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DXP ENTERPRISES INC - 10-Q - : MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
[November 07, 2014]

DXP ENTERPRISES INC - 10-Q - : MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS


(Edgar Glimpses Via Acquire Media NewsEdge) 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 September 30, 2014 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", "might", "estimates", "will", "should", "could", "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, 2014. 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 September 30, Nine Months Ended September 30, 2014 % 2013 % 2014 % 2013 % Sales $387,053 100.0 $329,719 100.0 $1,117,160 100.0 $927,758 100.0 Cost of sales 273,644 70.7 232,598 70.5 790,998 70.8 650,015 70.1 Gross profit 113,409 29.3 97,121 29.5 326,162 29.2 277,743 29.9 Selling, general and 204,876 22.1 administrative expense 81,605 21.1 70,223 21.3 243,798 21.8 Operating income 31,804 8.2 26,898 8.2 82,364 7.4 72,867 7.8 Interest expense 3,295 0.8 1,614 0.5 9,868 0.9 4,930 0.5 Other expense 1 0.0 (16) - (income), net 10 0.0 (38) - Income before income taxes 28,499 7.4 25,322 7.7 72,495 6.5 67,953 7.3 Provision for income taxes 10,856 2.8 8,970 2.7 27,695 2.5 24,620 2.6 Net income $17,643 4.6 $ 16,352 5.0 $ 44,800 4.0 $ 43,333 4.7 Per share amounts Basic earnings per share $ 1.20 $ 1.13 $ 3.04 $ 3.00 Diluted earnings $ 2.88 $ 2.84 per share $ 1.14 $ 1.07 14-------------------------------------------------------------------------------- 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 integrated pump system packages custom made to customer specifications.

Three Months Ended September 30, 2014 compared to Three Months Ended September 30, 2013 SALES. Sales for the three months ended September 30, 2014 increased $57.3 million, or 17.4%, to approximately $387.1 million from $329.7 million for the prior corresponding period. Sales by businesses acquired accounted for $46.4 million of the third quarter increase. Excluding third quarter 2014 sales from businesses acquired, on a same store sales basis, sales for the third quarter in 2014 increased by $11.0 million, or 3.3% from the prior corresponding period.

This sales increase is primarily the result of increases in our Service Center and SCS segments of $5.8 and $7.3 million, respectively, on a same store sales basis. These increases in sales were partially offset by a decrease of $2.2 million within our IPS segment, on a same store sales basis. These variances are explained in segment discussions below.

GROSS PROFIT. Gross profit as a percentage of sales for the three months ended September 30, 2014 decreased by approximately 20 basis points from the prior corresponding period in total, and on a same store sales basis. Declines in gross profit as a percentage of sales for the Service Center and SCS segments were partially offset by an increase in the percentage for the IPS segment.

These fluctuations are discussed below.

SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative expense (SG&A) for the three months ended September 30, 2014 increased by approximately $11.4 million, or 16.2% to $81.6 million from $70.2 million for the prior corresponding period. Selling, general and administrative expense from businesses acquired accounted for $8.1 million of the third quarter increase.

Excluding third quarter expenses from businesses acquired, on a same store sales basis, SG&A for the quarter increased by $3.3 million, or 4.7%. This increase is primarily related to a $1.1 million increase in health care claims. Excluding the increases in health care claims, the 3.1% increase in SG&A on a same store sales basis is consistent with the 3.3% increase in sales on a same store sales basis. As a percentage of sales, the third quarter 2014 expense decreased approximately 20 basis points to 21.1%, from 21.3% for the prior corresponding period primarily as a result of B27 and other businesses acquired in 2014 having lower SG&A as a percent of sales than the remainder of DXP.

OPERATING INCOME. Operating income for the third quarter of 2014 increased $4.9 million, or 18.2% compared to the prior corresponding period. This increase in operating income is primarily the result of the 17.4% increase in sales discussed above. Operating income from businesses acquired (primarily B27) accounted for $5.6 million of this increase. Excluding operating income from businesses acquired, on a same store sales basis, operating income decreased $0.7 million, or 2.6% from the prior corresponding period. This is primarily related to increased SG&A expenses discussed above.

INTEREST EXPENSE. Interest expense for the third quarter of 2014 increased 104.2% from the prior corresponding period primarily due to increased borrowings to fund our January 2, 2014 acquisition of B27, LLC and our May 1, 2014 acquisition of Machinery Tooling and Supply, LLC., further discussed in the Business Acquisitions and Supplemental Pro-forma Data section herein. The increased borrowings for the acquisitions also increased the interest rate on our borrowings.

INCOME TAXES. Our provision for income taxes differs from the U.S. statutory rate of 35% primarily due to state income taxes and non-deductible expenses. The effective tax rate for the third quarter of 2014 increased to 38.1% from 35.4% in the prior corresponding period primarily as a result of increased accruals for state income taxes.

15 -------------------------------------------------------------------------------- SERVICE CENTERS SEGMENT. Sales for the Service Centers segment increased by $22.5 million, or 9.7% for the third quarter of 2014 compared to the prior corresponding period. Excluding third quarter 2014 Service Centers segment sales from acquired businesses of $16.7 million, Service Centers segment sales for the third quarter in 2014 increased $5.8 million, or 2.5% from the prior corresponding period, on a same store sales basis. This sales increase is primarily the result of increased sales of rotating equipment to oil and gas related customers. We believe our oil and gas related customers increased purchases of rotating equipment primarily because of increased oil production in the U.S. This is not the result of a known trend. As a percentage of sales, third quarter gross profit percentage for the Service Centers segment decreased approximately 70 basis points from the prior corresponding period. This decline was primarily the result of acquired businesses having lower margins than the remainder of DXP. Excluding third quarter Service Centers segment results of acquired businesses, gross profit percentage decreased approximately 20 basis points. This decrease is primarily the result of an estimated $1.4 million decline in sales of higher margin safety service work primarily related to work over rigs. We believe a customer purchased fewer safety services because of a desire to eliminate costs. This decline is not considered to be the result of a known trend. However, we do not know when we will be able to replace all of this work. Operating income for the Service Centers segment increased $1.9 million, or 6.9%. Excluding third quarter Service Centers segment operating income from acquired businesses of $1.4 million, Service Centers segment operating income for the third quarter in 2014 increased by $0.5 million, or 1.8% primarily as a result of the increase in sales discussed above.

INNOVATIVE PUMPING SOLUTIONS SEGMENT. Sales for the IPS segment increased by $27.5 million, or 45.0% for the third quarter of 2014 compared to the prior corresponding period. Excluding third quarter 2014 IPS segment sales from an acquired business (B27) of $29.7million, IPS segment sales for the third quarter in 2014 decreased $2.2 million, or 3.5% from the prior corresponding period, on a same store sales basis. This decrease was primarily the result of timing of orders received from our customers and timing of our receipt of components from our vendors. This decline is not considered to be a result of a known trend.

Operating income for the IPS segment increased $5.9 million, or 65.4%, primarily as a result of the 45.0% increase in sales. Excluding operating income from acquired businesses of $5.8 million, operating income increased $0.1 million on a same store sales basis.

SUPPLY CHAIN SERVICES SEGMENT. Sales for the SCS segment increased by $7.3 million, or 20.2%, for the third quarter of 2014 compared to the prior corresponding period. The increase in sales is primarily related to increased sales to five customers in the gas turbine, oil and gas, and trucking industries that amounted to approximately $4.2 million of this increase. We suspect these customers purchased more products from DXP because the customers increased production during the period. The remainder of the increase was primarily the result of obtaining a new customer in the oil and gas industry as well as increased sales in the food and beverage industry. Operating income for the SCS segment increased 16.2% primarily as a result of the 20.2% increase in sales.

Nine Months Ended September 30, 2014 compared to Nine Months Ended September 30, 2013 SALES. Sales for the nine months ended September 30, 2014 increased $189.4 million, or 20.4%, to approximately $1,117.2 million from $927.8 million for the prior corresponding period. Sales by businesses acquired accounted for $160.4 million of the third quarter increase. Excluding 2014 sales from businesses acquired, on a same store sales basis, sales for the nine months ended September 30, 2014 increased by $29.0 million, or 3.1% from the prior corresponding period. This sales increase is primarily the result of increased sales by the Service Centers segment of $14.1 million, IPS segment of $3.5 million, and SCS segment of $11.4 million, on a same store sales basis. These increases are explained in the segment discussions below.

GROSS PROFIT. Gross profit as a percentage of sales for the nine months ended September 30, 2014 decreased by approximately 70 basis points compared with the prior corresponding period. This decrease was primarily the result of businesses acquired in 2014 having a lower gross profit percentage of 26.3% than the 29.7% gross profit percentage for the remainder of DXP. On a same store sales basis, gross profit as a percentage of sales for the nine months ended September 30, 2014 decreased by approximately 30 basis points compared with the prior corresponding period. This decline is primarily the result of an estimated $9.2 million decline in sales of higher margin safety services work primarily related to work over rigs in the U.S. and drilling and well completions in Canada. We believe our customers purchased fewer services because of eliminating costs in the U.S. and limitations on the ability to transport oil to markets in Canada.

This decline is not considered to be the result of a known trend. However, we do not know when we will be able to replace all of this work.

16 -------------------------------------------------------------------------------- SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative expense (SG&A) for the nine months ended September 30, 2014 increased by approximately $38.9 million to $243.8 million from $204.9 million for the prior corresponding period. Selling, general and administrative expense from businesses acquired accounted for $31.7 million of the year-to-date increase. Excluding expenses from businesses acquired, on a same store sales basis, SG&A year-to-date increased by $7.2 million, or 3.5%. This increase is partially related to a $2.3 million increase in health care claims. The remaining $4.9 million increase is consistent with the 3.1% increase in sales on a same store sales basis discussed above. As a percentage of sales, the year-to-date 2014 expense remained consistent with the prior corresponding period, on a same store sales basis.

OPERATING INCOME. Operating income for the nine months ended September 30, 2014 increased $9.5 million, or 13.0% compared to the prior corresponding period.

This increase in operating income is primarily the result of the 20.4% increase in sales discussed above. Business acquired in 2013 and 2014 (primarily B27) accounted for $10.6 million of the increase in operating income. Excluding operating income from businesses acquired, operating income decreased $1.1 million, or 1.5%. This decrease in operating income, on a same store sales basis, is primarily related to the increase in SG&A previously discussed.

INTEREST EXPENSE. Interest expense for the nine months ended September 30, 2014 increased 100.2% from the prior corresponding period primarily due to increased borrowings to fund our January 2, 2014 acquisition of B27, LLC and out May 1, 2014 acquisition of Machinery Tooling and Supply, LLC., further discussed in the Business Acquisitions and Supplemental Pro-forma Data section herein. The increased borrowings for the acquisitions also increased the interest rate on our borrowings.

INCOME TAXES. Our provision for income taxes differs from the U.S. statutory rate of 35% primarily due to state income taxes and non-deductible expenses. The effective tax rate for the nine months ended September 30, 2014 increased to 38.2% from 36.2% in the prior corresponding period primarily as a result of increased accruals for state income taxes.

SERVICE CENTERS SEGMENT. Sales for the Service Centers segment increased by $74.6 million, or 11.3% for the first nine months of 2014 compared to the prior corresponding period. Excluding year-to-date 2014 Service Centers segment sales from acquired businesses of $60.5 million, Service Centers segment sales for the first nine months in 2014 increased $14.1 million, or 2.1% from the prior corresponding period, on a same store sales basis. This sales increase is primarily the result of increased sales of pumps to oil and gas related customers. We believe our oil and gas related customers increased purchases of rotating equipment primarily because of increased oil production in the U.S.

Operating income for the Service Centers segment increased $3.4 million, or 4.5%. Excluding year-to-date Service Centers segment operating income from acquired businesses of $5.8 million, Service Centers segment operating income for the first nine months in 2014 decreased by $2.4 million, or 3.2% primarily as a result of an approximate 80 basis point decline in the gross profit percentage for the segment on a same store sales basis. The decline in gross profit as a percentage of sales, on a same store sales basis, is primarily the result of an estimated $9.2 million decline in sales of higher margin safety services work primarily related to work over rigs in the U.S. and drilling and well completions in Canada. We believe our customers purchased fewer safety services because of eliminating costs in the U.S. and limitations on the ability to transport oil to markets in Canada. This decline is not considered to be the result of a known trend. However, we do not know when we will be able to replace all of this work.

INNOVATIVE PUMPING SOLUTIONS SEGMENT. Sales for the IPS segment increased by $103.5 million, or 66.5% for the first nine months of 2014 compared to the prior corresponding period. Excluding year-to-date 2014 IPS segment sales from acquired businesses of $100.0 million, IPS segment sales for the first nine months in 2014 increased $3.5 million, or 2.3% from the prior corresponding period, on a same store sales basis. The sales increase primarily resulted from an increase in capital spending by our oil and gas related customers. Operating income for the IPS segment increased by $16.1 million, or 66.2%, primarily as a result of the 66.5% increase in sales. While B27 generated $11.9 million of the increase in operating income, the increase was partially offset by NatPro's operating loss of $1.0 million. Excluding operating income from acquired businesses of $10.9 million, operating income increased $5.1 million, or 21.2% on a same store sales basis. This increase was primarily the result of the increase in sales as well as an approximate 260 basis point increase in gross profit margins. The increased gross profit as a percentage of sales for the IPS segment, on a same store sales basis, is the result of improved margins on sales of pump packages to mid-stream oil and gas customers. We believe our mid-stream oil and gas related customers increased purchases of pump packages primarily because of increased oil production in the U.S. Gross profit margins for individual orders for the IPS segment can fluctuate significantly because each order is for a unique package which is built to unique customer specifications.

This improvement is not the result of a known trend.

17 -------------------------------------------------------------------------------- SUPPLY CHAIN SERVICES SEGMENT. Sales for the SCS segment increased by $11.4 million, or 10.2%, for the first nine months of 2014 compared to the prior corresponding period. The increase in sales is primarily related to increased sales to five customers in the oil and gas, general manufacturing, automotive, and food and beverage industries that amounted to approximately $10.5 million of this increase. We suspect these customers purchased more products from DXP because the customers increased production during the period.

Operating income for the SCS segment increased 9.2% primarily as a result of the 10.2% increase in sales.

BUSINESS ACQUISITIONS AND SUPPLEMENTAL PRO-FORMA DATA A key component of our growth strategy includes completing acquisitions of businesses with complementary or desirable product lines, locations or customers. Since 2004, we have completed 29 acquisitions across our three business segments. Below is a summary of recent acquisitions.

On April 16, 2013, DXP acquired all of the stock of National Process Equipment Inc. ("NatPro") through its wholly owned subsidiary, DXP Canada Enterprises Ltd.

DXP acquired this business to expand DXP's geographic presence in Canada and strengthen DXP's pump, integrated system packaging, compressor, and related equipment offering. The $40.0 million purchase price was financed with $36.6 million of borrowings under DXP's existing credit facility and 52,542 shares of DXP common stock. Additionally, the purchase agreement included an earn-out provision, which stated that former owners of NatPro may earn CDN $6.0 million based on achievement of an earnings target during the first year of DXP's ownership. The fair value of the earn-out recorded at the acquisition date was $2.8 million. As of December 31, 2013 the $2.8 million accrued liability associated with this earn-out provision was reversed and included in 2013 operating income. No earn-out was earned through its expiration on April 16, 2014.

On May 17, 2013, DXP acquired substantially all of the assets of Tucker Tool Company, Inc. ("Tucker Tool"). DXP acquired this business to expand DXP's geographic presence in the northern U.S. and strengthen DXP's industrial cutting tools offering. DXP paid approximately $5.0 million for Tucker Tool which was borrowed under our existing credit facility.

On July 1, 2013, DXP acquired all of the stock of Alaska Pump & Supply, Inc.

(APS). DXP acquired this business to expand DXP's geographic presence in Alaska.

DXP paid approximately $13.0 million for APS which was borrowed under our existing credit facility.

On July 31, 2013, DXP acquired substantially all of the assets of Tool-Tech Industrial Machine & Supply, Inc. ("Tool-Tech"). DXP acquired this business to enhance our metal working product offering in the southwest region of the United States. DXP paid approximately $7.6 million for Tool-Tech which was borrowed under our existing credit facility.

On January 2, 2014, the Company acquired all of the equity securities and units of B27, LLC ("B27"). DXP acquired this business to expand DXP's pump packaging offering. The total transaction value was approximately $293.6 million, excluding approximately $1.0 million in transaction costs. The purchase price was financed with borrowings under DXP's amended credit facility and approximately $4.0 million (36,000 shares) of DXP common stock.

On May 1, 2014, the Company completed the acquisition of all of the equity interests of Machinery Tooling and Supply, LLC (MT&S) by way of an Equity Purchase Agreement to expand DXP's cutting tools offering in the North Central region of the United States. DXP paid approximately $14.7 million for MT&S, which was borrowed under our existing credit facility.

18 -------------------------------------------------------------------------------- For the three months ended September 30, 2014, businesses acquired during 2014 and 2013 contributed sales of $45.3 million and $25.2 million, respectively, and earnings before taxes of approximately $3.4 million and $0.6 million, respectively.

For the nine months ended September 30, 2014, businesses acquired during 2014 and 2013 contributed sales of $125.4 million and $75.3million, respectively, and earnings before taxes of approximately $4.3 million and $0.2 million, respectively.

The following table summarizes the estimated fair values of the assets acquired and liabilities assumed during 2013 and 2014 in connection with the acquisitions described above (in thousands): NatPro Tucker Tool APS Tool-Tech B27 MT&S Total Cash $ - $ - $ - $ 430 $ 2,538 $ 806 $ 3,774 Accounts Receivable, net 14,549 505 1,424 1,505 51,448 5,656 75,087 Inventory 6,883 209 1,332 409 6,472 2,522 17,827 Property and equipment 3,317 - 172 19 14,573 557 18,638 Goodwill and intangibles 39,345 4,678 12,241 7,254 262,250 8,405 334,173 Other assets 698 - 389 2 1,163 59 2,311 Assets acquired 64,792 5,392 15,558 9,619 338,444 18,005 451,810 Current liabilities assumed 19,175 391 1,079 1,987 26,690 3,336 52,658 Non-current liabilities assumed 5,649 - 1,419 - 18,202 - 25,270 Net assets acquired $ 39,968 $ 5,001 $ 13,060 $ 7,632 $ 293,552 $14,669 $ 373,882 The pro forma unaudited results of operations for the Company on a consolidated basis for the three and nine months ended September 30, 2014 and 2013, assuming the acquisition of businesses completed in 2014 and 2013 were consummated as of January 1, 2013 are as follows (in thousands, except per share data): Three Months Ended Nine Months Ended September 30, September 30, 2014 2013 2014 2013 Net sales $ 387,053 $ 391,515 $ 1,130,108 $ 1,122,403 Net income $ 17,643 $ 20,988 $ 45,103 $ 50,947 Per share data Basic earnings $ 1.20 $ 1.45 $ 3.07 $ 3.51 Diluted earnings $ 1.14 $ 1.37 $ 2.90 $ 3.32 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 for information technology, warehouse equipment and safety services equipment. We also require cash to pay our lease obligations and to service our debt.

The Company generated $62.9 million of cash in operating activities during the nine months ended September 30, 2014 compared to $ 67.7 million during the prior corresponding period. This change between the two periods was primarily driven by changes in working capital. During the nine months ended September 30, 2014, the amount available to be borrowed under our credit agreement with our bank lender decreased from $154.1 million at December 31, 2013 to $77.4 million at September 30, 2014.

19 -------------------------------------------------------------------------------- This decrease in availability primarily resulted from the acquisition of B27 and the January 2, 2014 amendment and restatement of our credit facility.

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 (as amended, the "Original Facility"). On December 31, 2012, the Company amended the Original Facility which increased the Original Facility by $75 million. On January 2, 2014, the Company entered into an Amended and Restated Credit Agreement with Wells Fargo Bank, National Association, as Issuing Lender and Administrative Agent for other lenders (the "Facility"), amending and restating the Original Facility.

The Facility provides a term loan and a $350 million revolving line of credit to the Company. At September 30, 2014 the term loan component of the facility was $221.9 million.

The Facility provides the option of interest at LIBOR (or CDOR for Canadian dollar loans) plus an applicable margin ranging from 1.25% to 2.50% or prime plus an applicable margin from 0.25% to 1.50% where the applicable margin is determined by the Company's leverage ratio as defined by the Facility as of the last day of the fiscal quarter most recently ended prior to the date of borrowing. Commitment fees of 0.20% to 0.45% 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.

On September 30, 2014, the LIBOR based rate of the Facility was LIBOR plus 2.25%, the prime based rate of the Facility was prime plus 1.25%, and the commitment fee was 0.40%. At September 30, 2014, $443.6 million was borrowed under the Facility at a weighted average interest rate of approximately 2.41% under the LIBOR options. At September 30, 2014, the Company had approximately $77.4 million available for borrowing under the Facility.

The Facility expires on January 2, 2019. 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. Substantially all of the Company's assets are pledged as collateral to secure the credit facility.

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 3.75 to 1.0 as of the last day of each quarter from the closing date through June 30, 2014, not exceed 3.50 to 1.00 at September 30, 2014, and not to exceed 3.25 to 1.00 from December 31, 2014 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 September 30, 2014, the Company's Leverage Ratio was 2.92 to 1.00. This decrease in the Leverage Ratio will result in a 25 basis point reduction in the interest rates under the Facility beginning during November, 2014. The commitment fee will decrease from 0.40% to 0.35% at the same time.

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 September 30, 2014, the Company's Consolidated Fixed Charge Coverage Ratio was 2.11 to 1.00.

20 -------------------------------------------------------------------------------- Asset Coverage Ratio - The credit facility requires that the Asset Coverage Ratio at any time, beginning on December 31, 2014, 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 outstanding on such date. At September 30, 2014, the Company's Asset Coverage Ratio was 1.34 to 1.00. The Asset Coverage Ratio does not apply until December 31, 2014.

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 September 30, 2014 (in thousands, except for ratios): For the Twelve Months ended Leverage September 30, 2014 Ratio Income before taxes $ 99,259 Interest expense 11,220 Depreciation and amortization 28,798 Stock compensation expense 3,337 Pro forma acquisition EBITDA 11,701 Other adjustments (338) (A) Defined EBITDA $ 153,977 As of September 30, 2014 Total long-term debt $ 449,612 (B) Defined indebtedness $ 449,612 Leverage Ratio (B)/(A) 2.92 The following table sets forth the computation of the Asset Coverage Ratio as of September 30, 2014 (in thousands, except for ratios): Credit facility $ 221,763 Letters of credit 6,048 Defined indebtedness $ 227,811 Accounts receivable, net 269,537 85% $ 229,106 Inventory, net 117,051 65% 76,083 $ 305,189Asset Coverage Ratio (Assets/Defined indebtedness) 21 -------------------------------------------------------------------------------- Borrowings (in thousands): September 30, December 31, Increase 2014 2013 (Decrease) Current portion of long-term debt $ 38,816 $ 26,213 $ 12,603 Long-term debt, less current portion 410,796 168,372 242,424 Total long-term debt $ 449,612 $ 194,585 $ 255,027 (2) Amount available $ (76,746) $ 77,378(1) $ 154,124(1) (3) (1) Represents amount available to be borrowed at the indicated date under the Facility.

(2) The increase in total long-term debt is primarily the result of funds borrowed to acquire B27.

(3) The decrease in the amount available is primarily the result of the acquisition of B27 and the January 2, 2014 amendment to and restatement of the Original Facility.

Performance Metrics (in days): Three Months Ended September 30, Increase 2014 2013 (Decrease) Days of sales outstanding 66.7 57.2 9.5 Inventory turns 9.3 8.4 0.9 Accounts receivable days of sales outstanding were 66.7 days at September 30, 2014 compared to 57.2 days at September 30, 2013. The 9.5 days increase was primarily from our B27 acquisition that has more days sales in receivables.

Inventory turns were 9.3 times compared to 8.4 times at September 30, 2013. The slight increase is primarily related to our acquisition of B27 that has higher inventory turns.

Funding Commitments We believe our cash generated from operations and cash available under our 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 debt or equity securities. In connection with any such financing, we may issue securities that substantially dilute the interests of our shareholders. We may not be able to obtain additional financing on attractive terms, if at all.

Share Repurchases On May 7, 2014, the Board of Directors authorized DXP from time to time to purchase up to 200,000 shares of DXP's common stock over 24 months. DXP publicly announced the authorization on May 14, 2014. Purchases could be made in open market or in privately negotiated transactions. DXP has purchased 100,000 shares for $6.8 million under this authorization as of September 30, 2014.

Acquisitions All of the Company's acquisitions have been accounted for using the purchase method of accounting. Revenues and expenses of the acquired businesses have been included in the accompanying consolidated financial statements beginning on their respective dates of acquisition. The allocation of purchase price to the acquired assets and liabilities is based on estimates of fair market value.

22 -------------------------------------------------------------------------------- DISCUSSION OF SIGNIFICANT ACCOUNTING AND BUSINESS POLICIES Critical accounting and business 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. These policies have been discussed with the Audit Committee of the Board of Directors of DXP.

The Company's financial statements are prepared in accordance with accounting principles generally accepted in the United States of America ("USGAAP"). The accompanying consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. The accompanying unaudited condensed consolidated financial statements have been prepared on substantially the same basis as our annual consolidated financial statements and should be read in conjunction with our annual report on Form 10-K for the year ended December 31, 2013. For a more complete discussion of our significant accounting policies and business practices, refer to the consolidated annual report on Form 10-K filed with the Securities and Exchange Commission on March 11, 2014.

RECENT ACCOUNTING PRONOUNCEMENTS In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606), which provides guidance on revenue recognition. The core principal of this guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. This guidance requires entities to apply a five-step method to (1) identify the contract(s) with customers; (2) identify the performance obligation(s) in the contract; (3) determine the transaction price; (4) allocate the transaction price to the performance obligation(s) in the contract; and (5) recognize revenue when (or as) the entity satisfies a performance obligation. This pronouncement is effective for fiscal years, and interim periods within those years, beginning after December 15, 2016. We are evaluating the impact that the adoption of this standard will have on our consolidated financial statements.

In July 2013, the FASB issued ASU 2013-11, Income Taxes (Topic 740), which requires entities to present unrecognized tax benefits as a liability and not combine it with deferred tax assets to the extent a net operating loss carry-forward, a similar tax loss, or a tax credit carry-forward is not available at the reporting date. ASU 2013-11 is effective for fiscal years beginning after December 15, 2013. DXP adopted this guidance in the first quarter of 2014. There was no material effect on our financial statements.

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