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DXPE > SEC Filings for DXPE > Form 10-Q on 8-May-2013All Recent SEC Filings

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Form 10-Q for DXP ENTERPRISES INC


8-May-2013

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 months ended March 31, 2013 should be read in conjunction with our previous annual report on Form 10-K and our quarterly reports on Form 10-Q incorporated in this Quarterly Report on Form 10-Q by reference, and the financial statements and notes thereto included in our annual and quarterly reports. 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 implement our internal growth and acquisition growth strategies, general economic and business condition specific to our primary customers, changes in government regulations, 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. We cannot assure that these are all of the factors that could cause actual results to vary materially from the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in "Risk Factors", included in our Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 11, 2013. We assume no obligation and do not intend to update these forward-looking statements. Unless the context otherwise requires, references in this Report to the "Company", "DXP", "we" or "our" shall mean DXP Enterprises, Inc., a Texas corporation, together with its subsidiaries.

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

                                                 Three Months Ended March 31,
                                                  2013      %     2012      %
    Sales                                       $ 290,097 100.0 $ 252,287 100.0
    Cost of sales                                 200,990  69.3   180,813  71.7
    Gross profit                                   89,107  30.7    71,474  28.3
    Selling, general and administrative expense    66,403  22.9    51,569  20.4
    Operating income                               22,704   7.8    19,905   7.9
    Interest expense                                1,627   0.5       829   0.3
    Other income                                        1     -      (15)     -
    Income before income taxes                     21,076   7.3    19,091   7.6
    Provision for income taxes                      7,844   2.7     7,445   3.0
    Net income                                   $ 13,232   4.6 $  11,646   4.6
    Per share amounts
     Basic earnings per share                    $   0.92       $    0.81
     Diluted earnings per share                  $   0.87       $    0.77


DXP is organized into three business segments: Service Centers, Supply Chain Services (SCS) and Innovative Pumping Solutions (IPS). The Service Centers are engaged in providing maintenance, repair and operating (MRO) products, equipment and integrated services, including technical expertise and logistics capabilities, to industrial customers with the ability to provide same day delivery. The Service Centers provide a wide range of MRO products and services in the rotating equipment, bearing, power transmission, hose, fluid power, metal working, industrial supply and safety product and service categories. The SCS segment manages all or part of our customer's supply chain, including inventory. The IPS segment fabricates and assembles custom-made integrated pump system packages.

Three Months Ended March 31, 2013 compared to Three Months Ended March 31, 2012

SALES. Sales for the three months ended March 31, 2013 increased $37.8 million, or 15.0%, to approximately $290.1 million from $252.3 million for the prior corresponding period. Sales by businesses acquired since March 31, 2012 accounted for $41.1 million of first quarter 2013 sales. Excluding first quarter 2013 sales from businesses acquired in 2012, on a same store sales basis, sales for the first quarter in 2013 decreased 1.3% from the prior corresponding period. This sales decrease is primarily the result of two less business days in the 2013 first quarter compared to the prior corresponding period.

GROSS PROFIT. Gross profit as a percentage of sales for the three months ended March 31, 2013 increased by 240 basis points compared with the prior corresponding period. This increase was primarily due to product mix as well as contributions made by acquired companies with higher gross profit margins.

SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative expense for the three months ended March 31, 2012 increased by approximately $14.8 million to $66.4 million from $51.6 million for the prior corresponding period. Selling, general and administrative expense for acquisitions that occurred since March 31, 2012 accounted for $12.2 million of the 2013 increase, on a same store sales basis. Excluding first quarter expenses from businesses acquired since March 31, 2012, on a same store sales basis, the increase primarily related to increased health insurance costs, salaries, and commissions. As a percentage of sales, the first quarter 2013 expense increased to 22.9%, from 20.4% for the prior corresponding period primarily as a result of businesses acquired in 2012 having higher selling, general, and administrative expenses as a percentage of sales combined with increased health insurance costs.

OPERATING INCOME. Operating income for the first quarter of 2013 increased $2.8 million, or 14.1% compared to the prior corresponding period. This increase in operating income is the result the 15% increase in sales.

INTEREST EXPENSE. Interest expense for the three months ended March 31, 2013 increased 96.3% from the prior corresponding period primarily due to the higher average outstanding balance of debt during the period. The increased debt was incurred to acquire additional businesses during 2012.

SERVICE CENTERS SEGMENT. Sales for the Service Centers segment increased by $35.0 million, or 20% for the first quarter of 2013 compared to the prior corresponding period. Excluding first quarter 2013 Service Centers segment sales from acquired businesses of $41.1 million, Service Centers segment sales for the first quarter of 2013 decreased 3.5% from the prior corresponding period, on a same store sales basis. This sales decrease is primarily the result of two less business days in the 2013 first quarter than the prior corresponding period. Operating income for the Service Centers segment increased 35%, primarily as a result of the 20% increase in sales along with a 310 basis point increase in gross profit as a percentage of sales. The increase in the gross profit percentage is primarily related to product mix and acquired companies that contributed higher gross profit margins.

INNOVATIVE PUMPING SOLUTIONS SEGMENT. Sales for the IPS segment increased by $2.1 million, or 5.3% for the first quarter of 2013 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 decreased 13.7% despite the increase in sales due to lower gross profit as a percentage of sales and increased selling and administrative expense. The gross profit margin declined as a result of product mix. Selling and administrative costs increased as a result of increased capacity.


SUPPLY CHAIN SERVICES SEGMENT. Sales for the SCS segment increased by $0.7 million, or 1.9%, for the first quarter of 2013 compared to the prior corresponding period. Operating income for the SCS segment increased 13.0% primarily as a result of an increase in gross profit as a percentage of sales. The increase in sales and gross profit as a percentage of sales is a result of new customers.

BUSINESS ACQUISITIONS AND SUPPLEMENTAL PRO-FORMA DATA

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 $3.7 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, water and waste water treatment, pharmaceutical and industrial markets. DXP paid approximately $8.1 million for Aledco which was borrowed under our existing credit facility. Goodwill of $3.4 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. Industrial Paramedic Services is headquartered in Calgary, Alberta and operates out of three locations in Calgary, Nisku and Dawson Creek. The $25.3 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. Estimated goodwill of $12.1 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 May 31, 2012, DXP acquired the stock of Austin and Denholm Industrial Sales Alberta, Inc. ("ADI"). DXP acquired this business to expand DXP's geographic presence in Western Canada and strengthen DXP's pump products and services offering. DXP paid approximately $2.7 million for ADI which was borrowed under our existing credit facility. Goodwill of $0.3 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 ADI 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 estimated goodwill is included in the Service Centers segment.

On July 11, 2012, DXP completed the acquisition of HSE Integrated Ltd. ("HSE"). DXP Canada Enterprises Ltd., 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 credit facility. DXP acquired HSE to expand our industrial health and safety services offering. Estimated goodwill of $27.6 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.

On October 1, 2012, DXP acquired substantially all of the assets of Jerzy Supply, Inc. ("Jerzy"). DXP acquired this business to expand DXP's geographic presence in the Southern U.S. and strengthen DXP's industrial and hydraulic hoses offering. DXP paid approximately $5.3 million for Jerzy which was borrowed under our existing credit facility. No goodwill was recognized on the purchase.

The value assigned to the non-compete agreements and customer relationships for business acquisitions were determined by discounting the estimated cash flows associated with non-compete agreements and customer relationships as of the date the acquisition was consummated. The estimated cash flows were based on estimated revenues net of operating expenses and net of capital charges for assets that contribute to the projected cash flow from these assets. The projected revenues and operating expenses were estimated based on management estimates. Net capital charges for assets that contribute to projected cash flow were based on the estimated fair value of those assets. Discount rates of 17.0% to 28.2% were deemed appropriate for valuing these assets and were based on the risks associated with the respective cash flows taking into consideration the acquired company's weighted average cost of capital.

For the three months ended March 31, 2013, businesses acquired during 2012 contributed sales of $43.4 million and earnings before taxes of approximately $1.9 million.


The following table summarizes the estimated fair values of the assets acquired and liabilities assumed during 2012 in connection with the acquisitions described above (in thousands):

                    Cash                            $  12,374
                    Accounts Receivable, net           34,949
                    Inventory                           4,051
                    Property and equipment             34,889
                    Goodwill and intangibles           75,489
                    Other assets                        2,698
                    Assets acquired                   164,450
                    Current liabilities assumed      (26,293)
                    Non-current liabilities assumed  (15,296)
                     Net assets acquired            $ 122,861

The pro forma unaudited results of operations for the Company on a consolidated basis for the three months ended March 31, 2013 and 2012, assuming the acquisition of businesses completed in 2012 were consummated as of January 1, 2012 are as follows (in thousands, except per share data):

                                         Three Months Ended
                                             March 31,
                                          2013        2012
                      Net sales         $ 290,097   $ 292,868
                      Net income        $  13,232   $  14,008
                      Per share data
                      Basic earnings   $     0.92   $    0.98
                      Diluted earnings $     0.87   $    0.92

LIQUIDITY AND CAPITAL RESOURCES

General Overview

As a distributor of MRO products 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, warehouse equipment and capital expenditures for our safety products and services category. We also require cash to pay our lease obligations and to service our debt.

The Company generated $16.9 million of cash in operating activities during the three months ended March 31, 2013 compared to $26.6 million during the prior corresponding period. This change between the two periods was primarily driven by changes in working capital.

During the three months ended March 31, 2013, the amount available to be borrowed under our credit agreement with our bank lender increased from $109.5 million at December 31, 2012 to $133.4 million at March 31, 2013. This increase in availability primarily resulted from pay down of debt.

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. On December 31, 2012 the Company amended the agreement which increased the Credit Facility by $75 million (the "Facility"). The Facility consists of a term loan and a revolving credit facility that provides a $262.5 million line of credit to the Company as of March 31, 2013. The term loan component of the facility was $124.8 million at March 31, 2013.


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 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 included as interest in the consolidated statements of income.

Primarily because the leverage ratio was higher after the acquisition of HSE that occurred on July 11, 2012, interest rates in effect on July 11, 2012 were approximately 70 basis points higher than they were immediately prior to the acquisition.

On March 31, 2013, the LIBOR based rate on the line of credit portion of the Facility was LIBOR plus 1.50%, the prime based rate of the Facility was prime plus 0.50%, the LIBOR based rate on the term loan portion of the Facility was LIBOR plus 1.75% and the commitment fee was 0.25%. At March 31, 2013, $208.8 million was borrowed under the Facility at a weighted average interest rate of approximately 1.82% under the LIBOR options and $8.0 million was borrowed at 3.5% under the prime option. At March 31, 2013, the Company had approximately $133.4 million available for borrowing under the Facility.

The 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 Consolidated Leverage Ratio, determined at the end of each fiscal quarter, not exceed 3.5 to 1.0 as of the last day of each quarter from the closing date through March 31, 2015 and not to exceed 3.25 to 1.00 from June 30, 2015 and thereafter. The Consolidated Leverage Ratio is defined as the outstanding indebtedness divided by Consolidated EBITDA for the period of four consecutive fiscal quarters ending on or immediately prior to such date. Indebtedness is defined under the Facility for financial covenant purposes as: (a) all obligations of DXP for borrowed money including but not limited to obligations evidenced by bonds, debentures, notes or other similar instruments; (b) obligations to pay deferred purchase price of property or services; (c) capital lease obligations; (d) obligations under conditional sale or other title retention agreements relating to property purchased; (e) issued and outstanding letters of credit; and (f) contingent obligations for funded indebtedness. At March 31, 2013, the Company's Leverage Ratio was 1.76 to 1.00.

Consolidated Fixed Charge Coverage Ratio -The Facility requires that the Consolidated Fixed Charge Coverage Ratio on the last day of each quarter be not less than 1.25 to 1.0 with "Consolidated Fixed Charge Coverage Ratio" defined as the ratio of (a) Consolidated EBITDA for the period of 4 consecutive fiscal quarters ending on such date minus capital expenditures during such period (excluding acquisitions) minus income tax expense paid minus the aggregate amount of restricted payments defined in the agreement to (b) the interest expense paid in cash, scheduled principal payments in respect of long-term debt and the current portion of capital lease obligations for such 12-month period, determined in each case on a consolidated basis for DXP and its subsidiaries. At March 31, 2013, the Company's Consolidated Fixed Charge Coverage Ratio was 2.87 to 1.00.

Asset Coverage Ratio -The credit facility requires that the Asset Coverage Ratio at any time be not less than 1.0 to 1.0 with "Asset Coverage Ratio" defined as the ratio of (a) the sum of 85% of net accounts receivable plus 65% of net inventory to (b) the aggregate outstanding amount of the revolving credit outstandings on such date. At March 31, 2013, the Company's Asset Coverage Ratio was 2.44 to 1.00.

Consolidated EBITDA as defined under the Facility for financial covenant purposes means, without duplication, for any period the consolidated net income of DXP plus, to the extent deducted in calculating consolidated net income, depreciation, amortization (except to the extent that such non-cash charges are reserved for cash charges to be taken in the future), non-cash compensation including stock option or restricted stock expense, interest expense and income tax expense for taxes based on income, certain one-time costs associated with our acquisitions, integration costs, facility consolidation and closing costs, severance costs and expenses and one-time compensation costs in connection with the acquisition of HSE and any permitted acquisition, write-down of cash expenses incurred in connection with the existing credit agreement and extraordinary losses less interest income and extraordinary gains. Consolidated EBITDA shall be adjusted to give pro forma effect to disposals or business acquisitions assuming that such transaction(s) had occurred on the first day of the period excluding all income statement items attributable to the assets or equity interests that is subject to such disposition made during the period and including all income statement items attributable to property or equity interests of such acquisitions permitted under the Facility.


The following table sets forth the computation of the Leverage Ratio as of March 31, 2013 (in thousands, except for ratios):

                    For the Twelve Months ended    Leverage
                    March 31, 2013                  Ratio

                    Income before taxes            $  86,994
                    Interest expense                   6,358
                    Depreciation and amortization     19,823
                    Stock compensation expense         2,248
                    Pro forma acquisition EBITDA       8,585
                    Other adjustments                  1,709
                    (A) Defined EBITDA             $ 125,717

                    As of March 31, 2013
                    Total long-term debt           $ 220,288
                    Letters of credit outstanding        423
                    (B) Defined indebtedness       $ 220,711

                    Leverage Ratio (B)/(A)              1.76



Borrowings (in thousands):

                                March 31,       December 31,         Increase
                                  2013              2012            (Decrease)
     Current portion of
     long-term debt            $     22,057      $     22,057      $           -
     Long-term debt, less
. . .
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