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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, 2004 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 _______________ DXP ENTERPRISES, INC. (Exact name of registrant as specified in its charter) TEXAS 76-0509661 (State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification Number) 7272 Pinemont, Houston TX 77040 (Address of principal executive offices) (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 [ ] No [X] Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X] _______________ APPLICABLE ONLY TO CORPORATE ISSUERS: Number of shares outstanding of each of the issuer's classes of common stock, as of October 27, 2004: Common Stock: 4,030,901 PART I: FINANCIAL INFORMATION ITEM 1: FINANCIAL STATEMENTS DXP ENTERPRISES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE AMOUNTS) September 30, 2004 December 31, 2003 (Unaudited) ASSETS Current assets: Cash $ 1,415 $ 636 Trade accounts receivable, net of allowances for doubtful accounts of $1,601 and $1,420, respectively 22,999 19,412 Inventories, net 17,803 19,145 Prepaid expenses and other current assets 636 362 Deferred income taxes 914 876 Total current assets 43,767 40,431 Property and equipment, net 8,473 7,395 Deferred income taxes 338 403 Other assets 100 146 Total assets $ 52,678 $ 48,375 LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Current portion of long-term debt $ 1,422 $ 1,474 Trade accounts payable and accrued expenses 16,592 14,559 Accrued wages and benefits 2,143 1,426 Customer advances 65 2,922 Federal income taxes payable 413 1,040 Other accrued expenses 896 203 Total current liabilities 21,531 21,624 Long-term debt, less current portion 18,972 16,675 Shareholders' equity: Series A preferred stock, 1/10th vote per share; $1.00 par value; liquidation preference of $100 per share; ($112 at September 30, 2004) 1,000,000 shares authorized; 1,122 shares issued and outstanding 1 1 Series B convertible preferred stock, 1/10th vote per share; $1.00 par value; $100 stated value; liquidation preference of $100 per share ($1,500 at September 30, 2004); 1,000,000 shares authorized; 17,700 shares issued, 15,000 shares outstanding and 2,700 shares in treasury stock 18 18 Common stock, $0.01 par value, 100,000,000 shares authorized; 4,257,760 shares issued; 4,030,901 and 4,070,520 shares outstanding, and 226,859 and 187,240 shares in treasury stock, respectively 41 41 Paid-in capital 2,841 2,841 Retained earnings 12,471 10,404 Treasury stock, at cost (2,201) (1,897) Notes receivable from shareholders-David R. Little, CEO and James Webster, employee (996) (1,332) Total shareholders' equity 12,175 10,076 Total liabilities and shareholders' equity $ 52,678 $ 48,375 See notes to condensed consolidated financial statements. DXP ENTERPRISES, INC. AND SUBSIDIARIES UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF INCOME (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) Three Months Ended September 30, Nine Months Ended September 30, 2004 2003 2004 2003 Sales $ 42,871 $ 40,363 $ 122,836 $ 115,590 Cost of sales 32,928 30,056 93,222 86,257 Gross profit 9,943 10,307 29,614 29,333 Selling, general and administrative expense 8,563 9,010 25,647 25,932 Operating income 1,380 1,297 3,967 3,401 Other income 11 13 40 50 Interest expense (233) (277) (667) (947) Income before taxes 1,158 1,033 3,340 2,504 Provision for income taxes 415 381 1,205 939 Net income 743 652 2,135 1,565 Preferred stock dividend 23 23 68 68 Net income attributable to common shareholders $ 720 $ 629 $ 2,067 $ 1,497 Basic income per share $ 0.18 $ 0.15 $ 0.51 $ 0.37 Weighted average common shares outstanding 4,015 4,072 4,025 4,072 Diluted income per share $ 0.13 $ 0.13 $ 0.39 $ 0.33 Weighted average common and common equivalent shares outstanding 5,531 5,181 5,488 4,721 See notes to condensed consolidated financial statements.
DXP ENTERPRISES, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED |
|||
SEPTEMBER 30 |
|||
2004 |
2003 |
||
(in thousands) |
|||
OPERATING ACTIVITIES: |
|||
Net income |
$ 2,135 |
$ 1,565 |
|
Adjustments to reconcile net income to net cash provided |
|||
by (used in) activities |
|||
Depreciation and amortization |
722 |
785 |
|
Deferred income taxes |
27 |
(11) |
|
Gain on disposal of property and equipment |
(1) |
(2) |
|
Changes in operating assets and liabilities: |
|||
Trade accounts receivable |
(3,587) |
(2,548) |
|
Inventories |
1,342 |
1,493 |
|
Prepaid expenses and other current assets |
(227) |
(97) |
|
Accounts payable and other accrued liabilities |
(45) |
1,500 |
|
Net cash provided by operating activities |
366 |
2,685 |
|
INVESTING ACTIVITIES: |
|||
Purchase of property and equipment |
(270) |
(230) |
|
Proceeds from sale of equipment |
1 |
2 |
|
Net cash used in investing activities |
(269) |
(228) |
|
FINANCING ACTIVITIES: |
|||
Proceeds from debt |
116,133 |
110,056 |
|
Principal payments on revolving line of credit, long-term debt, |
|||
and notes payable to bank |
(115,418) |
(112,858) |
|
Dividends paid in cash |
(68) |
(68) |
|
Purchase of preferred stock |
-- |
(1) |
|
Proceeds from exercise of stock options |
35 |
-- |
|
Net cash provided by (used in) financing activities |
682 |
(2,871) |
|
INCREASE (DECREASE) IN CASH |
779 |
(414) |
|
CASH AT BEGINNING OF PERIOD |
636 |
1,171 |
|
CASH AT END OF PERIOD |
$ 1,415 |
$ 757 |
|
Noncash activities: |
|||
Financing activities exclude the exchange on March 31, 2004 of two notes receivable from Mr. Little, Chief Executive Officer, with a face value of $338,591 for 80,619 shares of DXP common stock. Investing activities and financing activities exclude $1,530,000 paid by a financial institution directly to the seller in connection with the purchase of an airplane on August 27, 2004. |
|||
See notes to condensed consolidated financial statements. |
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 accounting principles generally accepted in the United States of America 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 accounting principles generally accepted in the United States of America have been omitted. DXP Enterprises, Inc. (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, 2003, filed with the Securities and Exchange Commission.
NOTE 2: THE COMPANY
DXP Enterprises, Inc. and subsidiaries (DXP or the Company), 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: STOCK OPTIONS
The Company accounts for its stock-based compensation plans under Accounting Principles Board ("APB") Opinion No. 25, Accounting for Stock Issued to Employees. The pro forma information below is based on provisions of Statement of Financial Accounting Standard ("FAS") No. 123, Accounting for Stock-Based Compensation, as amended by FAS 148, Accounting for Stock-Based Compensation-Transition and Disclosure, issued in December 2002.
Three Months Ended |
Nine Months Ended |
||||||
September 30, |
September 30, |
||||||
2004 |
2003 |
2004 |
2003 |
||||
Pro forma impact of fair value method (FAS 148) (in thousands) |
|||||||
Reported net income attributable to common shareholders |
$ 720 |
$ 629 |
$ 2,067 |
$ 1,497 |
|||
Less: fair value impact of employee stock compensation |
(81) |
(11) |
(93) |
(35) |
|||
Pro forma net income attributable to common shareholders |
$ 639 |
$ 618 |
$ 1,974 |
$ 1,462 |
|||
|
|
|
|||||
Earnings per common share |
|
|
|
||||
Basic - as reported |
$ 0.18 |
$ 0.15 |
$ 0.51 |
$ 0.37 |
|||
Diluted - as reported |
$ 0.13 |
$ 0.13 |
$ 0.39 |
$ 0.33 |
|||
Basic - pro forma |
$ 0.16 |
$ 0.15 |
$ 0.49 |
$ 0.36 |
|||
Diluted - pro forma |
$ 0.12 |
$ 0.13 |
$ 0.36 |
$ 0.32 |
|||
Weighted average Black-Scholes fair value assumptions |
|||||||
Risk free interest rate |
4.5% |
3.9% |
4.5% |
3.9% |
|||
Expected life |
5-10 yrs. |
5-10 yrs. |
5-10 yrs. |
5-10 yrs. |
|||
Expected volatility |
77.8% |
82% |
77.8% |
82% |
|||
Expected dividend yield |
0.0% |
0.0% |
0.0% |
0.0% |
NOTE 4: INVENTORY
The Company uses the last-in, first-out ("LIFO") method of inventory valuation for approximately 80 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, 2004 |
December 31, 2003 |
||
(in Thousands) |
|||
Finished goods |
$ 20,911 |
$ 22,324 |
|
Work in process |
377 |
256 |
|
Inventories at FIFO |
21,288 |
22,580 |
|
Less - LIFO allowance |
(3,485) |
(3,435) |
|
Inventories |
$ 17,803 |
$ 19,145 |
NOTE 5: LONG-TERM DEBT
On August 30, 2004 the Company borrowed $1.5 million from a financial institution. The loan matures in five years with a ten year amortization, bears interest at 2.25% over ninety day commercial paper and is secured by an airplane.
NOTE 6: EARNINGS PER SHARE DATA
The following table sets forth the computation of basic and diluted earnings per share for the periods indicated.
Three Months Ended September 30, |
Nine Months Ended September 30, |
||||||
2004 |
2003 |
2004 |
2003 |
||||
(in thousands, except per share amounts) |
|||||||
Basic: |
|||||||
Weighted average shares outstanding |
4,015 |
4,072 |
4,025 |
4,072 |
|||
Net income |
$ 743 |
$ 652 |
$ 2,135 |
$ 1,565 |
|||
Convertible preferred stock dividend |
(23) |
(23) |
(68) |
(68) |
|||
Net income attributable to common shareholders |
$ 720 |
$ 629 |
$ 2,067 |
$ 1,497 |
|||
Per share amount |
$ 0.18 |
$ 0.15 |
$ 0.51 |
$ 0.37 |
|||
Diluted: |
|||||||
Weighted average shares outstanding |
4,015 |
4,072 |
4,025 |
4,072 |
|||
Net effect of dilutive stock options - based on the treasury stock method |
1,096 |
689 |
1,043 |
229 |
|||
Assumed conversion of convertible preferred stock |
420 |
420 |
420 |
420 |
|||
Total |
5,531 |
5,181 |
5,488 |
4,721 |
|||
Net income attributable to common shareholders |
$ 720 |
$ 629 |
$ 2,067 |
$ 1,497 |
|||
Convertible preferred stock dividend |
23 |
23 |
68 |
68 |
|||
Net income for diluted earnings per share |
$ 743 |
$ 652 |
$ 2,135 |
$ 1,565 |
|||
Per share amount |
$ 0.13 |
$ 0.13 |
$ 0.39 |
$ 0.33 |
NOTE 7: 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 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 to the Company's segments is as follows (in thousands):
Three Months Ended September 30, |
Nine Months Ended September 30, |
||||||||||
MRO |
|
Electrical |
Total |
MRO |
Electrical |
Total |
|||||
2003 |
|||||||||||
Sales |
39,748 |
615 |
40,363 |
113,795 |
1,795 |
115,590 |
|||||
Operating income |
1,282 |
15 |
1,297 |
3,389 |
12 |
3,401 |
|||||
2004 |
|||||||||||
Sales |
42,332 |
539 |
42,871 |
120,989 |
1,847 |
122,836 |
|||||
Operating income |
1,300 |
80 |
1,380 |
3,778 |
189 |
3,967 |
NOTE 8: CERTAIN TRANSACTIONS
In January 2004, the Company paid a former officer of the Company $100,000 to terminate a stock option agreement between the Company and the former officer. The terminated stock option agreement provided for the former officer to purchase 359,000 shares of DXP's common stock at $1.64 per share.
On March 31, 2004, DXP exchanged two of the notes receivable from Mr. Little, Chief Executive Officer, with a face value of $338,591, including accrued interest, for 80,619 shares of DXP's common stock held by three trusts for the benefit of Mr. Little's children. The shares were valued at the $4.20 per share closing market price on March 31, 2004.
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
Three Months Ended September 30, |
Nine Months Ended September 30, |
||||||||||||||
2004 |
% |
2003 |
% |
2004 |
% |
2003 |
% |
||||||||
Sales |
42,871 |
100.0 |
$40,363 |
100.0 |
122,836 |
100.0 |
$115,590 |
100.0 |
|||||||
Cost of sales |
32,928 |
76.8 |
30,056 |
74.5 |
93,222 |
75.9 |
86,257 |
74.6 |
|||||||
Gross profit |
9,943 |
23.2 |
10,307 |
25.5 |
29,614 |
24.1 |
29,333 |
25.4 |
|||||||
Selling, general and administrative expense |
8,563 |
20.0 |
9,010 |
22.3 |
25,647 |
20.9 |
25,932 |
22.4 |
|||||||
Operating income |
1,380 |
3.2 |
1,297 |
3.2 |
3,967 |
3.2 |
3,401 |
3.0 |
|||||||
Interest expense |
(233) |
(0.5) |
(277) |
(0.7) |
(667) |
(0.5) |
(947) |
(0.8) |
|||||||
Other income |
11 |
-- |
13 |
-- |
40 |
-- |
50 |
-- |
|||||||
Income before income taxes |
1,158 |
2.7 |
1,033 |
2.5 |
3,340 |
2.7 |
2,504 |
2.2 |
|||||||
Provision for income taxes |
415 |
1.0 |
381 |
0.9 |
1,205 |
1.0 |
939 |
0.8 |
|||||||
Net income |
$ 743 |
1.7 |
$ 652 |
1.6 |
$2,135 |
1.7 |
$ 1,565 |
1.4 |
|||||||
Per share amounts |
|||||||||||||||
Basic earnings per share |
$ 0.18 |
$ 0.15 |
$ 0.51 |
$ 0.37 |
|||||||||||
Diluted earnings per share |
$ 0.13 |
$ 0.13 |
$ 0.39 |
$ 0.33 |
Three Months Ended September 30, 2004 compared to Three Months Ended September 30, 2003
SALES. Revenues for the quarter ended September 30, 2004, increased $2.5 million, or 6.2%, to approximately $42.9 million from $40.4 million in 2003. Sales for the MRO Segment increased $2.6 million, or 6.5%, primarily due to increased sales of products for offshore energy production. Sales for the Electrical Contractor segment for the third quarter of 2004 decreased 12.4% from the third quarter of 2003. This decline resulted from an effort to focus on sales of higher margin specialty electrical products and to be selective on sales of lower margin commodity type electrical products.
GROSS PROFIT. Gross profit as a percentage of sales decreased by approximately 2.3% for the third quarter of 2004, when compared to the same period in 2003. Gross profit as a percentage of sales for the MRO segment decreased to 22.9% for the three months ended September 30, 2004, from 25.3% in the comparable period of 2003. This decrease can be primarily attributed to lower than average margins on certain large sales of products for offshore energy production. The abnormal frequency and magnitude of recent vendor price increases has made it difficult to immediately pass through the increases to our customers. We are working to pass these increases to our customers, which will improve our gross profit margin. Gross profit was reduced by costs incurred due to leaks discovered during pressure testing of a recently introduced type of fiberglass reinforced pipe installed on an offshore energy production platform. Gross profit as a percentage of sales for the Electrical Contractor segment increased to 48.4% for the three months ended September 30, 2004, from 38.5% in the comparable period of 2003. This increase resulted from increased sales of higher margin specialty electrical products and reduced sales of lower margin commodity type electrical products.
SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative expense for the quarter ended September 30, 2004, decreased by approximately $0.4 million when compared to the same period in 2003. This decrease is primarily attributed to decreased payroll, payroll-related expenses, communication expense and marketing expense in 2004 compared to 2003. The payroll and payroll related expenses declined as a result of a reduced number of employees. Communication expense declined due to a lower cost contract for long distance voice communication. Marketing costs declined as a result of selective cost reduction. As a percentage of revenue, the 2004 expense decreased by approximately 2.3% to 20.0% from 22.3% for 2003. This decrease is attributable to a decreased level of expenses being spread over an increased revenue amount.
OPERATING INCOME. Operating income for the third quarter of 2004 increased 6.4% when compared to the same period in 2003. Operating income for the MRO segment increased 1.4% as a result of gross profit decreasing by less than selling, general and administrative expense decreased. Operating income for the Electrical Contractor segment improved to a profit in 2004 from slightly above break even in 2003. The improved operating income for the Electrical Contractor segment is the result of reduced selling, general and administrative expense combined with increased gross profit.
INTEREST EXPENSE. Interest expense for the quarter ended September 30, 2004 decreased 15.9%, to $0.2 million from $0.3 million during the same period in 2003. This decline results from a lower average debt balance for the third quarter of 2004 when compared to the third quarter of 2003, as well as lower interest rates.
Nine Months Ended September 30, 2004 compared to Nine Months Ended September 30, 2003
SALES. Revenues for the nine months ended September 30, 2004, increased $7.2 million, or 6.3%, to approximately $122.8 million from $115.6 million in 2003. Sales for the MRO Segment increased $7.2 million, or 6.3%, primarily due to increased sales of products for offshore energy production. Sales for the Electrical Contractor segment increased 2.9%, for the current nine months when compared to same period in 2003. This increase is the result of selling more specialty type electrical products.
GROSS PROFIT. Gross profit as a percentage of sales decreased by approximately 1.3% for the first nine months of 2004, when compared to the same period in 2003. Gross profit as a percentage of sales for the MRO segment decreased to 23.9% for the nine months ended September 30, 2004, from 25.2% in the comparable period of 2003. This decrease can be primarily attributed to lower than average margins on certain large sales of products for offshore energy production. The abnormal frequency and magnitude of recent vendor price increases has made it difficult to immediately pass through the increases to our customers. We are working to pass these increases to our customers, which will improve our gross profit margin. Gross profit was reduced by costs incurred due to leaks discovered during pressure testing of a recently introduced type of fiberglass reinforced pipe installed on several offshore energy production platforms. Gross profit as a percentage of sales for the Electrical Contractor s egment increased to 39.7% for the nine months ended September 30, 2004, from 36.4% in the comparable period of 2003. This increase resulted from increased sales of higher margin specialty type electrical products.
SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative expense for the nine months ended September 30, 2004, decreased by approximately $0.3 million when compared to the same period in 2003. This decrease is primarily attributed to decreased payroll and payroll related expenses in 2004 compared to 2003. These expenses decreased as a result of a reduced number of employees. As a percentage of revenue, the 2004 expense decreased by approximately 1.5% to 20.9% from 22.4% for 2003. This decrease is attributable to a decreased level of expenses being spread over an increased revenue amount.
OPERATING INCOME. Operating income for the first nine months of 2004 increased 16.6% when compared to the same period in 2003. Operating income for the MRO segment increased 11.5% as a result of gross profit increasing and selling, general and administrative expense decreasing. Operating income for the Electrical Contractor segment improved to a profit in 2004 from slightly above break even in 2003. The improved operating income for the Electrical Contractor segment is the result of reduced selling, general and administrative expense combined with increased gross profit.
INTEREST EXPENSE. Interest expense for the nine months ended September 30, 2004 decreased by 29.6%, to $0.7 million from $0.9 million during the same period in 2003. This decline results from a lower average debt balance for the first nine months of 2004 when compared to the first nine months of 2003, as well as lower interest rates.
LIQUIDITY AND CAPITAL RESOURCES
General Overview
As a distributor of MRO products and Electrical Contractor 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, transportation equipment and warehouse equipment. We also require cash to pay our lease obligations and to service our debt.
We generated $0.4 million of cash in operating activities during the first nine months of 2004 as compared to generating $2.7 million in cash in operating activities during the first nine months of 2003. This change between the two periods is primarily attributable to a larger increase in accounts receivable in the 2004 period compared to the 2003 period and a $1.5 million increase in accounts payable and accrued expenses in 2003 compared to a small decline in 2004.
We purchased approximately $1.8 million of fixed assets during the first nine months of 2004 compared to purchasing $0.2 million of fixed assets in the same period in 2003. The 2004 capital expenditures related primarily to an airplane and computer equipment. We purchased the airplane to increase our efficiency in marketing to a nationwide customer base and managing our numerous remote branch locations. Capital expenditures in 2003 were primarily related to computer equipment, software and pump testing equipment.
The amount available to be borrowed under our loan agreement with our bank lender (the "Credit Facility") was approximately $9.6 million at December 31, 2003 and September 30, 2004. The similar availability level resulted from the increase in accounts receivable collateral value, partially offset by the $1.0 million increase in amounts borrowed under the Credit Facility at September 30, 2004 compared to December 31, 2003. The funds obtained from the increase in long-term debt were used to purchase products which were sold for use in offshore energy production. During the nine months ended September 30, 2004, the balance of customer advances for orders for products, which were primarily for use in offshore energy production, decreased from $2.9 million, to $0.1 million. The balance of customer advances declined because we completed the projects associated with the advances. We purchased products and incurred other costs to complete these projects during 2004. Management belie ves that the liquidity of our balance sheet at September 30, 2004, will provide us with the ability to meet our working capital needs during 2004 and 2005.
Credit Facility
Under the Credit Facility, all available cash is generally applied to reduce outstanding borrowings, with operations funded through borrowings under the Credit Facility. The Credit Facility consists of a secured line of credit and a secured term loan.
The Credit Facility allows us to elect a rate of interest at LIBOR plus a margin ranging from 2.25% to 3.25% or prime plus a margin ranging from 0.0% to 0.75%. At September 30, 2004 the prime based interest rate option was prime on the revolving portion of the Credit Facility and prime plus 0.25% on the term portion of the Credit Facility. At September 30, 2004 the LIBOR based interest rate option was LIBOR plus 2.25% on the revolving portion of the Credit Facility and LIBOR plus 2.50% on the term portion of the Credit Facility. The LIBOR interest option resulted in interest rates which were lower than the prime interest option. At September 30, 2004, $14.0 million was borrowed at a weighted average rate of 4.11% under the LIBOR option. The prime rate at September 30, 2004 was 4.75%.
The Credit Facility 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) $30.0 million, and matures April 1, 2006. 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 a certain cash flow and other financial ratios. At September 30, 2004, we were in compliance with these covenants. Although we expect to be able to comply with the 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 amend such covenants. In addition to the $1.4 million of cash at September 30, 2004, we had $9.6 million available for borrowings under the Credit Facility at September 30, 2004.
Borrowings
September 30, |
December 31, |
Increase |
|||
2004 |
2003 |
(Decrease) |
|||
(in Thousands) |
|||||
Current portion of long-term debt |
$ 1,422 |
$ 1,474 |
$ (52) |
||
Long-term debt, less current portion |
18,972 |
16,675 |
2,297 |
||
Total long-term debt |
$ 20,394 |
$ 18,149 |
$ 2,245(2) |
||
Amount available (1) |
$ 9,625 |
$ 9,562 |
$ 63 (3) |
||
(1) Represents amount available to be borrowed at the indicated date under the Credit Facility. |
|||||
(2) The $2.2 million increase in long-term debt is attributable to the increase in accounts receivable, which resulted from increased sales, combined with increased debt associated with $1.8 million of fixed asset additions. |
|||||
(3) The $0.1 million increase in the amount available is primarily a result of the increase in accounts receivable collateral value partially offset by the $1.0 million increase in amounts borrowed under the Credit Facility. |
Performance Metrics
Nine Months Ended |
|||||
September 30 |
|||||
2004 |
2003 |
Increase |
|||
Days of sales outstanding (in Days) |
54.7 |
50.8 |
3.9 |
||
Annualized inventory turns |
7.0 |
6.1 |
0.9 |
Accounts receivable days of sales outstanding were 54.7 at September 30, 2004 compared to 50.8 at September 30, 2003. The increase in days of sales outstanding results from certain energy related customers with large receivables resulting from sales of products for offshore energy production, paying us more slowly than our average collection period. Annualized inventory turns were 7.0 at September 30, 2004 compared to 6.1 at September 30, 2003. The improvement resulted from the completion of several large customer orders for products for use in offshore energy production.
Funding Commitments
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 2004 and 2005. However, we may require additional debt or equity financing to meet our future debt service obligations, which may include additional bank debt or the public or private sale of equity or debt securities. In connection with any 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, 2006. We will need to extend the maturity of, or replace our Credit Facility on or before April 1, 2006. 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 de pend, in part, upon the level of our asset base for collateral purposes, our future financial performance and our ability to obtain additional equity.
DISCUSSION OF CRITICAL ACCOUNTING POLICIES
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America 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 collectibility 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.
Income Taxes
In accordance with SFAS 109, Accounting for Income Taxes, we have recorded a net deferred tax asset of $1.3 million as of September 30, 2004. We believe it is more likely than not that this net deferred tax asset will be realized based primarily on the assumption of future taxable income.
Management periodically re-evaluates these estimates as events and circumstances change. Together with the effects of the matters discussed above, these factors may significantly impact the Company's results of operations from period-to-period.
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 September 30, 2004, a 100 basis point change in interest rates would result in an estimated $0.2 million change in annual interest expense.
ITEM 4: CONTROLS AND PROCEDURES
As of the end of the period covered by this Quarterly Report on Form 10-Q, the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) promulgated under the Securities Exchange Act of 1934) was evaluated by our management with the participation of our President and Chief Executive Officer, David R. Little (principal executive officer), and our Senior Vice President and Chief Financial Officer, Mac McConnell (principal financial officer). Messrs. Little and McConnell have concluded that our disclosure controls and procedures are effective, as of the end of the period covered by this Quarterly Report on Form 10-Q, to help ensure that information we are required to disclose in reports that we file with the SEC is accumulated and communicated to management and recorded, processed, summarized and reported within the time periods prescribed by the SEC.
There were no changes in our internal control over financial reporting that occurred during our last fiscal quarter (the quarter ended September 30, 2004) that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II: OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
DXP and DXP's vendor of fiberglass reinforced pipe have been sued in Louisiana by a major energy company regarding the failure of Bondstrand PSX JFC pipe, a recently introduced type of fiberglass reinforced pipe which had been installed on four energy production platforms. Plaintiff alleges negligence and breach of contract and warranty and that damages exceed $20 million. DXP management believes the failures were caused by the failure of the pipe and not by work performed by DXP. We intend to vigorously defend these claims. Our insurance carrier has agreed, under a reservation of rights to deny coverage, to provide a defense against these claims.
No material developments have occurred in the asbestos related litigation disclosed in the Company's Annual Report on Form 10-K for the year ended December 31, 2003. One insurance carrier has agreed, under a reservation of rights to deny coverage, to provide a defense against these asbestos claims.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
The following table summarizes all repurchases of DXP equity securities by DXP during the three months ended September 30, 2004.
ISSUER PURCHASES OF EQUITY SECURITIES |
||||||||
Period |
(a) Total Number of Shares (or Units) Purchased |
(b) Average Price Paid per Share (or Unit) |
(c) Total Number of Shares (or Units) Purchased as Part of Publicly Announced Plans or Programs |
(d) Maximum Number (or Approximate Dollar Value) of Shares (or Units) that May Yet Be Purchased Under the Plans or Programs |
||||
Month #1 (July 1, 2004 - July 30, 2004) |
N/A |
N/A |
N/A |
N/A |
||||
Month #2 (August 1, 2004 - August 31, 2004) |
N/A |
N/A |
N/A |
N/A |
||||
Month #3 (September 1, 2004 - September 30, 2004 |
N/A |
N/A |
N/A |
N/A |
||||
Total |
N/A |
N/A |
N/A |
N/A |
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.
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. 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 authorizations for certain product lines and depend on these distribution authorizations for a substantial portion of our business. Many of these distribution authorizations are pursuant to contracts that are subject to cancellation upon little or no prior notice. Although we believe that we could obtain alternate distribution authorizations in the event of such a cancellation, the termination or limitation by any key supplier of its relationship with our company could 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.
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). |
|
|
||
31.1 |
Certification of Chief Executive Officer pursuant to Rule 13a-14(a) and rule 15d-14(a) of the Securities Exchange Act, as amended. (Filed herewith). |
|
31.2 |
Certification of Chief Financial Officer pursuant to Rule 13a-14(a) and rule 15d-14(a) of the Securities Exchange Act, as amended. (Filed herewith). |
|
32.1 |
Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (Filed herewith). |
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: October 28, 2004
Exhibit 31.1
CERTIFICATION
I, David R. Little, the Chief Executive Officer of DXP Enterprises, Inc., certify that:
October 28, 2004
/s/ David R. Little
David R. Little
President and Chief Executive Officer
(Principal Executive Officer)
Exhibit 31.2
CERTIFICATION
I, Mac McConnell, the Chief Financial Officer of DXP Enterprises, Inc., certify that:
October 28, 2004
/s/ Mac McConnell
Mac McConnell
Senior Vice President and Chief Financial Officer
(Principal Financial Officer)
Exhibit 32.1
CERTIFICATION
Pursuant to 18 U.S.C. Section 1350, the undersigned officer of DXP Enterprises, Inc. (the "Company"), hereby certifies that the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 2004 (the "Report") fully complies with the requirements of Section 13(a) or 15(d), as applicable, of the Securities Exchange Act of 1934 and that the information contained in the Report fairly represents, in all material respects, the financial condition and results of operations of the Company.
/s/David R. Little
David R. Little
President and Chief Executive Officer
October 28, 2004
The foregoing certification is being furnished solely pursuant to 18 U.S.C. Section 1350 and is not being filed as part of the Report or as a separate disclosure document.
CERTIFICATION
Pursuant to 18 U.S.C. Section 1350, the undersigned officer of DXP Enterprises, Inc. (the "Company"), hereby certifies that the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 2004 (the "Report") fully complies with the requirements of Section 13(a) or 15(d), as applicable, of the Securities Exchange Act of 1934 and that the information contained in the Report fairly represents, in all material respects, the financial condition and results of operations of the Company.
/s/Mac McConnell
Mac McConnell
Chief Financial Officer
October 28, 2004
The foregoing certification is being furnished solely pursuant to 18 U.S.C. Section 1350 and is not being filed as part of the Report or as a separate disclosure document.
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