1 FORM 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 (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, 1997 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 (I.R.S. Employer or organization) Identification No.) 580 Westlake Park Boulevard, Suite 1100 77079 Houston, Texas (Zip Code) (Address of principal executive offices) 281/531-4214 (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 7, 1997: Common Stock: 8,168,551
2 ITEM 1. FINANCIAL STATEMENTS DXP ENTERPRISES, INC. AND SUBSIDIARIES (CONDENSED CONSOLIDATED BALANCE SHEETS) (IN THOUSANDS) <TABLE> <CAPTION> September 30, December 31, 1997 1996 -------------------------------- (Unaudited) <S> <C> <C> Assets Current assets: Cash $ 556 $ 876 Trade accounts receivable, net of allowance for doubtful accounts of $310,000 and $210,000, respectively 26,891 17,125 Inventory 28,027 17,175 Prepaid expenses and other current assets 151 539 Deferred income taxes 638 511 ----------------------------------- Total current assets 56,263 36,226 Property and equipment, net 10,552 7,818 Other assets 3,170 998 ----------------------------------- Total assets $ 69,985 $ 45,042 =================================== Liabilities and Shareholders' Equity Current liabilities: Trade accounts payable $ 15,782 $ 6,963 Employee compensation 1,427 1,296 Other accrued liabilities 682 601 Current portion of long-term debt 917 609 Current portion of subordinated debt -- 1,145 ----------------------------------- Total current liabilities 18,808 10,614 Long-term debt, less current portion 35,793 22,300 Deferred compensation 739 739 Deferred income taxes 433 330 Equity subject to redemption: Note 9 Series A Preferred stock--1,122 and 1,496 shares 112 150 Series B convertible preferred stock -- 1,800 and 4,500 shares 180 450 Common Stock -- 280,428 shares 1,963 -- Shareholders' Equity: Series A preferred stock, 1/10th vote per share; $1.00 par value; liquidation preference of $100 per share; 1,000,000 shares authorized; 3,366 shares issued and outstanding: 2 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; 19,500 shares issued and outstanding 18 15 Common stock, $.01 par value, 100,000,000 shares authorized; 7,993,997 shares issued and outstanding (7,993,997 outstanding at December 31, 1996) 80 80 Paid-in capital 673 368 Retained earnings 11,765 9,994 ----------------------------------- 12,538 10,459 Less: treasury stock, 374 shares series A preferred, 2,700 shares series B preferred, and 60,872 shares common stock (581) -- ----------------------------------- Total shareholders' equity 11,957 10,459 Total liabilities and shareholders' equity $ 69,985 $ 45,042 =================================== </TABLE> See notes to condensed consolidated financial statements. 2
3 DXP ENTERPRISES, INC. AND SUBSIDIARIES (CONDENSED CONSOLIDATED STATEMENTS OF INCOME) (Unaudited) (In Thousands, except Per Share Amounts) <TABLE> <CAPTION> Three Months Ended Nine Months Ended September 30, September 30, 1997 1996 1997 1996 ----------- ----------- ----------- ----------- <S> <C> <C> <C> <C> Sales $ 48,806 $ 32,193 $ 118,277 $ 95,214 Cost of sales 36,334 23,784 86,706 70,574 --------------------------------------------------- Gross Profit 12,472 8,409 31,571 24,640 Selling, general and administrative expenses 11,295 7,424 27,642 22,230 --------------------------------------------------- Operating income 1,177 985 3,929 2,410 Other income 86 129 981 643 Interest expense (793) (548) (1,960) (1,556) --------------------------------------------------- (707) (419) (979) (913) --------------------------------------------------- Income before income taxes 470 566 2,950 1,497 Provision for income taxes 182 230 1,070 607 --------------------------------------------------- $ 288 $ 336 $ 1,880 $ 890 Net income 38 23 109 68 Preferred Stock Dividend --------------------------------------------------- Net Income Attributable to Common Shareholders $250 $313 $ 1,771 $ 822 ==================================================== Primary net income per common and common equivalent shares $0.02 $0.04 $0.17 $0.10 ==================================================== Number of shares used to compute primary net income per common and common equivalent shares 10,251 8,580 10,251 8,580 ==================================================== Fully diluted net income per common and common equivalent share $0.02 $0.04 $0.17 $0.09 ==================================================== Number of shares used to compute fully diluted net income per common and common equivalent shares 10,251 9,724 11,192 9,724 ==================================================== </TABLE> See notes to condensed consolidated financial statements. 3
4 DXP ENTERPRISES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (In Thousands) <TABLE> <CAPTION> Nine Months Ended September 30, 1997 1996 --------------- ------------------ <S> <C> <C> OPERATING ACTIVITIES Net cash provided by operating activities ($2,081) $ 2,118 INVESTING ACTIVITIES Proceeds from sale of property and equipment -- 7 Purchase of Austin Bearing net assets -- (550) Purchase of Strategic Supply net assets (4,118) -- Purchase of Pelican State Supply common stock (1,070) -- Purchase of property and equipment (648) (971) ------------------------------- Net cash used in investing activities (5,836) (1,514) FINANCING ACTIVITIES Proceeds from debt 133,488 93,856 Principal payments on revolving line of credit, long-term and subordinated debt, and notes payable to bank (125,314) (95,884) Acquisition of common stock (581) -- Dividends paid (109) (68) ------------------------------- Net cash used in financing activities 7,597 (2,095) ------------------------------- INCREASE(DECREASE) IN CASH (320) (1,491) CASH AT BEGINNING OF PERIOD 876 1,492 ------------------------------- CASH AT END OF PERIOD $ 556 $ 1 =============================== </TABLE> See notes to condensed consolidated financial statements 4
5 DXP ENTERPRISES, INC. AND SUBSIDIARIES As used herein, references to the "Company" are to DXP Enterprises, Inc. and its subsidiaries, unless the context otherwise indicates. 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 for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been omitted. 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 Annual Report on Form 10-K for the year ended December 31, 1996, as amended by Amendment No. 1 to Form 10-K on Form 10-K/A. Note 2: The Company The Company was incorporated on July 26, 1996 in the State of Texas. The Company was formed to facilitate a proposed reorganization transaction whereby subsequent to July 31, 1996 the Company became a public holding company and acquired 100% of the outstanding capital stock of SEPCO Industries, Inc. ("SEPCO"), a private distribution company with revenues of approximately $125 million, and Newman Communications Corporation ("Newman"), an inactive public entity with nominal net tangible assets. The Company filed a registration statement on Form S-4 with the Securities and Exchange Commission to register 9,292,200 shares of its Common Stock (on a post-reverse stock split basis), 19,500 shares of its Series B Convertible Preferred Stock and 3,366 shares of its Series A Preferred Stock. This registration statement became effective on November 12, 1996. Because the Company (prior to the reorganization) and Newman were non-operating entities with nominal tangible net assets, the transaction was accounted for as a recapitalization of SEPCO into the Company and an issuance of shares for the net tangible assets of Newman. Accordingly, the historical financial statements for the Company prior to December 4, 1996 are those of SEPCO. Note 3. Per Share Amounts Net income per common and common equivalent share has been computed for the three- and nine-month periods ended September 30, 1996, as if the reorganization had occurred between the Company and SEPCO on January 1, 1996. These amounts were determined by dividing net income applicable to common stock by the weighted average number of shares of common stock and common stock equivalents outstanding during the period. To the extent they are dilutive, options to purchase common stock issued by the Company within the twelve months preceding the filing of the registration statement referenced above have been included in the calculation of common equivalent shares outstanding (using the treasury stock method) as if they were outstanding for all periods presented. The computation of fully diluted net income per common and common equivalent share assumes the Class A convertible preferred stock was converted as of the beginning of the period, unless the results are anti-dilutive. 5
6 In February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 128, "Earnings Per Share" ("SFAS No. 128"). Under SFAS No. 128, primary earnings per share ("Primary EPS") will be replaced by basic earnings per share ("Basic EPS"), and fully diluted earnings per share ("Fully Diluted EPS") will be replaced with diluted earnings per share ("Diluted EPS"). Basic EPS differs from Primary EPS in that it only includes the weighted average impact of outstanding shares of the Company's Common Stock (i.e., it excludes common stock equivalents and the dilutive effect of options, etc.). Diluted EPS is substantially similar to Fully Diluted EPS as previously reported. The provisions of SFAS No. 128 will result in the retroactive restatement of previously reported Primary EPS and Fully Diluted EPS figures, but SFAS No. 128 prohibits such restatement prior to December 31, 1997. Based on the Company's computations, the adoption of SFAS 128 is not expected to materially impact earnings per share amounts reported during the current quarter or any recent prior period. On or about April 30, 1997, a proxy statement was furnished to the holders of the Company's Common Stock, Series A Preferred Stock and Series B Preferred Stock, in connection with a solicitation of consents by the Board of Directors of the Company for the adoption of an amendment to the Restated Articles of Incorporation of the Company to effect a two-to-one reverse split of the issued and outstanding shares of Common Stock and change the name of the Company from Index, Inc. to DXP Enterprises, Inc. The shareholders approved the two-to-one reverse stock split and name change, which became effective after the close of market on May 12, 1997. Common stock and earnings per share have been restated to give effect to the two-to-one reverse stock split. Note 4: Inventory The Company uses the last-in, first-out ("LIFO") method of inventory valuation for approximately 59% 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: <TABLE> <CAPTION> September 30, 1997 December 31, 1996 --------------------------------------- (in thousands) <S> <C> <C> Finished Goods $ 28,188 $ 18,215 Work in process 3,284 2,405 ------------------ ------------------- Inventories at FIFO 31,472 20,620 Less - LIFO allowance (3,445) (3,445) ------------------- ------------------- Inventories $ 28,027 $ 17,175 ------------------- ------------------- </TABLE> Note 5: Acquisition Effective February 2, 1996, the Company acquired the net assets of Austin Bearing Corporation. The purchase price totaled approximately $578,000 and consisted of (i) issuance of a $249,000 note, bearing interest at 9%, payable monthly over five years and (ii) cash of $329,000. The acquisition has been accounted for using the purchase method of accounting. Goodwill of $84,000 was recorded in connection 6
7 with the acquisition. Effective May 30, 1997, the Company acquired 100% of the outstanding stock of Pelican State Supply Company ("Pelican"). The purchase price totaled approximately $3.0 million and consisted of 280,428 shares of the Company's Common Stock and cash of approximately $1.0 million. The acquisition has been accounted for using the purchase method of accounting. Goodwill of approximately $2.0 million was recorded in connection with the acquisition. On June 2, 1997, a wholly owned subsidiary of the Company acquired substantially all the assets of Strategic Supply, Inc. ("Strategic"). The purchase price, which is subject to adjustments, consisted of approximately $4.1 million in cash, assumption of $4.7 million of trade payables and other accrued expenses, $2.8 million in promissory notes payable to the seller and earn-out payments (based on the earnings before interest and taxes of Strategic) to be paid over a period of approximately six years, up to a maximum of $3.5 million. The acquisition has been accounted for using the purchase method of accounting. Goodwill of $50,000 was recorded in connection with the acquisition. Goodwill may be adjusted based upon the final purchase price. The acquisitions discussed above were accounted for using the purchase method of accounting. The results of operations of the companies acquired are included in the consolidated statements of income from the date of acquisition of such companies. The Company is continuing its evaluation of the acquisitions of Pelican and Strategic as it relates to the purchase price allocations. The allocation of the respective purchase prices are based on the estimates of the Company using information currently available. Certain adjustments relating to these acquisitions are subject to change based upon the final determination of the fair values of the net assets acquired. Note 6: Commitments and Contingencies In September 1997 the Company reached a settlement with the Internal Revenue Service ("IRS") which had asserted claims against one of the Company's subsidiaries for additional taxes and penalties of approximately $1 million plus interest of approximately $328,000. The claims related primarily to a challenge by the IRS of the Company's use of the LIFO method of accounting for inventory. The September 1997 settlement with the IRS resulted in a payment by the Company of approximately $52,000 in additional tax plus interest of approximately $18,000. The Company had accrued sufficiently for this expense at December 31, 1996 and, therefore, the payment will have no impact on current period earnings. Note 7: Stock Options Prior to and during 1995, the Company issued non-qualified, book value plan stock options to certain officers of the Company to purchase shares of its Class A common stock, which had exercise prices equal to the book value of the common stock on the date of the grant. The option agreement allowed the employee to put the stock acquired back to the Company at the book value at that time. The Company recognized compensation expense for increases in the book value of the stock while the options were outstanding. Effective March 31, 1996, the stock option agreements were amended to become non-qualified, market value plan stock options. Under the amended agreement, the employees can no longer put the acquired stock back to the Company. In connection with these changes, the Company recognized approximately $618,000 of compensation expense in the three months ended March 31, 1996. Note 8: Long-Term Debt In September 1996, the Company amended its credit facility which increased the existing balance of the term loan from $123,898 to $5.0 million upon conversion of approximately $4.9 million of the amounts outstanding under the revolving loan to the term loan. In May 1997, the Company further amended its credit facility to increase the borrowing base from $20 million to $25 million. 7
8 Also in May 1997, the Company secured two additional lines of credit from its existing lender in amounts of $3.0 million and $12.0 million for the purpose of financing two acquisitions and providing for working capital needs of the newly acquired companies. The two new subsidiaries are the borrowers under these lines of credit and the Company has guaranteed the indebtedness thereunder. The interest rate on the new lines of credit range from LIBOR plus 2.25% to prime plus .50%. Each line of credit is secured by accounts receivable, inventory, machinery and equipment and real estate of the respective subsidiary and matures January 1999. The borrowings available under the Company's credit facilities at September 30, 1997 approximated $3.5 million. Note 9: Equity Subject to Redemption The Company is obligated to repurchase certain of its Series A and Series B preferred stock owned by certain employees upon the occurrence of certain events which would result in the employee no longer being employed by the Company. Additionally, the shares of Common Stock issued pursuant to the purchase of Pelican are subject to a put option whereby any time between November 30, 1998 and November 30, 2000 the Company may be required to purchase all or part of such shares at a price of $7.00 per share. The shares issued for the purchase of Pelican are subject to certain rights of offset pursuant to terms of the purchase agreement. 8
9 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. The following discussion of operations and financial condition of the Company should be read in conjunction with the Financial Statements and Notes thereto included elsewhere in this Quarterly Report on Form 10-Q. Special Note: Certain statements set forth below constitute "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended. See "Special Note Regarding Forward- Looking Statements" and "Cautionary Statements". RESULTS OF OPERATIONS Three Months Ended September 30, 1997 Compared to Three Months Ended September 30, 1996 Revenues for the three months ended September 30, 1997 increased 51.6% to $48.8 million from the three months ended September 30, 1996. The Company's acquisitions during the period accounted for $13.8 million of the increase in revenues. Sales of bearings and power transmission equipment for the quarter ended September 30, 1997 increased 3.3%, or $430,000 over the comparable period in 1996, accounting for $1.3% of the revenue increase. Sales of valve and valve automation equipment declined by $128,000 over the comparable period in 1996 due primarily to increased competition. During the three months ended September 30, 1997, sales of pumps and pump products increased 15.0%, or $2.5 million, over the comparable period in 1996, accounting for 7.8% of the revenue increase. Gross margins decreased .5% for the third quarter of 1997 as compared to the third quarter of 1996, from 26.1% of sales to 25.6%. The decrease in gross margin is attributable to lower margins associated with the two acquisitions in May 1997. The Company currently expects some increase in manufacturers' prices to continue due to increased raw material costs and strong market conditions. Although the Company intends to attempt to pass on these price increases to its customers to maintain current gross margins, there can be no assurance that the Company will be successful in this regard. Selling, general and administrative expense were consistent as a percentage of revenues for the third quarter of 1997 as compared to the third quarter of 1996. Operating income for the three month period ended September 30, 1997 decreased as a percentage of revenues from 3.0% to 2.4%, due to the various factors discussed above and absorption of the acquisition of Pelican and Strategic. Interest expense during the third quarter of 1997 increased by $245,000 to $793,000 compared to the third quarter of 1996. Long-term debt at September 30, 1997 increased by $14.0 million as a result of the financing of two acquisitions during the second quarter of 1997, resulting in greater interest costs. Excluding the increased debt incurred in connection with these acquisitions, long-term debt levels were substantially unchanged. Average interest rates were slightly lower during the three months ended September 30, 1997 as compared to 1996. The Company's provision for income taxes for the three months ended September 30, 1997 decreased by $48,000 compared to the same period of 1996, as a result of a decrease in pre-tax income. Net income for the three month period ended September 30, 1997 decreased $48,000, or 14.3%, from the three month period ended September 30, 1996, due primarily to the factors discussed above. Nine Months Ended September 30, 1997 Compared to Nine Months Ended September 30, 1996 Revenues for the nine months ended September 30, 1997 increased 24.2% to $118.3 million from the nine 9
10 months ended September 30, 1996. The Company's acquisitions during the period accounted for $18.5 million or 19.4% of this increase in revenues. Sales of bearings and power transmission equipment for the nine months ended September 30, 1997 increased 5.0%, or $1.9 million over the comparable period in 1996 accounting for 2.0% of the overall revenue increase. Sales of valve and valve automation equipment declined by $1.6 million over the comparable period in 1996 due primarily to increased competition. During the nine months ended September 30, 1997, sales of pumps and pump products increased 8.6%, or $4.3 million over the comparable period in 1996, accounting for 4.5% of the overall revenue increase. Gross margin increased $6.9 million, or 28.1% in the first nine months of 1997 as compared to the same period in 1996, from 25.9% of sales to 26.7%. The increase in gross margin is attributable to the Company's avoidance of low-margin sales, the ability to pass on manufacturer price increases and reductions in cost-of-sales overhead expenses. Gross margins for the first nine months of 1997 as compared to the same period in 1996 were affected by lower average margins associated with the acquisition of Pelican and Strategic. Selling, general and administrative expenses as a percentage of revenues remained consistent at 23.3% in the first nine months of 1997 compared to the same period in 1996. However, both nine month periods experienced substantial expenditures unique to each period. For the nine month period ended September 30, 1996, the Company recognized $618,000 in compensation expense as a result of amending its stock option agreements from being book value to market value options. For the nine month period ended September 30, 1997, selling, general, and administrative costs were increased by administrative costs related to the Company's expansion of its administrative personnel in an effort to provide expanded services to its customers. Operating income for the nine month period ended September 30, 1997 increased 63.0% from the corresponding period in 1996, from $2.4 million to $3.9 million. As a percentage of revenues, operating income increased from 2.5% of sales to 3.3%, due to the various factors discussed above. Interest expense for the first nine months of 1997 increased by $404,000, or 26.0%, from the first nine months of 1996 as a result of increased debt levels associated with the Company's acquisitions during 1997, and due to greater investments in working capital components during the period. Average interest rates were slightly lower during the nine months ended September 30, 1997 as compared to 1996. The Company's provision for income taxes for the nine months ended September 30, 1997 increased by $463,000 compared to the same period of 1996 as a result of an increase of approximately $1.5 million in pre-tax income. Results attributable to the Company's acquisitions during the first nine months of 1997 reduced pre-tax income by approximately $796,000, resulting in a decrease in taxes of approximately $271,000. Net income for the nine month period ended September 30, 1997 increased $990,000, or 111%, from the nine month period ended September 30, 1996. Increased net income for the first nine months of 1997 as compared to the same period in 1996 can be primarily attributed to an increase in gross margins. These increases in gross profits were slightly offset by increased administrative costs associated with the Company's expansion of its corporate administrative expenses, expenses associated with its expansion program, and higher interest costs and losses associated with the absorption of two acquisitions made in June 1997. LIQUIDITY AND CAPITAL RESOURCES Under the Company's credit facilities, all available cash generally is applied to reduce outstanding borrowings, with operations funded through borrowings under the credit facilities. The Company's policy is to maintain low levels of cash and cash equivalents and to use borrowings under its lines of credit for working capital. The Company had $3.5 million available for borrowings under its working capital line of credit at September 30, 1997. Working capital at September 30, 1997 and December 31, 1996 was $37 million and $26 million, respectively. During the first nine months of 1997 and the year ended December 10
11 31, 1996, the Company collected its trade receivables in approximately 55 and 48 days, respectively, and turned its inventory approximately five times on an annualized basis. The Company currently has $40.0 million in secured lines of credit with an institutional lender. The lines of credit provided for interest rates ranging from LIBOR plus 2.25% to prime plus .5% (9.0% at September 30, 1997). The lines of credit are secured by receivables, inventory and machinery and equipment and mature in January 1999. The facilities contain customary affirmative and negative covenants as well as financial covenants that require the Company to maintain a positive cash flow and other financial ratios, such as aggregate indebtedness to tangible net worth less than five to one and current assets to current liabilities greater than two to one. The Company currently expects to renew the lines of credit at their maturity. The Company utilized cash from operating activities of $2.1 million in the first nine months of 1997 as compared to generating cash from operating activities of $2.1 million during the first nine months of 1996, due primarily to a greater investment in the net working capital components for the first nine months of 1997 as compared to the first nine months of 1996. Investment in working capital components such as inventory and receivables resulting in a use of cash from operating activities does not result in a violation of any of the loan covenants. The cash flow covenant is computed by increasing earnings for depreciation and amortization and subtracting acquisition of fixed assets, principal payments and dividends. The Company had capital expenditures of approximately $648,000 for the first nine months of 1997 as compared to $971,000 during the same period of 1996. Capital expenditures in the first nine months of 1997 were predominantly for the expansion of a facility in Laporte, Texas ($144,000), and for computers and related equipment($131,000). Capital expenditures for 1996 were primarily for office and shop equipment and computer automation. In the second quarter of 1997, the Company acquired the common stock of Pelican, with the cash portion of the purchase price totaling approximately $1.1 million. Also in the second quarter of 1997, the Company acquired certain assets of Strategic for cash of approximately $4.1 million. In September 1997 the Company reached a settlement with the Internal Revenue Service ("IRS") which had asserted claims against one of the Company's subsidiaries for additional taxes and penalties of approximately $1 million plus interest of approximately $328,000. The claims related primarily to a challenge by the IRS of the Company's use of the LIFO method of accounting for inventory. The September 1997 settlement with the IRS resulted in a payment by the Company of approximately $52,000 in additional tax plus interest of approximately $18,000. The Company had accrued sufficiently for this expense at December 31, 1996 and, therefore, the payment will have no impact on current period earnings. The Company's software will be Year 2000 compliant by the end of the first quarter of 1998. These compliance issues and associated costs are being handled through new releases of current software. Such costs are part of normal software upgrades and normal operating costs. The Company expects that any costs related to ensuring Year 2000 compliance will not be material to the financial condition or results of operations of the Company. The Company believes that cash generated from operations and available under its credit facility will meet its future ongoing operational and liquidity needs and capital requirements. Funding of the Company's acquisition program and integrated supply strategy will require capital in the form of the issuance of additional equity or debt financing. There can be no assurance that such financing will be available to the Company or as to the terms thereof. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET PRICE Not Applicable 11
12 PART II: OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS In September 1997 the Company reached a settlement with the Internal Revenue Service ("IRS") which had asserted claims against one of the Company's subsidiaries for additional taxes and penalties of approximately $1 million plus interest of approximately $328,000. The claims related primarily to a challenge by the IRS of the Company's use of the LIFO method of accounting for inventory. The September 1997 settlement with the IRS resulted in a payment by the Company of approximately $52,000 in additional tax plus interest of approximately $18,000. The Company had accrued sufficiently for this expense at December 31, 1996 and, therefore, the payment will have no impact on current period earnings. 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 Special Note Regarding Forward-Looking Statements This Quarterly Report on Form 10-Q includes "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. All statements other than statements of historical facts included in this Report, including without limitation, statements regarding the Company's financial position, business strategy, products, products under development, markets, budgets and plans and objectives of management for future operations, are forward-looking statements. Although the Company believes that the expectations reflected in such forward-looking statements are reasonable, it can give no assurance that such expectations will prove to have been correct. Important factors that could cause actual results to differ materially from the Company's expectations ("Cautionary Statements") are disclosed under "Cautionary Statements" and elsewhere in this Report, including, without limitation, in conjunction with the forward-looking statements included in this Report. All subsequent written and oral forward-looking statements attributable to the Company, or persons on its behalf, are expressly qualified in their entirety by the Cautionary Statements. 12
13 Cautionary Statements See "Special Note Regarding Forward-Looking Statements". Substantial Competition The Company's business is highly competitive. The Company competes with a variety of industrial supply distributors, some of which may have greater financial and other resources than the Company. Although many of the Company's traditional distribution competitors are small enterprises selling to customers in a limited geographic area, the Company also competes with larger distributors that provide integrated supply programs such as those offered through the iPower Consortium and outsourcing services similar to those that are being offered by American MRO, Inc. ("AMRO"), a wholly owned subsidiary of the Company. Some of these large distributors may be able to supply their products in a more timely and cost-efficient manner than the Company. The Company's competitors include direct mail suppliers, large warehouse stores and, to a lesser extent, certain manufacturers. Risks Associated with Implementation of Corporate Strategy Future results for the Company also will be dependent on the success of the Company in implementing its acquisition and growth strategy. This strategy includes taking advantage of a consolidation in the industry and effecting acquisitions of distributors with complementary or desirable new product lines, strategic distribution locations and attractive customer bases and manufacturer relations. The Company's strategy also includes expanding its product lines, adding new product lines and establishing alliances and joint ventures with other suppliers in order to provide the Company's customers with a source of integrated supply. The ability of the Company to implement this strategy will depend on its ability to identify, consummate and assimilate acquisitions on economic terms, to acquire and successfully integrate new product lines and to establish and successfully market new integrated forms of supply arrangements such as that being pursued by AMRO. Although the Company is actively seeking acquisitions and integrated supply arrangements that would meet its strategic objectives, there can be no assurance that the Company will be successful in these efforts. Further, the ability of the Company to effect its strategic plans will depend on obtaining financing for its planned expansions and acquisitions. There can be no assurance that such financing will be available on a timely basis or on terms satisfactory to the Company. The Company plans to examine appropriate methods of financing any such acquisition, including issuance of additional capital stock, debt or other securities or a combination of both. If the Company were to issue shares of its capital stock in any acquisition, such issuance could be dilutive to existing shareholders. Dependence on Key Personnel The Company will continue to be dependent to a significant extent upon the efforts and ability of David R. Little, its Chairman of the Board and Chief Executive Officer. The loss of the services of Mr. Little or any other executive officer of the Company could have a material adverse effect on the Company's financial condition and results of operations. The Company does not maintain key-man life insurance on Mr. Little or on the lives of its other executive officers. In addition, the Company's ability to grow successfully will be dependent upon its ability to attract and retain qualified management and technical and operational personnel. The failure to attract and retain such persons could materially adversely affect the Company's financial condition and results of operation. Risks Associated with Hazardous Materials Certain of the Company's activities involve the controlled use of hazardous materials and chemicals. Although the Company believes that its safety procedures for handling and disposing of such materials comply with the standards prescribed by state and federal regulations, the risk of accidental contamination or injury from these materials cannot be eliminated completely. In the event of such an accident, the 13
14 Company could be held liable for any damages that result and any such liability could exceed the resources of the Company. Limitations on Ability to Pay Dividends The Company anticipates that future earnings, except for dividends payable on the Series B Convertible Preferred Stock, will be retained to finance the continuing development of its business. Accordingly, the Company does not anticipate paying cash dividends on the Common Stock in the foreseeable future. 14
15 Item 6. Exhibits and Reports on Form 8-K (a) Exhibits 10.1* Employment Agreement dated dated effective as of July 1, 1996, by and between Sepco Industries, Inc. and Gary A. Allcorn, as amended. 10.2* Employment Agreement dated effective as of July 1, 1996, by and between Sepco Industries, Inc. and Jerry J. Jones, as amended. 11.1* Statement re: Computation of Per Share Earnings 27.1* Financial Data Schedule ________________ * Filed herewith. (b) Reports on Form 8-K Current Report on Form 8-K dated June 2, 1997, as amended by Amendment No. 1 to Current Report on Form 8-K on Form 8-K/A and Amendment No. 2 to Current Report on Form 8-K on Form 8-K/A, reporting the acquisition by the Company of Strategic Supply, Inc., the audited historical financial statements of Strategic Supply, Inc. and the pro forma financial statements of the Company including Strategic Supply, Inc. . 15
16 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 hereunto duly authorized. DXP Enterprises, Inc. Date: November 14, 1997 By: /s/ GARY A. ALLCORN ----------------------------------- Gary A. Allcorn Senior Vice President/Finance (Duly authorized officer and principal financial officer)
17 EXHIBIT INDEX Exhibit No. Description -- ----------- 10.1* Employment Agreement dated effective as of July 1, 1996, by and between Sepco Industries, Inc. and Gary A. Allcorn, as amended. 10.2* Employment Agreement dated effective as of July 1, 1996, by and between Sepco Industries, Inc. and Jerry J. Jones, as amended. 11.1* Statement re: Computation of Per Share Earnings 27.1* Financial Data Schedule ____________________ * Filed herewith.