Business Context and Reporting Period
DXP Enterprises, Inc. distributes maintenance, repair and operating products, equipment and services to industrial customers. Its segments are Service Centers, Innovative Pumping Solutions (IPS), and Supply Chain Services (SCS). This unaudited Form 10-Q covers the three months ended March 31, 2014, compared with the three months ended March 31, 2013.
Key Financial Metrics
| Metric | Q1 2014 | Q1 2013 | Change |
|---|---|---|---|
| Sales | $348.5 million | $290.1 million | 20.1% increase |
| Gross profit | $101.7 million | $89.1 million | 14.1% increase |
| Gross margin | 29.2% | 30.7% | Down 1.5 percentage points |
| Operating income | $22.2 million | $22.7 million | 2.4% decrease |
| Operating margin | 6.4% | 7.8% | Down 1.4 percentage points |
| Net income | $11.6 million | $13.2 million | 12.2% decrease |
| Diluted EPS | $0.75 | $0.87 | 13.8% decrease |
| Operating cash flow | $20.7 million | $16.9 million | 21.9% increase |
Cash was $12.1 million at March 31, 2014, compared with $5.5 million at December 31, 2013. Accounts receivable were $250.3 million and inventories were $110.7 million. Days sales outstanding increased to 67.0 days from 61.1 days, while inventory turns improved to 9.0 from 8.2.
Total debt was $470.5 million, including $39.1 million of current maturities, compared with $194.6 million at December 31, 2013. The company had approximately $113.4 million available under its credit facility, down from $154.1 million at year-end. The facility included a $240.6 million term loan and a $350 million revolving line of credit. Borrowings under the facility totaled approximately $463.6 million at a weighted-average interest rate of approximately 2.16% under LIBOR-based options.
At March 31, 2014, the consolidated leverage ratio was 2.99 to 1.00 against a covenant limit of 3.75 to 1.00, and the fixed charge coverage ratio was 2.46 to 1.00 against a minimum of 1.25 to 1.00. A 100-basis-point change in floating interest rates would affect annual interest expense by approximately $4.6 million.
Material Changes Versus the Prior Comparable Period
- Sales increased primarily because of acquisitions, which contributed $53.4 million of the $58.4 million increase. Same-store sales increased 1.7%, primarily reflecting one additional business day.
- The January 2, 2014 acquisition of B27 contributed approximately $30.4 million of first-quarter sales and was financed primarily with new debt. The transaction value was approximately $293.6 million, excluding approximately $1.0 million of transaction costs.
- Goodwill increased to $374.1 million from $188.1 million at year-end, and other intangible assets increased to $145.3 million from $69.7 million, largely due to the B27 acquisition.
- Gross margin declined because acquired businesses had lower margins and because of customer and product mix changes in Service Centers.
- SG&A increased $13.1 million to $79.5 million, substantially reflecting acquired businesses. SG&A as a percentage of sales declined modestly to 22.8% from 22.9%.
- Interest expense more than doubled to $3.4 million because of acquisition-related borrowings and higher borrowing levels.
- Service Centers sales increased 10.1%, but same-store sales increased only 0.1% and segment operating income declined 2.5%. IPS sales increased 92.4%, including substantial acquisition contribution, while SCS sales declined 2.8% because of weakness among automotive and truck manufacturing customers.
- Net cash used in investing activities was $290.4 million, including $287.0 million for acquisitions. Financing activities provided $276.6 million, including $380.4 million of debt proceeds.
Guidance, Outlook, Risks and Unusual Items
The filing does not provide specific quantitative revenue or earnings guidance. Management states that operating cash flow and remaining credit availability are expected to meet normal working-capital needs for the next twelve months, but additional debt or equity financing may be required for potential acquisitions. Such financing may be unavailable or may dilute shareholders.
Management identifies risks related to execution of internal and acquisition growth strategies, integration of acquired businesses, economic conditions affecting industrial customers, regulation, pricing and market conditions, and interest-rate volatility. The company’s assets substantially collateralize its credit facility, which expires January 2, 2019 and contains leverage, fixed-charge coverage and other covenants.
Acquired businesses generated approximately $23.0 million of sales and a $0.8 million pretax loss from 2013 acquisitions, and $30.4 million of sales and a $1.5 million pretax loss from the 2014 acquisition during the quarter. Purchase-price allocations for B27 remain preliminary, including estimated goodwill of $186.0 million and intangible assets of $81.1 million.
On May 1, 2014, after the reporting period, DXP acquired substantially all of the equity interests of Machinery Tooling & Supply, LLC for approximately $14.9 million, financed under the credit facility. The company reports no material changes to previously disclosed risk factors, no material adverse expected effect from ordinary-course litigation, and effective disclosure controls.
Investor Verification Items
- Verify the preliminary valuation, goodwill, intangible assets, and earnings contribution of the B27 acquisition, including potential future purchase-price adjustments or impairment risk.
- Monitor leverage, covenant headroom, credit availability, refinancing needs, and sensitivity to floating interest rates.
- Assess whether lower acquired-business margins and higher amortization and interest costs could continue to pressure consolidated earnings.
- Evaluate working-capital trends, particularly the increase in accounts-receivable days and the company’s ability to convert earnings into cash.
- Review the sustainability of IPS growth and the weakness in SCS customers serving automotive and truck manufacturing industries.
- Confirm the financing and subsequent accounting effects of the May 1, 2014 MT&S acquisition.