Proceeds from debt ............................................... 139,753 132,974
Principal payments on revolving line of credit,
long-term debt, and notes payable to bank ...................... (142,805) (140,338)
Purchase of preferred stock ...................................... (35) --
Dividends paid in cash ........................................... (68) (68)
--------- ---------
Net cash used in financing activities ........................ (3,155) (7,432)
--------- ---------
DECREASE IN CASH ................................................. (1,620) (2,511)
CASH AT BEGINNING OF PERIOD ...................................... 2,260 2,744
--------- ---------
CASH AT END OF PERIOD ............................................ $ 640 $ 233
========= =========
Noncash activities:
Changes in inventories and principal payments on debt exclude the $1.9 million
noncash reduction of inventory cost and debt associated with a litigation
settlement recorded in 2002. See note 4.
See notes to condensed consolidated financial statements.
4
DXP ENTERPRISES INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1: BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements
have been prepared in accordance with generally accepted accounting principles
in the United States of America (GAAP) for interim financial information and
with the instructions to Form 10-Q. Accordingly, certain information and
footnote disclosures normally included in financial statements prepared in
accordance with GAAP have been omitted. DXP Enterprises, Inc. ("DXP" or the
"Company") believes that the presentations and disclosures herein are adequate
to make the information not misleading. The condensed consolidated financial
statements reflect all elimination entries and adjustments (consisting of normal
recurring adjustments) necessary for a fair presentation of the interim periods.
The results of operations for the interim periods are not necessarily
indicative of the results of operations to be expected for the full year. These
condensed consolidated financial statements should be read in conjunction with
the Company's audited consolidated financial statements included in the
Company's 10-K Annual Report for the year ended December 31, 2001, filed with
the Securities and Exchange Commission.
NOTE 2: THE COMPANY
DXP , a Texas corporation, was incorporated on July 26, 1996, to be the
successor to SEPCO Industries, Inc. (SEPCO). The Company is organized into two
segments: Maintenance, Repair and Operating (MRO) and Electrical Contractor.
NOTE 3: INVENTORY
The Company uses the last-in, first-out ("LIFO") method of inventory
valuation for approximately 64 percent of its inventories. Remaining inventories
are accounted for using the first-in, first-out ("FIFO") method. An actual
valuation of inventory under the LIFO method can be made only at the end of each
year based on the inventory levels and costs at that time. Accordingly, interim
LIFO calculations must necessarily be based on management's estimates of
expected year-end inventory levels and costs. Because these are subject to many
forces beyond management's control, interim results are subject to the final
year-end LIFO inventory valuation. The reconciliation of FIFO inventory to LIFO
basis is as follows:
SEPTEMBER 30, 2002 DECEMBER 31, 2001
------------------ -----------------
(IN THOUSANDS)
Finished goods...... $ 22,961 $25,454
Work in process..... 1,788 921
-------- -------
Inventories at FIFO. 24,749 26,375
Less - LIFO allowance (3,596) (3,453)
-------- -------
Inventories......... $ 21,153 $22,922
======== =======
NOTE 4: LONG-TERM DEBT
On May 13, 2002, the Company finalized the settlement of the dispute
regarding the adjustment of the purchase price paid to the seller for a MRO
business acquired by the Company in 1997. Under the terms of the settlement
agreement, the Company paid $0.1 million to the seller, the Company retained
ownership of the inventory acquired in 1997 remaining on hand, and the $2.0
million subordinated note payable by the Company to the seller was cancelled.
From September 30, 2000 through December 31, 2001, the balances outstanding
under the subordinated note and a $5.8 million secured line of credit were in
default and included in current maturities of long-term debt. Since March 31,
2002, the balance outstanding under the $5.8 million secured line of credit is
included in long-term debt. The balance of the subordinated note, less the $0.1
million settlement payment, was recorded as of March 31, 2002, as a reduction of
the cost of the inventory acquired in 1997 remaining on hand.
5
NOTE 5: EARNINGS PER SHARE DATA
The following table sets forth the computation of basic and diluted
earnings per share before cumulative effect of a change in accounting principle
for the periods indicated.
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
----------------------- -----------------------
2002 2001 2002 2001
---------- ---------- ---------- ----------
Basic:
Average shares outstanding........................... 4,071,685 4,071,685 4,071,685 4,071,685
Income before cumulative effect of a change in
accounting principle............................... $ 408,000 $ 272,000 $1,173,000 $ 706,000
Convertible preferred stock dividend................. (23,000) (23,000) (68,000) (68,000)
---------- ---------- ---------- ----------
Income attributable to common shareholders before
cumulative effect of a change in accounting
principle.......................................... $ 385,000 $ 249,000 $1,105,000 $ 638,000
Per share amount..................................... $ 0.09 $ 0.06 $ 0.27 $ 0.16
========== ========== ========== ==========
Diluted:
Average shares outstanding........................... 4,071,685 4,071,685 4,071,685 4,071,685
Net effect of dilutive stock options-based on the
treasury stock method.............................. 47,922 94,800 62,752 12,979
Assumed conversion of convertible preferred stock.... 420,000 420,000 420,000 420,000
---------- ---------- ---------- ----------
Total................................................ 4,539,607 4,586,485 4,554,437 4,504,664
========== ========== ========== ==========
Income attributable to common shareholders before
cumulative effect of a change in accounting
principle.......................................... $ 385,000 $ 249,000 $1,105,000 $ 638,000
Convertible preferred stock dividend................. 23,000 23,000 68,000 68,000
---------- ---------- ---------- ----------
Income for diluted earnings per share, before
cumulative effect of a change in accounting
principle.......................................... $ 408,000 $ 272,000 $1,173,000 $ 706,000
========== ========== ========== ==========
Per share amount..................................... $ 0.09 $ 0.06 $ 0.26 $ 0.16
========== ========== ========== ==========
The computation of diluted loss per share after cumulative effect of a change in
accounting principle for the nine months ended September 30, 2002, excludes
outstanding stock options and the convertible preferred stock because these
items would be anti-dilutive.
NOTE 6: SEGMENT REPORTING
The MRO Segment is engaged in providing maintenance, repair and
operating products, equipment and integrated services, including engineering
expertise and logistics capabilities, to industrial customers. The Company
provides a wide range of MRO products in the fluid handling equipment, bearing,
power transmission equipment, general mill, safety supply and electrical
products categories. The Electrical Contractor segment sells a broad range of
electrical products, such as wire conduit, wiring devices, electrical fittings
and boxes, signaling devices, heaters, tools, switch gear, lighting, lamps,
tape, lugs, wire nuts, batteries, fans and fuses, to electrical contractors. The
Company began offering electrical products to electrical contractors following
its acquisition of the assets of two electrical supply businesses in 1998.
During August 2001, the Company sold the majority of the assets of one of the
two businesses which comprised the Electrical Contractor segment. Historically,
the business which was sold accounted for approximately two thirds of the sales
of the Electrical Contractor segment.
6
The high degree of integration of the Company's operations necessitates
the use of a substantial number of allocations and apportionments in the
determination of business segment information. Sales are shown net of
intersegment eliminations. All business segments operate primarily in the United
States.
Financial information relating the Company's segments is as follows (in
thousands):
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------- -------------------------------
ELECTRICAL ELECTRICAL
MRO CONTRACTOR TOTAL MRO CONTRACTOR TOTAL
------- ---------- ------- -------- ---------- -------
2002
Sales.................................... $37,614 $ 808 $38,422 $110,998 $2,186 $113,184
Operating income......................... 1,003 55 1,058 3,132 7 3,139
2001
Sales.................................... $41,431 $1,809 $43,240 $128,353 $7,473 $135,826
Operating income......................... 1,119 (89) 1,030 3,711 (405) 3,306
NOTE 7: CHANGE IN ACCOUNTING PRINCIPLE
In June 2001, SFAS No. 142, "Goodwill and Other Intangible Assets" was
issued. SFAS No. 142 changes the treatment of goodwill by no longer amortizing
goodwill, and instead requiring, at least annually, an assessment for impairment
by applying a fair-value based test. However, other identifiable intangible
assets with determinable lives are to be separately recognized and amortized.
This statement is effective for fiscal years beginning after December 15, 2001.
All of the Company's goodwill pertained to one reporting unit as
defined in SFAS 142. The goodwill was tested for impairment during the first
quarter of 2002 as required by SFAS 142 upon adoption based upon the expected
present value of future cash flows approach. As a result of this valuation
process as well as the application of the remaining provisions of SFAS 142, the
Company recorded a transitional impairment loss of $2.5 million before income
taxes ($1.7 million after income taxes). This write-off was reported as a
cumulative effect of a change in accounting principle in the Company's
consolidated statement of operations as of January 1, 2002. This adoption of the
statement has resulted in the elimination of approximately $79,000 of annual
goodwill amortization subsequent to December 31, 2001.
7
The following table discloses the Company's net income (loss), assuming
it excluded goodwill amortization for the periods ended (in thousands, except
per share data):
THREE MONTHS NINE MONTHS
ENDED ENDED SEPTEMBER
SEPTEMBER 30, 30,
-------------- ---------------
2002 2001 2002 2001
----- ----- ------ -----
Net income (loss) $ 408 $ 272 $ (556) $ 706
Add back:
Goodwill amortization, net of income taxes................ -- 13 -- 39
----- ----- ------ -----
Adjusted net income (loss).............................. $ 408 $ 285 $ (556) $ 745
===== ===== ====== =====
Basic earnings (loss) per share $0.09 $0.06 $(0.15) $0.16
Add back:
Goodwill amortization, net of income taxes................ -- -- -- 0.01
----- ----- ------ -----
Adjusted basic earnings (loss) per share................ $0.09 $0.06 $(0.15) $0.17
===== ===== ====== =====
Diluted earnings (loss) per share........................... $0.09 $0.06 $(0.15) $0.16
Add back:
Goodwill amortization, net of income taxes................ -- -- -- 0.01
----- ----- ------ -----
Adjusted diluted earnings (loss) per share.............. $0.09 $0.06 $(0.15) $0.17
===== ===== ====== =====
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS OF OPERATIONS
Three Months Ended September 30, 2002 compared to Three Months Ended
September 30, 2001
SALES. Revenues for the quarter ended September 30, 2002, decreased
$4.8 million, or 11.1%, to approximately $38.4 million from $43.2 million in
2001. Sales for the MRO Segment decreased $3.8 million, or 9.2%, primarily due
to slowing of the overall economy. Sales for the Electrical Contractor segment
decreased by $1.0 million, or 55.3%, for the current quarter when compared to
same period in 2001. This decrease is the result of the sale during August 2001
of the majority of the assets of a business in San Antonio, Texas, which
accounted for approximately two thirds of the sales of the Electrical Contractor
segment, combined with a slow down in the construction business for electrical
contractors.
GROSS PROFIT. Gross profit as a percentage of sales increased by
approximately 0.1% for the third quarter of 2002, when compared to the same
period in 2001. This increase can be primarily attributed to increased margins
for the Electrical Contractor segment, partially offset by reduced margins for
the MRO segment. Gross profit as a percentage of sales for the Electrical
Contractor segment increased to 38.0% for the three months ended September 30,
2002, up from 22.1% in the comparable period of 2001. This increase resulted
from the sale of the business in San Antonio, Texas which had lower gross profit
margins. Gross profit as a percentage of sales for the MRO segment decreased to
25.2% the quarter ended September 30, 2002, down from 25.4% for the comparable
period of 2001. The decline resulted from changes in product mix.
SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and
administrative expense for the quarter ended September 30, 2002, decreased by
approximately $1.2 million, or 12.0%, when compared to the same period in 2001.
This decrease is primarily attributed to reduced payroll and payroll related
expenses. As a percentage of revenue, the 2002 expense decreased to 22.7% from
22.9% for 2001.
OPERATING INCOME. Operating income for the third quarter of 2002 was
approximately the same when compared to the same period in 2001. This similar
result is the net of a $0.1 million decrease in operating income for the MRO
Segment and a $0.1 million improvement in operating income for the Electrical
Contractor segment. The reduced operating income for the MRO segment is the
result of lower sales and gross profit partially
8
offset by reduced selling, general and administrative expenses. The improvement
for the Electrical Contractor Segment is primarily the result of the sale during
August 2001 of the majority of the assets of a business in San Antonio, Texas,
which was not profitable.
INTEREST EXPENSE. Interest expense for the quarter ended September 30,
2002 decreased by $0.2 million, or 31%, when compared to the same period in
2001. This decline results from lower interest rates for the third quarter of
2002 when compared to the third quarter of 2001 as well as a lower average debt
balance.
Nine Months Ended September 30, 2002 compared to Nine Months Ended
September 30, 2001
SALES. Revenues for the nine months ended September 30, 2002, decreased
$22.6 million, or 16.7%, to approximately $113.2 million from $135.8 million in
2001. Sales for the MRO segment decreased $17.4 million, or 13.5%, primarily due
to slowing of the overall economy. Sales for the Electrical Contractor segment
decreased by $5.3 million, or 70.7%, for the first nine months when compared to
same period in 2001. This decrease is the result of the sale during August 2001
of the majority of the assets of a business in San Antonio, Texas, which
accounted for approximately two thirds of the sales of the Electrical Contractor
segment, combined with a slow down in the construction business for electrical
contractors.
GROSS PROFIT. Gross profit as a percentage of sales increased by
approximately 0.5% for the first nine months of 2002, when compared to the same
period in 2001. This increase can be primarily attributed to increased margins
for the Electrical Contractor segment. Gross profit as a percentage of sales for
the Electrical Contractor segment increased to 38.8% for the nine months ended
September 30, 2002, up from 21.0% in the comparable period of 2001. This
increase resulted from the sale of the business in San Antonio, Texas which had
lower gross profit margins. Gross profit as a percentage of sales for the MRO
segment was 25.4% for both periods.
SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and
administrative expense for the nine months ended September 30, 2002, decreased
by approximately $4.9 million, or 16.0%, when compared to the same period in
2001. This decrease is primarily attributed to reduced payroll and payroll
related expenses. As a percentage of revenue, the 2002 expense increased by
approximately 0.2% to 22.9% from 22.7% for 2001. This increase is primarily
attributable to non-variable costs being spread over a smaller revenue amount.
OPERATING INCOME. Operating income for the first nine months of 2002
decreased by approximately $0.2 million, or 5.1%, when compared to the same
period in 2001. This decrease is the net of a $0.6 million decrease in operating
income for the MRO Segment and a $0.4 million improvement in operating income
for the Electrical Contractor segment. The reduced operating income for the MRO
segment is the result of lower sales and gross profit partially offset by
reduced selling, general and administrative expenses. The improvement for the
Electrical Contractor segment is primarily the result of the sale during August
2001 of the business in San Antonio, Texas, which was not profitable.
INTEREST EXPENSE. Interest expense for the nine months ended September
30, 2002 decreased by $0.8 million to $1.2 million from $2.0 million during the
same period in 2001. This decline results from lower interest rates for the nine
months of 2002 when compared to the first nine months of 2001 as well as a lower
average debt balance.
LIQUIDITY AND CAPITAL RESOURCES
GENERAL
As a distributor of MRO and Electrical products, we require significant
amounts of working capital to fund inventories and accounts receivable.
Additional cash is required for capital items such as information technology and
warehouse equipment. We also require cash to pay our lease obligations and to
service our debt.
Under the loan agreements with our bank lender, all available cash is
generally applied to reduce outstanding borrowings, with operations funded
through borrowings under the Credit Facility. Our policy is to maintain low
levels of cash and cash equivalents and to use borrowings under our lines of
credit for working capital. We had approximately $4.0 million available for
borrowings under the revolving portion of the Credit Facility at
9
September 30, 2002. Working capital at September 30, 2002 and December 31, 2001
was approximately $21.9 million and $19.8 million, respectively. During the
first nine months of 2002 and 2001, we collected trade receivables in
approximately 51 and 46 days, respectively. For the nine months ended September
30, 2002 and 2001, we turned our inventory approximately five and six times,
respectively, on an annualized basis.
On May 13, 2002, the Company finalized the settlement of the dispute
regarding the adjustment of the purchase price paid to the seller for a MRO
business acquired by the Company in 1997. Under the terms of the settlement
agreement, the Company paid $0.1 million to the seller, the Company retained
ownership of the inventory acquired in 1997 remaining on hand, and the $2.0
million subordinated note payable by the Company to the seller was cancelled.
From September 30, 2000 through December 31, 2001, the balances outstanding
under the subordinated note and a $5.8 million secured line of credit were in
default and included in current maturities of long-term debt. Since March 31,
2002, the balance outstanding under the $5.8 million secured line of credit has
been included in long-term debt. The balance of the subordinated note, less the
$0.1 million settlement payment, has been recorded as a reduction of the cost of
the inventory acquired in 1997 remaining on hand.
The Credit Facility with our bank lender provides for borrowings up to
an aggregate of the lesser of (i) a percentage of the collateral value based on
a formula set forth therein or (ii) $35.0 million, and matures April 1, 2004.
Interest accrues at prime plus 1/2% on the revolving portion of the Credit
Facility and prime plus 1 1/2% on the term portion of the Credit Facility. The
prime rate at September 30, 2002, was 4.75%. The margin above prime may increase
by 50 basis points if the ratio of earnings, before interest, taxes,
depreciation and amortization, to fixed charges (as defined) is equal to or less
than 1.1 to 1.0. The Credit Facility is secured by receivables, inventory, real
estate and machinery and equipment. The Credit Facility contains customary
affirmative and negative covenants as well as financial covenants that are
measured monthly and require that we maintain certain cash flow and other
financial ratios. We have, from time to time, not been in compliance with
certain covenants under the Credit Facility including the minimum earnings
requirement and the fixed charge coverage ratio. At September 30, 2002, we are
in compliance with these covenants. In addition to the $0.6 million of cash on
hand at September 30, 2002, we had $4.0 million available for borrowings under
the Credit Facility at September 30, 2002. Although we expect to be able to
comply with the covenants, including the financial covenants, of the Credit
Facility, there can be no assurance that in the future we will be able to do so
or that our lender will be willing to waive such non-compliance or further amend
such covenants
We generated approximately $1.8 million of cash in operating activities
in the first nine months of 2002 as compared to generating approximately $4.4
million of cash during the first nine months of 2001. This change is primarily
attributable to increased accounts receivable in 2002 compared to a $3.7 million
decrease in accounts receivable in 2001.
Fixed asset purchases of $0.3 during the first nine months of 2002
related primarily to computer equipment. Capital expenditures of $0.7 million
during the first nine months of 2001 were related primarily to computer
software.
Our internal cash flow projections indicate our cash generated from
operations and available under our Credit Facility will meet our normal working
capital needs during the next twelve months. However, we may require additional
debt or equity financing to meet our future debt service obligations beyond
September 30, 2003, which may include additional bank debt or the public or
private sale of equity or debt securities. In connection with such financing, we
may be required to issue securities that substantially dilute the interest of
our shareholders. As described above, all of our Credit Facility matures on or
before April 1, 2004. However, we may not be able to renew and extend or replace
the Credit Facility. Any extended or replacement facility may have higher
interest costs, less borrowing capacity, more restrictive conditions and could
involve equity dilution. Our ability to obtain a satisfactory credit facility
may depend, in part, upon the level of our asset base for collateral purposes,
our future financial performance and our ability to obtain additional equity.
We would require additional capital to fund any future acquisitions. At
this time, we do not plan to grow through acquisitions unless the market price
of our common stock rises to levels that will make acquisitions accretive to our
earnings or we generate excess cash flow. We may also pursue additional equity
or debt financing to fund future acquisitions, although we may not be able to
obtain additional financing on attractive terms.
10
DISCUSSION OF CRITICAL ACCOUNTING POLICIES
The preparation of financial statements in conformity with GAAP
requires us to make estimates and assumptions in determining the reported
amounts of assets and liabilities and 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. The significant estimates
made by us in the accompanying financial statements relate to reserves for
accounts receivable collectibility, inventory valuations and self-insured
medical claims. Actual results could differ from those estimates.
Critical accounting policies are those that are both most important to
the portrayal of a company's financial position and results of operations, and
require management's subjective or complex judgments. Below is a discussion of
what we believe are our critical accounting policies.
Revenue Recognition
We recognize revenues when an agreement is in place, price is fixed,
title for product passes to the customer or services have been provided, and
collecitibility is reasonably assured.
Allowance for Doubtful Accounts
Provisions to the allowance for doubtful accounts are made monthly and
adjustments are made periodically (as circumstances warrant) based upon the
expected collectibility of all such accounts.
Inventory
Inventory consists principally of finished goods and is priced at lower
of cost or market, cost being determined using both the first-in and first out
(FIFO) and the last-in, first-out (LIFO) method. Reserves are provided against
inventory for estimated obsolescence based upon the aging of the inventory and
market trends.
RECENTLY ISSUED ACCOUNTING STANDARDS
In June 2001, SFAS No. 142, "Goodwill and Other Intangible Assets" was
issued. SFAS No. 142 changes the treatment of goodwill by no longer amortizing
goodwill, and instead requiring, at least annually, an assessment for impairment
by applying a fair-value based test. However, other identifiable intangible
assets with determinable lives are to be separately recognized and amortized.
The statement is effective for fiscal years beginning after December 15, 2001.
The adoption of the statement has resulted in the elimination of approximately
$79,000 of goodwill amortization, annually, subsequent to December 31, 2001. The
new requirements for assessing whether goodwill assets have been impaired
involve market-based information. Based on the new standards, we recorded a
noncash, pre-tax goodwill impairment charge of $2.5 million as of January 1,
2002. This charge is reflected as a cumulative effect of a change in accounting
principle.
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations." This statement addresses financial accounting and
reporting for obligations associated with the retirement of tangible long-lived
assets and the associated asset retirement costs. The purpose of this statement
is to develop consistent accounting for asset retirement obligations and related
costs in the financial statements and provide more information about future cash
outflows, leverage and liquidity regarding retirement obligations and the gross
investment in long-lived assets. This statement is effective for financial
statements issued for fiscal years beginning after June 15, 2002. The Company
will implement SFAS No. 143 on January 1, 2003. The impact of such adoption is
not anticipated to have a material effect on the Company's financial statements.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets," which is effective for fiscal
years beginning after December 15, 2001. This Statement addresses financial
accounting and reporting for the impairment or disposal of long-lived assets.
This Statement supercedes SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," and the
accounting and reporting provisions of APB Opinion No. 30, "Reporting the
Results of Operations - Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions," for the disposal of a segment of a business (as previously
defined in that Opinion). This Statement also amends Accounting Research Board
No. 51, "Consolidated Financial Statements," to
11
eliminate the exception to consolidation for subsidiaries for which control is
likely to be temporary. The Company has adopted SFAS No. 144 beginning January
1, 2002. The impact of such adoption did not have a material effect on the
Company's financial statements.
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Our market risk results from volatility in interest rates. This risk is
monitored and managed. Our exposure to interest rate risk relates primarily to
our Credit Facility. Based on our capital structure at June 30, 2002, a 100
basis point change in interest rates would result in an estimated $0.3 million
change in annual interest expense.
ITEM 4: CONTROLS AND PROCEDURES
Based on their evaluations as of a date within 90 days of the filing
date of this report, the principle executive officer and principal financial
officer of the Company have concluded that the Company's disclosure controls and
procedures (as defined in Rules 13a-14 (c) and 15d-14 (c) under the Securities
Exchange Act) are effective to ensure that information required to be disclosed
by the Company in reports that the Company files or submits under the Securities
Exchange Act is recorded, processed, summarized and reported within the time
periods specified in the rules and forms of the SEC.
There were no significant changes in the Company's internal controls or
in other factors that could significantly affect these internal controls
subsequent to the date of their most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
PART II: OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
From time to time, the Company is a party to legal proceedings arising in
the ordinary course of business. The Company is not currently a party to any
litigation that it believes could have a material adverse effect on the results
of operations or financial condition of the Company.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None
ITEM 5. OTHER INFORMATION.
CAUTIONARY STATEMENTS
Our expectations with respect to future results of operations that may
be embodied in oral and written forward-looking statements, including any
forward-looking statements that may be contained in this Quarterly Report on
Form 10-Q, are subject to risks and uncertainties that must be considered when
evaluating the likelihood of our realization of such expectations. Our actual
results could differ materially. Factors that could cause or contribute to such
differences include, but are not limited to, those discussed below.
12
Ability to Comply with Financial Covenants of Credit Facility
Our loan agreements with our bank lender (the "Credit Facility")
requires that we comply with certain specified covenants, restrictions,
financial ratios and other financial and operating tests. Our ability to comply
with any of the foregoing restrictions will depend on our future performance,
which will be subject to prevailing economic conditions and other factors,
including factors beyond our control. A failure to comply with any of these
obligations could result in an event of default under the Credit Facility, which
could permit acceleration of our indebtedness under the Credit Facility. From
time to time we have been unable to comply with some of the financial covenants
contained in the Credit Facility (relating to, among other things, the
maintenance of prescribed financial ratios) and have, when necessary, obtained
waivers or amendments to the covenants from our lender. Although we expect to be
able to comply with the covenants, including the financial covenants, of the
Credit Facility, there can be no assurance that in the future we will be able to
do so or that our lender will be willing to waive such non-compliance or further
amend such covenants.
Risks Related to Internal Growth Strategy
Future results for us will depend in part on our success in
implementing our internal growth strategy, which includes expanding our existing
geographic areas and adding new customers. Our ability to implement this
strategy will depend on our success in selling more to existing customers,
acquiring new customers, hiring qualified sales persons, and marketing
integrated supply arrangements such as those being pursued by us through our
SmartSource program. Although we intend to increase sales and product offerings
to existing customers and reduce costs through consolidating certain
administrative and sales functions, there can be no assurance that we will be
successful in these efforts.
Substantial Competition
Our business is highly competitive. We compete with a variety of
industrial supply distributors, some of which may have greater financial and
other resources than us. Although many of our traditional distribution
competitors are small enterprises selling to customers in a limited geographic
area, we also compete with larger distributors that provide integrated supply
programs such as those offered through outsourcing services similar to those
that are offered by our SmartSource program. Some of these large distributors
may be able to supply their products in a more timely and cost-efficient manner
than us. Our competitors include direct mail suppliers, large warehouse stores
and, to a lesser extent, certain manufacturers.
Risks of Economic Trends
Demand for our products is subject to changes in the United States
economy in general and economic trends affecting our customers and the
industries in which they compete in particular. Many of these industries, such
as the oil and gas industry, are subject to volatility while others, such as the
petrochemical industry, are cyclical and materially affected by changes in the
economy. As a result, we may experience changes in demand for our products as
changes occur in the markets of our customers.
Dependence on Key Personnel
We will continue to be dependent to a significant extent upon the
efforts and ability of David R. Little, our Chairman of the Board, President and
Chief Executive Officer. The loss of the services of Mr. Little or any other
executive officer of our company could have a material adverse effect on our
financial condition and results of operations. We do not maintain key-man life
insurance on the life of Mr. Little or on the lives of our other executive
officers. In addition, our ability to grow successfully will be dependent upon
our ability to attract and retain qualified management and technical and
operational personnel. The failure to attract and retain such persons could
materially adversely affect our financial condition and results of operations.
Dependence on Supplier Relationships
We have distribution rights for certain product lines and depend on
these distribution rights for a substantial portion of our business. Many of
these distribution rights are pursuant to contracts that are subject to
cancellation upon little or no prior notice. Although we believe that we could
obtain alternate distribution rights in the event of such a cancellation, the
termination or limitation by any key supplier of its relationship with our
company could
13
result in a temporary disruption on our business and, in turn, could adversely
affect results of operations and financial condition.
Risks Associated With Hazardous Materials
Certain of our operations are subject to federal, state and local laws
and regulations controlling the discharge of materials into or otherwise
relating to the protection of the environment. Although we believe that we have
adequate procedures to comply with applicable discharge and other environmental
laws, the risks of accidental contamination or injury from the discharge of
controlled or hazardous materials and chemicals cannot be eliminated completely.
In the event of such an accident, we could be held liable for any damages that
result and any such liability could have a material adverse effect on our
financial condition and results of operations.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits.
3.1 Restated Articles of Incorporation, as amended (incorporated by
reference to Exhibit 4.1 to the Registrant's Registration
Statement on Form S-8 (Reg. No. 333-61953), filed with Commission
on August 20, 1998)
3.2 Bylaws (incorporated by reference to Exhibit 3.2 to the
Registrant's Registration Statement on Form S-4 (Reg. No.
333-10021), filed with the Commission on August 12, 1996).
(b) Reports on Form 8-K.
None
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
DXP ENTERPRISES, INC.
(Registrant)
By: /s/ MAC McCONNELL
-------------------------------------
Mac McConnell
Senior Vice-President/Finance and
Chief Financial Officer
Dated: November 14, 2002
14
CERTIFICATIONS
I, David R. Little, the Chief Executive Officer of DXP Enterprises, Inc.,
certify that:
1. I have reviewed this quarterly report on Form 10-Q of DXP
Enterprises, Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material
fact necessary to make the statements made, in light of the
circumstances under which such statements were made, not misleading
with respect to the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other
financial information included in this quarterly report, fairly
present in all material respects the financial condition, results
of operations and cash flows of the registrant as of, and for, the
periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible
for establishing and maintaining disclosure controls and procedures
(as defined in Exchange Act Rules 13a-14 and 15d-14) for the
registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors
and the audit committee of registrant's board of directors (or
persons performing the equivalent function):
a. all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b. any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes
in internal controls or in other factors that could significantly
affect internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
November 14, 2002
/s/ David R. Little
-----------------------
David R. Little
Chief Executive Officer
15
I, Mac McConnell, the Chief Financial Officer of DXP Enterprises, Inc., certify
that:
1. I have reviewed this quarterly report on Form 10-Q of DXP
Enterprises, Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material
fact necessary to make the statement made, in light of the
circumstances under which such statements were made, not misleading
with respect to the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other
financial information included in this quarterly report, fairly
presents in all material respects the financial condition, results
of operations and cash flows of the registrant as of, and for, the
periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible
for establishing and maintaining disclosure controls and procedures
(as defined in Exchange Act Rules 13a-14 and 15d-14) for the
registrant and we have:
a. designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b. evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date this quarterly report (the "Evaluation Date"); and
c. presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors
and the audit committee of registrant's board of directors (or
persons performing the equivalent function):
a. all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b. any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes
in internal controls or in other factors that could significantly
affect internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
November 14, 2002
/s/ Mac McConnell
-----------------------
Mac McConnell
Chief Financial Officer
16