3:
UNITED STATES
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, 2005
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 [X ] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
Yes [ ] No [X]
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
APPLICABLE ONLY TO CORPORATE ISSUERS:
Number of shares outstanding of each of the issuer's classes of common stock, as of October 26, 2005:
Common Stock: 4,736,477
PART I: FINANCIAL INFORMATION
ITEM 1: FINANCIAL STATEMENTS
DXP ENTERPRISES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
September 30, 2005
December 31, 2004
(Unaudited)
ASSETS
Current assets:
Cash
$ 1,022
$ 2,303
Trade accounts receivable, net of allowances for doubtful accounts
of $1,959 and $1,776, respectively
22,842
19,126
Inventories, net
19,010
16,995
Prepaid expenses and other current assets
683
327
Deferred income taxes
1,042
945
Federal income taxes recoverable
2,753
-
Total current assets
47,352
39,696
Property and equipment, net
7,455
8,261
193
257
Goodwill and other intangibles
2,782
Other assets
68
69
Total assets
$ 57,850
$ 48,283
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt
$ 210
$ 1,420
Trade accounts payable
14,362
12,905
Accrued wages and benefits
2,976
2,370
Federal income taxes payable
432
Other accrued liabilities
2,557
2,343
Customer advances
1,818
826
Total current liabilities
21,923
20,296
Long-term debt, less current portion
18,840
14,925
Minority interest in consolidated subsidiary
60
186
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, 2005)
1,000,000 shares authorized; 1,122 shares issued and outstanding
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, 2005); 1,000,000 shares authorized;
17,700 shares issued, 15,000 shares outstanding and 2,700 shares
in treasury stock at December 31, 2004; 15,000 shares issued and
outstanding at September 30, 2005
15
18
Common stock, $0.01 par value, 100,000,000 shares authorized;
4,736,477 and 4,257,760 shares issued; 4,736,477 and 4,030,313 shares
outstanding; and zero and 227,447 shares in treasury stock, respectively
47
41
Paid-in capital
1,425
2,489
Retained earnings
16,419
13,094
Treasury stock
(1,797)
Notes receivable from shareholders
(880)
(970)
Total shareholders' equity
17,027
12,876
Total liabilities and shareholders' equity
See notes to condensed consolidated financial statements.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Three Months Ended
Nine Months Ended
September 30
2005
2004
Sales
$ 43,378
$ 42,871
$ 130,630
$ 122,836
Cost of sales
31,927
32,928
95,966
93,222
Gross profit
11,451
9,943
34,664
29,614
Selling, general and administrative expense
9,618
8,563
28,813
25,647
Operating income
1,833
1,380
5,851
3,967
Other income
9
11
36
40
Interest expense
(216)
(233)
(733)
(667)
Minority interest in loss of consolidated subsidiary
29
126
Income before taxes
1,655
1,158
5,280
3,340
Provision for income taxes
594
415
1,888
1,205
Net income
1,061
743
3,392
2,135
Preferred stock dividend
23
Net income attributable to common shareholders
$ 1,038
$ 720
$ 3,324
$ 2,067
Basic income per share
$ 0.24
$ 0.18
$ 0.79
$ 0.51
Weighted average common shares outstanding
4,406
4,015
4,213
4,025
Diluted income per share
$ 0.13
$ 0.59
$ 0.39
Weighted average common and common equivalent shares outstanding
5,895
5,531
5,792
5,488
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
NINE MONTHS ENDED
SEPTEMBER 30
OPERATING ACTIVITIES:
$ 3,392
$ 2,135
Adjustments to reconcile net income to net cash provided by
activities
Depreciation
717
722
(Benefit) provision for deferred income taxes
(33)
27
(Gain) on disposal of property and equipment
(1)
(126)
Changes in operating assets and liabilities, net of assets and
liabilities acquired in business combination:
Trade accounts receivable
(3,716)
(3,587)
Inventories
(858)
1,342
64
(227)
Accounts payable and accrued liabilities
2,051
(45)
Net cash provided by operating activities
1,491
366
INVESTING ACTIVITIES:
Purchase of property and equipment
(370)
(270)
Purchase of pump manufacturing business
(2,417)
Proceeds from sale of property and equipment
932
Net cash used in investing activities
(1,855)
(269)
FINANCING ACTIVITIES:
Proceeds from debt
129,181
116,133
Principal payments on revolving line of credit and other
(126,476)
(115,418)
long term debt
Dividends paid in cash
(68)
Proceeds from exercise of stock options
473
35
Payments for employee taxes related to exercise of stock options
(4,027)
Net cash (used in) provided by financing activities
(917)
682
(DECREASE) INCREASE IN CASH
(1,281)
779
CASH AT BEGINNING OF PERIOD
2,303
636
CASH AT END OF PERIOD
$ 1,415
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.
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. (together with its subsidiaries, the "Company" or "DXP") 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, 2004, 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: 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.
September 30,
(in Thousands)
Pro forma impact of fair value method (FAS 148)
Reported net income attributable to common shareholders
Less: fair value impact of employee stock compensation
(2)
(81)
(113)
(93)
Pro forma net income attributable to common shareholders
$1,036
$ 639
$ 3,211
$ 1,974
Earnings per common share
Basic - as reported
Diluted - as reported
Basic - pro forma
$ 0.16
$ 0.76
$ 0.49
Diluted - pro forma
$ 0.12
$ 0.57
$ 0.36
Weighted average Black-Scholes fair value assumptions
Risk free interest rate
4.14%
4.5%
Expected life
5-10 yrs.
Expected volatility
74.6%
77.8%
Expected dividend yield
0.0%
In December 2004, the FASB released Statement 123R, "Share-Based Payment". Statement 123R requires that the compensation cost relating to share-based payment transactions be recognized in financial statements, and provides expanded guidance on measuring the fair value of share-based payment transactions. Statement 123R is effective for the Company's stock option plans beginning January 1, 2006. While the ultimate impact of applying this guidance cannot be fully predicted at this time, the Company does not expect the impact to be significantly different from that presented in the pro-forma disclosures above.
NOTE 4: INVENTORY
The Company uses the last-in, first-out ("LIFO") method of inventory valuation for approximately 90 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:
December 31,
Finished goods
$ 20,852
$ 20,441
Work in process
2,145
253
Inventories at FIFO
22,997
20,694
Less - LIFO allowance
(3,987)
(3,699)
$ 19,010
$ 16,995
NOTE 5: EARNINGS PER SHARE DATA
The following table sets forth the computation of basic and diluted earnings per share for the periods indicated.
(in Thousands, except per share amounts)
Basic:
Weighted average shares outstanding
$ 1,061
$ 743
Convertible preferred stock dividend
(23)
Net income attributable to common
shareholders
Per share amount
Diluted:
Net effect of dilutive stock options -
based on the treasury stock method
1,069
1,096
1,159
1,043
Assumed conversion of convertible
preferred stock
420
Total
Net income for diluted earnings per share
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 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
ElectricalContractor
42,332
539
42,871
120,989
1,847
122,836
1,300
80
3,778
189
Income before tax
1,116
42
3,266
74
42,714
664
43,378
128,835
1,795
130,630
1,729
104
5,651
200
1,580
75
5,182
98
NOTE 7: NEW CREDIT FACILITY
On August 2, 2005 the Company entered into a credit agreement (the "Facility") with Wells Fargo Bank. The Facility consists of a revolving credit facility that provides a $30 million line of credit to the Company. This new line of credit replaced the Company's prior credit facility, which was last amended and restated on June 25, 2003 and consisted of a term loan and revolving credit facility. The new Facility expires on July 31, 2009.
The Company's borrowings and letters of credit outstanding under the Facility at each month-end must be less than a borrowing base measured as of the same month-end. The borrowing base is defined under the Facility as the sum of 85% of the Company's eligible accounts receivable and 55% of eligible inventory, with advances against inventory at no time exceeding more than 50% of the total borrowing base. The Company's borrowing and letter of credit capacity under the Facility at any given time is $30 million less borrowings and letters of credit outstanding, subject to the borrowing base described above. The borrowing base for the Facility calculated as of September 30, 2005 was $26.8 million. At September 30, 2005 $10.6 million was available for borrowing under the Facility.
The Facility provides for interest at LIBOR plus a margin ranging from 0.75% to 1.25% or prime minus a margin of 1.75% to 1.25%. At September 30, 2005 the LIBOR based rate was LIBOR plus 75 basis points. At September 30, 2005 the prime based rate was prime minus 175 basis points. At September 30, 2005 $10 million was borrowed at an interest rate of 4.5% under the LIBOR option and $5.3 million was borrowed at an interest rate of 5.0% under the prime option. Commitment fees of .125 percent per annum are payable on the portion of the Facility capacity not in use for borrowings at any given time. Borrowings under the Facility are secured by all of the Company's accounts receivable, inventory and general intangibles.
The Facility contains financial covenants defining various financial measures and levels of these measures with which the Company must comply. Covenant compliance is assessed as of each quarter-end. The Facility's principal financial covenants include:
Fixed Charge Coverage Ratio - The Facility requires that the Fixed Charge Coverage Ratio be not less than 2.0 to 1.0 as of each fiscal quarter end, determined on a rolling four quarters basis, with "Fixed Charge Coverage Ratio" defined as the aggregate of net profit after taxes plus depreciation expense, amortization expense, and cash capital contributions minus dividends and distributions divided by the aggregate of the current maturity of long-term debt and capitalized lease payments.
Debt to Credit Facility Adjusted EBITDA - EBITDA is defined under the Facility ("Credit Facility Adjusted EBITDA") for financial covenant purposes as net profit before tax, plus interest expense (net of capitalized interest expense), depreciation expense and amortization, inclusive of any acquisitions. The Facility requires that the Company's ratio of Total Funded Debt to Credit Facility Adjusted EBITDA, determined on a rolling four quarters basis, not exceed 4.0 to 1.0 as of each quarter end. Total Funded Debt is defined under the Facility for financial covenant purposes as the sum of all obligations for borrowed money (excluding subordinated debt) plus all capital lease obligations.
NOTE 8: ACQUISITION
On August 20, 2005 the Company purchased the assets of a pump remanufacturer for approximately $3.9 million. The Company made this acquisition to enhance its ability to meet customer needs for shorter lead times on selected pumps. The $3.9 million purchase price was reduced by $0.9 million of liabilities assumed and a $0.5 million credit given to the seller to use to purchase maintenance, repair and operating supplies from the Company. The $2.4 million cash portion was financed using funds available under the Company's bank revolving credit facility. At September 30, 2005 the Company has recorded a liability to the seller of approximately $0.1 million for purchase price. The pro forma unaudited results of operations for the Company on a consolidated basis for the nine months ended September 30, 2005 and September 30, 2004, assuming the consummation of the purchase as of January 1, 2004, are as follows:
In Thousands, except for per share data
Net sales
$135,655
$125,204
$ 3,879
$ 2,028
Per share data
Basic earnings
$ 0.90
$ 0.48
Diluted earnings
$ 0.67
$ 0.37
The allocation of purchase price reflected in the September 30, 2005 condensed consolidated balance sheet is preliminary. The initial purchase price allocations may be adjusted within one year of the purchase date for changes in the estimates of the fair value of assets acquired and liabilities assumed. The following table summarizes the estimated fair values of the assets acquired and liabilities assumed on August 20, 2005 (in thousands).
Inventory
$ 879
Property and equipment
131
Goodwill and intangibles
Assets acquired
3,882
Current liabilities assumed
882
Net assets acquired
$ 3,000
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
%
$43,378
100.0
$42,871
$130,630
$122,836
73.6
76.8
73.5
75.9
26.4
23.2
26.5
24.1
Selling, general & administrative
22.2
20.0
22.0
20.9
4.2
3.2
4.5
(0.5)
(0.6)
Minority interest
0.1
Income before income taxes
3.8
2.7
4.0
Provision for
income taxes
1.4
1.0
2.4
1.7
2.6
$2,135
Per share
amounts
per share
Three Months Ended September 30, 2005 compared to Three Months Ended September 30, 2004
SALES. Revenues for the quarter ended September 30, 2005, increased $0.5 million, or 1.2%, to approximately $43.4 million from $42.9 million for the same period in 2004. Sales for the MRO Segment increased $0.4 million, or 0.9%, primarily due to a broad based increase in sales of bearings, safety products and mill supplies to companies engaged in oilfield service, oil and gas production, mining, electricity generation and petrochemical processing. The sales increases appear to be at least partially the result of an improving economy and high energy prices. These increases were partially offset by the effect of two major hurricanes which struck the U. S. Gulf Coast during August and September 2005. As a result of the hurricanes, our New Orleans service center was closed for approximately four weeks and 17 of our locations, including the corporate office, were closed for at least two business days. Despite temporarily relocating most of our New Orleans employees to other DXP locations, s ales to New Orleans customers, for the third quarter of 2005, declined by $2.4 million from the level for the second quarter of 2005. Sales for the Electrical Contractor segment increased by $0.1 million, or 23.2%, for the current quarter when compared to the same period in 2004. This increase resulted from increased sales of lower margin commodity type electrical products.
GROSS PROFIT. Gross profit for the third quarter of 2005 increased 15.2% compared to the same period in 2004. Gross profit as a percentage of sales increased by approximately 3.2% for the third quarter of 2005, when compared to the same period in 2004. Gross profit as a percentage of sales for the MRO segment increased to 26.2% for the three months ended September 30, 2005, from 22.9% in the comparable period of 2004. This increase can be primarily attributed to a change in product mix sold by the MRO segment. The 2004 period included certain large sales of products for offshore energy production with lower than average margins. In 2005 we have replaced those sales with smaller, higher margin sales. Gross profit as a percentage of sales for the Electrical Contractor segment decreased to 40.7% for the three months ended September 30, 2005, from 48.4% in the comparable period of 2004. This decrease resulted from increased sales of lower margin commodity type electrical products.
SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative expense for the quarter ended September 30, 2005, increased by approximately $1.1 million when compared to the same period in 2004. As a percentage of revenue, the 2005 expense increased by approximately 2.2% to 22.2% from 20.0% for 2004. These increases are primarily attributed to employee assistance related to two hurricanes, physical damage from two hurricanes, costs to relocate inventory from service centers temporarily closed due to hurricanes, increased salaries, incentive compensation, employee benefits and payroll related expenses for the three months ended September 30, 2005 from the same period in 2004. The hurricane related costs totaled approximately $0.2 million for the three months ended September 30, 2005. Salaries have increased partially as a result of hiring more sales related personnel for the purpose of increasing sales. Incentive compensation has increased as a result of increased gross profit. Th e majority of our employees receive incentive compensation which is based upon gross profit. Selling, general and administrative expense as a percentage of gross profit declined in the 2005 period compared to the 2004 period.
OPERATING INCOME. Operating income for the third quarter of 2005 increased 32.8% when compared to the same period in 2004. Operating income for the MRO segment increased 33.0% as a result of increased gross profit, partially offset by increased selling, general and administrative expense. Operating income for the Electrical Contractor segment increased 30.0% as a result of increased gross profit and reduced selling, general and administrative expense.
INTEREST EXPENSE. Interest expense for the quarter ended September 30, 2005 decreased by 7.3% from the same period in 2004. This decrease results from a lower average debt balance for the third quarter of 2005 when compared to the third quarter of 2004 and lower rates under the New Credit Facility compared to the Old Credit Facility, the effect of which was partially offset by an approximate 200 basis point increase in prime and LIBOR market interest rates.
Nine Months Ended September 30, 2005 compared to Nine Months Ended September 30, 2004
SALES. Revenues for the nine months ended September 30, 2005, increased $7.8 million, or 6.3%, to approximately $130.6 million from $122.8 million for the same period in 2004. Sales for the MRO Segment increased $7.8 million, or 6.5%, primarily due to a broad based increase in sales of pumps, bearings, safety products and mill supplies to companies engaged in oilfield service, oil and gas production, mining, electricity generation and petrochemical processing. The sales increases appear to be at least partially the result of an improving economy and high energy prices. These increases were partially offset by a $5.3 million decrease in sales of fiberglass reinforced pipe and the effect of two major hurricanes which struck the U. S. Gulf Coast during August and September 2005. As a result of the hurricanes, our New Orleans service center was closed for approximately four weeks and seventeen of our locations, including the corporate office, were closed for at least two business days. Des pite temporarily relocating most of our New Orleans employees to other DXP locations, sales to New Orleans customers, for the third quarter of 2005, declined by $2.4 million from the level for the second quarter of 2005. Sales for the Electrical Contractor segment decreased by $0.1 million, or 2.8%, for the current nine months when compared to same period in 2004. This decrease resulted from an effort to focus on sales of higher margin specialty electrical products and to be selective on selling lower margin commodity type electrical products.
GROSS PROFIT. Gross profit for the first nine months of 2005 increased 17.1% compared to the same period in 2004. Gross profit as a percentage of sales increased by approximately 2.4% for the first nine months of 2005, when compared to the same period in 2004. Gross profit as a percentage of sales for the MRO segment increased to 26.4% for the nine months ended September 30, 2005, from 23.9% in the comparable period of 2004. This increase can be primarily attributed to increased margins on pump related equipment sold by the MRO segment. The 2004 period included certain large sales of products for offshore energy production with lower than average margins. In 2005 we have replaced those sales with smaller, higher margin sales. Gross profit as a percentage of sales for the Electrical Contractor segment increased to 39.8% for the nine months ended September 30, 2005, from 39.7% in the comparable period of 2004. This increase resulted from an effort to focus on sales of higher margin specialty electrical products and to be selective on selling lower margin commodity type electrical products.
SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative expense for the nine months ended September 30, 2005, increased by approximately $3.2 million when compared to the same period in 2004. As a percentage of revenue, the 2005 expense increased by approximately 1.1% to 22.0% from 20.9% for 2004. These increases are primarily attributed to employee assistance related to two hurricanes, physical damage from two hurricanes, costs to relocate inventory from service centers temporarily closed due to hurricanes, increased salaries, incentive compensation, employee benefits and payroll related expenses for the three months ended September 30, 2005 from the same period in 2004. The hurricane related costs totaled approximately $0.2 million for the nine months ended September 30, 2005. Salaries have increased partially as a result of hiring more sales related personnel for the purpose of increasing sales. Incentive compensation has increased as a result of increased gross profit. The majority of our employees receive incentive compensation which is based upon gross profit. Selling, general and administrative expense as a percentage of gross profit declined in the 2005 period compared to the 2004 period.
OPERATING INCOME. Operating income for the first nine months of 2005 increased 47.5% when compared to the same period in 2004. Operating income for the MRO segment increased 49.6% as a result of increased gross profit, partially offset by increased selling, general and administrative expense. Operating income for the Electrical Contractor segment increased 5.8% as a result of selling, general and administrative costs decreasing more than gross profit decreased.
INTEREST EXPENSE. Interest expense for the nine months ended September 30, 2005 increased by 9.9% from the same period in 2004. This increase results from an approximate 180 basis point increase in prime and LIBOR market interest rates, the effect of which was partially offset by a lower average debt balance for the first nine months of 2005 when compared to the first nine months of 2004.
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 and warehouse equipment. We also require cash to pay our lease obligations and to service our debt.
We generated $1.5 million of cash in operating activities during the first nine months of 2005 as compared to generating $0.4 million in cash in operating activities during the first nine months of 2004. This change between the two periods is primarily attributable to increased net income in the 2005 period compared to the 2004 period.
During the first nine months of 2005, the amount available to be borrowed under our loan agreement in place at the time increased from $10.0 million at December 31, 2004 to $10.6 million at September 30, 2005. This increase in availability resulted primarily from the increase in accounts receivable and inventory collateral value, partially offset by a $2.7 million increase in long-term debt during the first nine months of 2005. The funds obtained from the increase in debt were used to purchase a pump manufacturing business.
Credit Facilities
On August 2, 2005, we entered into a new credit facility ("New Credit Facility") which replaced the previous credit facility ("Old Credit Facility").
The New 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 July 31, 2009. The New Credit Facility is secured by receivables, inventory and intangibles. The New Credit Facility contains customary affirmative and negative covenants as well as financial covenants that are measured quarterly and require that we maintain a certain cash flow and other financial ratios.
The New Credit Facility allows us to borrow at LIBOR plus a margin ranging from 0.75% to 1.25% or prime minus a margin of 1.75% to 1.25%. At September 30, 2005 the LIBOR based rate was LIBOR plus 75 basis points. At September 30, 2005 the prime based rate was prime minus 175 basis points. The LIBOR and prime based rates under the New Credit Facility are generally 150 basis points and 175 basis points lower, respectively, than those assessed under the Old Credit Facility. At September 30, 2005 $10 million was borrowed at an interest rate of 4.5% under the LIBOR option and $5.3 million was borrowed at an interest rate of 5.0% under the prime option. Commitment fees of .125 percent per annum are payable on the portion of the Facility capacity not in use for borrowings at any given time. This fee is 12.5 basis points lower than the same fee under the Old Credit Facility. At September 30, 2005, we were in compliance with all covenants. In addition to the $1.0 million of cash at September 30, 20 05, we had $10.6 million available for borrowings under the New Credit Facility at September 30, 2005.
The New Credit Facility's principal financial covenants include:
Fixed Charge Coverage Ratio - The New Credit Facility requires that the Fixed Charge Coverage Ratio be not less than 2.0 to 1.0 as of each fiscal quarter end, determined on a rolling four quarters basis, with "Fixed Charge Coverage Ratio" defined as the aggregate of net profit after taxes plus depreciation expense, amortization expense, and cash capital contributions minus dividends and distributions divided by the aggregate of the current maturity of long-term debt and capitalized lease payments.
Debt to Credit Facility Adjusted EBITDA - The New Credit Facility requires that the Company's ratio of Total Funded Debt to Credit Facility Adjusted EBITDA, determined on a rolling four quarters basis, not exceed 4.0 to 1.0 as of each quarter end. Total Funded Debt is defined under the Facility for financial covenant purposes as the sum of all obligations for borrowed money (excluding subordinated debt) plus all capital lease obligations.
Borrowings
Increase
(Decrease)
$ (1,210)
3,915
Total long-term debt
19,050
$ 16,345
$ 2,705(2)
Amount available
$ 10,613(1)
$ 9,998(1)
$ 615(3)
(1) Represents amount available to be borrowed at the indicated date under the New Credit Facility and the Old Credit Facility, respectively.
(2) The funds obtained from the increase in long-term debt were used to purchase a pump manufacturing business.
(3) The $0.6 million increase in the amount available is a result of an increase in accounts receivable and inventory collateral value, partially offset by the $2.7 million increase in total long-term debt.
Performance Metrics
Days of sales outstanding
51.8
54.7
(2.9)
Inventory turns
6.7
7.0
(0.3)
For the nine months ended September 30, 2005 accounts receivable days of sales outstanding were 51.8 at September 30, 2005 compared to 54.7 at September 30, 2004. The decrease resulted primarily from a change in customer mix, which resulted in faster collection of accounts receivable. For the nine months ended September 30, 2005 annualized inventory turns were 6.7 at September 30, 2005 compared to 7.0 at September 30, 2004. The decline in inventory turns is primarily a result of increased work in process for the pump manufacturing business acquired in August 2005.
Funding Commitments
We believe our cash generated from operations and available under our New Credit Facility will meet our normal working capital needs during the next twelve months. However, we may require additional debt or equity financing to fund potential acquisitions. Such additional financings 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 interests of our shareholders.
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, income taxes 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. Write-offs could be materially different from the reserve provided if economic conditions change or actual results deviate from historical trends.
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. Actual obsolescence could be materially different from the reserve if economic conditions or market trends change significantly.
Income Taxes
In accordance with SFAS 109, Accounting for Income Taxes, we have recorded a net deferred tax asset of $1.2 million as of September 30, 2005. 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. As a result of tax deductions resulting from the exercise of stock options, we expect to record a federal taxable loss for 2005. We expect to recover $2.8 million of tax payments made during 2005, 2004 and 2003.
Self-insured Medical Claims
We accrue for the estimated outstanding balance of unpaid medical claims for our employees and their dependents. The accrual is adjusted monthly based on recent claims experience. The actual claims could deviate from recent claims experience and be materially different from the reserve.
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.
New Accounting Standards Not Yet Adopted
In December 2004, the FASB released Statement 123R, "Share-Based Payment". Statement 123R requires that the compensation cost relating to share-based payment transactions be recognized in financial statements, and provides expanded guidance on measuring the fair value of share-based payment transactions. Statement 123R is effective for the Company's stock option plans beginning January 1, 2006. While the ultimate impact of applying this guidance cannot be fully predicted at this time, the Company does not expect the impact to be significantly different from that presented in the pro-forma disclosures noted in Note 3 to the Condensed Consolidated Financial Statements.
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Our market risk results from volatility in interest rates. Our exposure to interest rate risk relates primarily to our debt portfolio. Using floating interest rate debt outstanding at September 30, 2005, a 100 basis point change in interest rates would result in approximately a $167,000 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, 2005) 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.
No material developments have occurred in the asbestos related litigation or the litigation with BP America Production Company disclosed in the Company's Annual Report on Form 10-K for the year ended December 31, 2004.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
On July 15, 2005, at the Company's annual meeting of shareholders, the individuals listed below were elected directors by the holders of Common Stock, Series A Preferred Stock and Series B Preferred Stock, voting together as a class. Additionally, the shareholders approved the DXP Enterprises, Inc. Restricted Stock Plan (the "Plan"). Set forth for each director and the Plan is the tabulation of votes cast.
Nominee
Votes For
Votes Against
Votes Withheld
David R. Little
3,465,610
15,400
0
Cletus Davis
3,467,943
13,067
Kenneth Miller
Timothy Halter
Restricted Stock Plan
2,476,990
127,937
41,414
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.
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 result in a temporary disruption on our business and, in turn, could adversely affect results of operations and financial condition.
Ability to Comply with Financial Covenants of New Credit Facility
Our New 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 New Credit Facility, which could permit acceleration of our indebtedness under the New Credit Facility. Although we expect to be able to comply with the covenants, including the financial covenants, of the New 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.
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
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)
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).
10.1
Credit Agreement by and among DXP Enterprises, Inc., as Borrower, and Wells Fargo Bank, as Bank, dated as of August 2, 2005. (incorporated by reference to Exhibit 10.1 to Registrant's Current Report on Form 8-K filed with the Commission on August 4, 2005).
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).
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.
(Registrant)
By: /s/MAC McCONNELL
Mac McConnell
Senior Vice-President/Finance and Chief Financial Officer
Dated: October 27, 2005
Exhibit 31.1
CERTIFICATION
I, David R. Little, the Chief Executive Officer of DXP Enterprises, Inc., certify that:
October 27, 2005
/s/ David R. Little
President and Chief Executive Officer
(Principal Executive Officer)
Exhibit 31.2
I, Mac McConnell, the Chief Financial Officer of DXP Enterprises, Inc., certify that:
/s/ Mac McConnell
Senior Vice President and Chief Financial Officer
(Principal Financial Officer)
Exhibit 32.1
Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 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, 2005 (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
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.
/s/Mac McConnell
Chief Financial Officer