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DXPE > SEC Filings for DXPE > Form 10-Q on 7-Nov-2012All Recent SEC Filings

Show all filings for DXP ENTERPRISES INC

Form 10-Q for DXP ENTERPRISES INC


7-Nov-2012

Quarterly Report


ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following management discussion and analysis (MD&A) of the financial condition and results of operations of DXP Enterprises, Inc. together with its subsidiaries (collectively "DXP," "Company," "us," "we," or "our") for the three and nine months ended September 30, 2012 is provided as of November 7, 2012. It is supplemental to, and should be read in conjunction with, the financial statements of the Company for the three and nine months ended September 30, 2012 and 2011. The Company's financial statements are prepared in accordance with accounting principles generally accepted in the United States of America ("USGAAP").

DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q (this "Report") contains statements that constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995, as amended. Such statements can be identified by the use of forward-looking terminology such as "believes", "expects", "may", "estimates", "will", "should", "plans" or "anticipates" or the negative thereof or other variations thereon or comparable terminology, or by discussions of strategy. Any such forward-looking statements are not guarantees of future performance and may involve significant risks and uncertainties, and actual results may vary materially from those discussed in the forward-looking statements as a result of various factors. These factors include the effectiveness of management's strategies and decisions, our ability to affect our internal growth strategy, general economic and business conditions, developments in technology, our ability to effectively integrate businesses we may acquire, new or modified statutory or regulatory requirements and changing prices and market conditions. This Report identifies other factors that could cause such differences. Additional factors that could cause or contribute to actual results varying materially from those discussed in the forward-looking statements are discussed in the section titled "Risk Factors" included in our Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 9, 2012. We cannot assure that these are all of the factors that could cause actual results to vary materially from the forward-looking statements. We assume no obligation and do not intend to update these forward-looking statements.

RESULTS OF OPERATIONS
(in thousands, except percentages and per share data)

                     Three Months Ended September 30,       Nine Months Ended September 30,
                      2012       %       2011      %         2012      %       2011      %
Sales                $289,923   100.0   $207,855  100.0     $804,104  100.0   $588,617  100.0
Cost of sales         206,414    71.2    148,384   71.4      572,492   71.2    419,454   71.3
Gross profit           83,509    28.8     59,471   28.6      231,612   28.8    169,163   28.7
Selling, general
and administrative
expense                58,995    20.3     45,035   21.7      166,346   20.7    129,554   22.0
Operating income       24,514     8.5     14,436    6.9       65,266    8.1     39,609    6.7
Interest expense        2,287     0.8        760    0.3        3,878    0.5      2,805    0.5
Other income             (21)       -        (4)      -         (33)      -       (40)      -
Income
before income
taxes                  22,248     7.7     13,680    6.6       61,421    7.6     36,844    6.2
Provision
for income taxes        9,156     3.2      5,406    2.6       24,506    3.0     14,617    2.4
Net income           $ 13,092     4.5    $ 8,274    4.0     $ 36,915    4.6   $ 22,227    3.8
Per share amounts
 Basic
earnings per share   $   0.91             $ 0.58            $   2.56            $ 1.55
 Diluted
earnings per share   $   0.86             $ 0.55            $   2.43            $ 1.47

DXP is organized into three business segments: Service Centers, Supply Chain Services (SCS) and Innovative Pumping Solutions (IPS). The Service Centers segment is engaged in providing maintenance, repair and operating products (MROP), equipment and integrated services, including logistics capabilities, to industrial customers. The Service Centers provides a wide range of MROP products in the rotating equipment, bearing, power transmission, hose, fluid power, metal working, fastener, industrial supply, safety products and safety services categories. The IPS segment fabricates and assembles custom-made engineered pump packages. The SCS segment manages all or part of a customer's supply chain, including warehouse and inventory management.

Three Months Ended September 30, 2012 compared to Three Months Ended September 30, 2011

SALES. Sales for the three months ended September 30, 2012 increased $82.1 million, or 39.5%, to approximately $289.9 million from $207.9 million for the prior corresponding period. Sales by businesses acquired since September 30, 2011 accounted for $66.7 million of third quarter 2012 sales. Excluding third quarter 2012 sales from businesses acquired in 2011 and 2012, sales for the third quarter in 2012 increased 7.4% from the prior corresponding period, on a same store sales basis. This sales increase is primarily due to improvement in the oil and gas and manufacturing portions of the U.S. economy.

GROSS PROFIT. Gross profit as a percentage of sales for the three months ended September 30, 2012 is consistent with the prior corresponding period.

SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative expense for the three months ended September 30, 2012 increased by approximately $14.0 million to $59.0 million from $45.0 million for the prior corresponding period. The increase relates to $13.8 million of selling, general and administrative expense, including amortization of intangibles and acquisition costs, associated with businesses acquired in 2011 and 2012. Excluding third quarter expenses from businesses acquired in 2011 and 2012, increased compensation related expenses for the quarter were offset by lower healthcare costs, professional fees, travel expenses and collection of a $0.5 million legal settlement. As a percentage of sales, the third quarter 2012 expense decreased to 20.3%, from 21.7% for the prior corresponding period as a result of corporate expenses being spread over increased sales. Selling, general and administrative expense for the three months ended September 30, 2012 includes approximately $1.1 million in professional fees associated with the acquisition of HSE.

OPERATING INCOME. Operating income for the third quarter of 2012 increased $10.1 million, or 69.8% compared to the prior corresponding period. This increase in operating income is the result of gross profit increasing by 40.4%, while selling, general and administrative expense increased only 31.0%.

INTEREST EXPENSE. Interest expense for the three months ended September 30, 2012 increased 200.9% from the prior corresponding period. On July 11, 2012 DXP entered into a credit facility with Wells Fargo Bank, National Association, as Issuing Lender, Swingline Lender and Administrative Agent for the lenders. The new facility consists of a $100 million term loan and a revolving credit facility that provides a $225 million line of credit to the Company. This new facility replaced the Company's prior credit facility. The pricing grid for the new facility is similar to the prior facility. The increase is primarily due to a $0.7 million charge to fully amortize debt issuance costs related to the prior credit facility, increased interest rates as a result of increased leverage, and increased amortization of debt issuance costs for the current facility, and a higher average outstanding balance on our credit facility. Borrowings under the facility were used to acquire additional businesses during the period.

SERVICE CENTERS SEGMENT. Sales for the Service Centers segment increased by $70.7 million, or 49.8% for the third quarter of 2012 compared to the prior corresponding period. Excluding third quarter 2012 Service Centers segment sales from acquired businesses of $62.3 million, Service Centers segment sales for the third quarter of 2012 increased 5.9% from the prior corresponding period, on a same store sales basis. This sales increase is primarily due to improvement in the oil and gas and manufacturing portions of the U.S. economy. Operating income for the Service Centers segment increased 66.5%, primarily as a result of the 49.8% increase in sales.

INNOVATIVE PUMPING SOLUTIONS SEGMENT. Sales for the IPS segment increased by $7.5 million, or 24.0% for the third quarter of 2012 compared to the prior corresponding period. The sales increase resulted from the increase in capital spending by our oil and gas and mining related customers. Operating income for the IPS segment increased 50.2% as a result of the 24.0% increase in sales combined with only a 9.2% increase in selling, general and administrative expenses.
SUPPLY CHAIN SERVICES SEGMENT. Sales for the SCS segment increased by $3.9 million, or 11.2%, for the third quarter of 2012 compared to the prior corresponding period. Excluding third quarter 2012 SCS segment sales from acquired businesses of $4.5 million, SCS segment sales decreased by 1.7% the third quarter of 2012 on a same store sales basis due to reduced sales to military and truck related customers. Operating income for the SCS segment increased 37.5% primarily as a result of a decline in selling, general and administrative expense primarily as a result of reduced overhead costs.

Nine Months Ended September 30, 2012 compared to Nine Months Ended September 30, 2011

SALES. Sales for the nine months ended September 30, 2012 increased $215.5 million, or 36.6%, to approximately $804.1 million from $588.6 million for the prior corresponding period. Sales by businesses acquired since September 30, 2011 accounted for $137.6 million of 2012 sales. Excluding 2012 sales from businesses acquired in 2011 and 2012, sales for the first nine months in 2012 increased 13.2% from the prior corresponding period, on a same store sales basis. This sales increase is primarily due to improvement in the oil and gas and manufacturing portions of the U.S. economy.

GROSS PROFIT. Gross profit as a percentage of sales for the nine months ended September 30, 2012 is consistent with the prior corresponding period.

SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative expense for the nine months ended September 30, 2012 increased by approximately $36.8 to $166.3 million from $129.6 million for the prior corresponding period. The majority of the increase relates to $27.9 million of selling, general and administrative expense associated with businesses acquired in 2011 and 2012. Excluding expenses from businesses acquired in 2011 and 2012, the increase primarily resulted from increased salaries, incentive compensation and employee benefits compared to 2011. As a percentage of sales, the nine month 2012 expense decreased to 20.7%, from 22.0% for the prior corresponding period as a result of corporate expenses being spread over increased sales.

OPERATING INCOME. Operating income for the first nine months of 2012 increased $25.7 million, or 64.8% compared to the prior corresponding period. This increase in operating income is the result of gross profit increasing 36.9%, while selling, general and administrative expense increased only 28.4ญญ%.

INTEREST EXPENSE. Interest expense for the nine months ended September 30, 2012 increased 38.3% from the prior corresponding period. On July 11, 2012 DXP entered into a credit facility with Wells Fargo Bank, National Association, as Issuing Lender, Swingline Lender and Administrative Agent for the lenders. The new facility consists of a $100 million term loan and a revolving credit facility that provides a $225 million line of credit to the Company. This new facility replaced the Company's prior credit facility. The pricing grid for the new facility is similar to the prior facility. The increase is primarily due to a $0.7 million charge to fully amortize debt issuance costs related to the prior credit facility, increased amortization of debt issuance costs for the current facility, increased interest rates as a result of increased leverage, and a higher average outstanding balance on our credit facility. Borrowings under the facility were used to acquire additional businesses during the period.

SERVICE CENTERS SEGMENT. Sales for the Service Centers segment increased by $158.8 million, or 38.5% for the nine months ended September 30, 2012 compared to the prior corresponding period. Excluding 2012 Service Centers segment sales from acquired businesses of $126.0 million, Service Centers segment sales for 2012 increased 7.9% from the prior corresponding period, on a same store sales basis. This sales increase is primarily due to improvement in the oil and gas and manufacturing portions of the U.S. economy. Operating income for the Service Centers segment increased 40.6%, primarily as a result of the 38.5% increase in sales.

INNOVATIVE PUMPING SOLUTIONS SEGMENT. Sales for the IPS segment increased by $43.6 million, or 62.5% for the nine months ended September 30, 2012 compared to the prior corresponding period. The sales increase resulted from the increase in capital spending by our oil and gas and mining related customers. Operating income for the IPS segment increased 108.4% as a result of the 62.5% increase in sales combined with only a 30.8% increase in selling, general and administrative expenses.

SUPPLY CHAIN SERVICES SEGMENT. Sales for the SCS segment increased by $13.1 million, or 12.3%, for the nine months ended September 30, 2012 compared to the prior corresponding period. Excluding 2012 SCS segment sales from acquired businesses of $11.5 million, SCS segment sales increased by 1.4% from the corresponding period of 2011 on a same store sales basis due to sales to customers added during the period, partially offset by reduced sales to military and truck related customers. Operating income for the SCS segment increased 56.4% primarily as a result of a decline in selling, general and administrative expense primarily as a result reduced overhead costs.

BUSINESS ACQUISITIONS AND SUPPLEMENTAL PRO-FORMA DATA

On October 10, 2011, DXP acquired substantially all of the assets of Kenneth Crosby (KC). DXP acquired this business to expand DXP's geographic presence in the Eastern U.S. and strengthen DXP's metal working offering. DXP paid approximately $15.6 million for KC, which was borrowed under our existing credit facility. Goodwill of $5.8 million was recognized for this acquisition and is calculated as the excess of the consideration transferred over the net assets recognized and represents the future economic benefits arising from other assets acquired that could not be individually identified and separately recognized. It specifically includes the expected synergies and other benefits that we believe will result from combining the operations of KC with the operations of DXP and any intangible assets that do not qualify for separate recognition such as the assembled workforce. All of the goodwill is included in the Service Centers segment.

On December 30, 2011, DXP acquired substantially all of the assets of C.W. Rod Tool Company ("CW Rod"). DXP acquired this business to strengthen DXP's metal working offering. DXP paid approximately $1.1 million of DXP's common stock (35,714 shares) and approximately $41.7 million in cash for CW Rod, which was borrowed during 2011 and 2012 under our credit facility. The $41.7 million of cash paid for CW Rod includes $36.7 million paid in the form of checks which did not clear our bank until 2012. Goodwill of $10 million was recognized for this acquisition and is calculated as the excess of the consideration transferred over the net assets recognized and represents the future economic benefits arising from other assets acquired that could not be individually identified and separately recognized. It specifically includes the expected synergies and other benefits that we believe will result from combining the operations of CW Rod with the operations of DXP and any intangible assets that do not qualify for separate recognition such as the assembled workforce. All of the goodwill is included in the Service Centers segment.

On January 31, 2012, DXP acquired substantially all of the assets of Mid-Continent Safety ("Mid-Continent"). DXP acquired this business to expand DXP's geographic presence in the Midwestern U.S. and strengthen DXP's safety products offering. DXP paid approximately $3.8 million for Mid-Continent, which was borrowed under our existing credit facility. Goodwill of $1.2 million was recognized for this acquisition and is calculated as the excess of the consideration transferred over the net assets recognized and represents the future economic benefits arising from other assets acquired that could not be individually identified and separately recognized. It specifically includes the expected synergies and other benefits that we believe will result from combining the operations of Mid-Continent with the operations of DXP and any intangible assets that do not qualify for separate recognition such as the assembled workforce. All of the goodwill is included in the Service Centers segment.

On February 29, 2012, DXP acquired substantially all of the assets of Pump & Power Equipment, Inc. ("Pump & Power"). DXP acquired this business to expand DXP's geographic presence in the Midwestern U.S. and strengthen DXP's municipal pump products and services offering. DXP paid approximately $1.9 million for Pump & Power which was borrowed under our existing credit facility. Goodwill of $0.7 million was recognized for this acquisition and is calculated as the excess of the consideration transferred over the net assets recognized and represents the future economic benefits arising from other assets acquired that could not be individually identified and separately recognized. It specifically includes the expected synergies and other benefits that we believe will result from combining the operations of Pump & Power with the operations of DXP and any intangible assets that do not qualify for separate recognition such as the assembled workforce. All of the goodwill is included in the Service Centers segment.

On April 2, 2012, DXP acquired the stock of Aledco, Inc. ("Aledco"). Aledco is focused on servicing customers in the oil and gas, ware and waste water treatment, pharmaceutical and industrial markets. DXP paid approximately $8.0 million for Aledco which was borrowed under our existing credit facility. Goodwill of $2.9 million was recognized for this acquisition and is calculated as the excess of the consideration transferred over the net assets recognized and represents the future economic benefits arising from other assets acquired that could not be individually identified and separately recognized. It specifically includes the expected synergies and other benefits that we believe will result from combining the operations of Aledco with the operations of DXP and any intangible assets that do not qualify for separate recognition such as the assembled workforce. None of the estimated goodwill is expected to be tax deductible. All of the goodwill is included in the Service Centers segment.

On May 1, 2012, DXP completed the acquisition of Industrial Paramedic Services through its wholly owned subsidiary, DXP Canada Enterprises Ltd. Industrial Paramedic Services is a provider of industrial medical and safety services to industrial customers operating in remote locations and large facilities in western Canada. DXP acquired this business to expand DXP's geographic presence into Canada and to expand our safety services offering. IPS is headquartered in Calgary, Alberta and operates out of three locations in Calgary, Nisku and Dawson Creek. The $24.1 million purchase price was financed with $20.6 million of borrowings under DXP's existing credit facility, $2.5 million of promissory notes bearing a 5% interest rate and 19,685 shares of DXP common stock. DXP has not completed appraisals of intangibles or property and equipment for Industrial Paramedic Services. DXP has made preliminary estimates for purposes of this disclosure. Estimated goodwill of $11.9 million was recognized for this acquisition and is calculated as the excess of the consideration transferred over the net assets recognized and represents the future economic benefits arising from other assets acquired that could not be individually identified and separately recognized. It specifically includes the expected synergies and other benefits that we believe will result from combining the operations of Industrial Paramedic Services with the operations of DXP and any intangible assets that do not qualify for separate recognition such as the assembled workforce. None of the estimated goodwill is expected to be tax deductible. All of the goodwill is included in the Service Centers segment.

On July 11, 2012, DXP completed the acquisition of HSE Integrated Ltd. ("HSE"). Through its wholly-owned subsidiary, DXP Canada Enterprises Ltd., DXP acquired all of the outstanding common shares of HSE by way of a plan of arrangement under the Business Corporations Act (Alberta) (the "Arrangement"). Pursuant to the Arrangement, HSE shareholders received CDN $1.80 in cash per each common share of HSE held. The total transaction value is approximately $85 million, including approximately $4 million in debt and approximately $3 million in transaction costs. The purchase price was financed with borrowings under DXP's new $325 million credit facility. DXP acquired HSE to expand our industrial health and safety services offering. Estimated goodwill of $22.6 million was recognized for this acquisition. The estimate of goodwill for this acquisition is calculated as the excess of the consideration transferred over the net assets recognized and represents the future economic benefits arising from other assets acquired that could not be individually identified and separately recognized. It specifically includes the expected synergies and other benefits that we believe will result from combining the operations of these companies with the operations of DXP and any intangible assets that do not qualify for separate recognition such as the assembled workforce. None of the estimated goodwill is expected to be tax deductible. All of the goodwill is included in the Service Centers Segment.

DXP has not completed appraisals of intangibles or property and equipment for all acquisitions completed in 2012. DXP has made preliminary estimates for purposes of this disclosure.

For the three and nine months ended September 30, 2012, business acquisitions that occurred subsequent to September 30, 2011 contributed sales of $66.7 million and $137.6 million, respectively. Income before taxes provided by these acquisitions for the three and nine months ended September 30, 2012 was approximately $3.4 million and $7.4 million, respectively.

The following table summarizes the estimated fair values of the assets acquired and liabilities assumed during 2012 and 2011 in connection with the acquisitions described above and two additional insignificant acquisitions that were completed during the second quarter of 2012 (in thousands):

                   Cash                              $   11,976
                   Accounts Receivable, net              49,448
                   Inventory, net                        16,033
                   Property and equipment                29,139
                   Goodwill and intangibles             114,814
                   Other assets                           2,839
                   Assets acquired                      224,249
                   Current liabilities assumed         (34,374)
                   Non-current liabilities assumed     (13,753)
                    Net assets acquired              $  176,122

The pro forma unaudited results of operations for the Company on a consolidated basis for the three and nine months ended September 30, 2012 and 2011, assuming the acquisition of businesses completed in 2012 and 2011 were consummated as of January 1, 2011 are as follows (in thousands, except per share data):

                              Three Months Ended        Nine Months Ended
                                September 30,             September 30,
                              2012         2011         2012         2011
          Net sales        $  293,110   $  273,167   $  877,091   $  781,537
          Net income       $   13,137   $   11,696   $   39,233   $   28,751
          Per share data
          Basic earnings   $     0.91   $     0.81   $     2.72   $     2.00
          Diluted earnings $     0.86   $     0.77   $     2.58   $     1.89

LIQUIDITY AND CAPITAL RESOURCES

General Overview

As a distributor of MROP products, equipment and services, we require significant amounts of working capital to fund inventories and accounts receivable. Additional cash is required for capital items such as information technology, safety, transportation and warehouse equipment. We also require cash to pay our lease obligations and to service our debt.

The Company generated $21.3 million of cash in operating activities during the first nine months of 2012 as compared to generating $18.4 million during the prior corresponding period. This change between the two periods was primarily attributable to the $14.7 million increase in net income.

During the first nine months of 2012, the amount available to be borrowed under our credit agreement with our bank lender (the "Facility") decreased from $78.2 million at December 31, 2011 to $67.4 million at September 30, 2012. This decrease in availability primarily resulted from increased borrowings to fund acquisitions and working capital, partially offset by cash flow from operations.

Credit Facility

On July 11, 2012 DXP entered into a credit facility with Wells Fargo Bank, National Association, as Issuing Lender, Swingline Lender and Administrative Agent for the lenders (the "Facility"). The new facility consists of a $100 million term loan and a revolving credit facility that provides a $225 million line of credit to the Company. This new facility replaced the Company's prior credit facility, which was last amended on December 30, 2011 and consisted of a $200 million revolving credit facility.

The line of credit portion of the Facility provides the option of interest at LIBOR plus an applicable margin ranging from 1.25% to 2.25% or prime plus an applicable margin from 0.25% to 1.25% where the applicable margin is determined by the Company's leverage ratio as defined by the Facility at the date of borrowing. Rates for the $100 million term loan component are 25 basis points higher than the line of credit borrowings. Commitment fees of 0.20% to 0.40% per annum are payable on the portion of the Facility capacity not in use at any given time on the line of credit. Commitment fees are charged as interest in the consolidated statements of operations.

Primarily because the leverage ratio is higher after the acquisition of HSE that occurred on July 11, 2012, interest rates in effect at September 30, 2012 are approximately 70 points higher than they were prior to the acquisition. Approximately $0.7 million of debt issuance costs associated with the prior credit facility were expensed in the third quarter of 2012.

On September 30, 2012, the LIBOR based rate on the line of credit portion of the Facility was LIBOR plus 1.75%, the prime based rate of the Facility was prime plus 0.75% and the commitment fee was 0.30%. At September 30, 2012, $240.4 million was borrowed under the Facility at a weighted average interest rate of approximately 2.09% under the LIBOR options and $12.8 million was borrowed at 3.75% under the prime option. At September 30, 2012, the Company had $67.4 million available for borrowing under the Facility.

The new facility expires on July 11, 2017. 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:

Consolidated Leverage Ratio - The Facility requires that the Company's . . .

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