DXP Enterprises, Inc. — Form 10-Q Summary
Business context and reporting period
DXP distributes maintenance, repair and operating products and services to energy and industrial customers. It also provides engineered pump packages, pump remanufacturing and private-label pump manufacturing. Reportable segments are Service Centers, Innovative Pumping Solutions and Supply Chain Services. This unaudited Form 10-Q covers the three and nine months ended September 30, 2018, compared with the corresponding 2017 periods.
Financial performance and position
| Metric | Three months ended September 30 | Nine months ended September 30 |
|---|---|---|
| Sales | $308.0 million, up 22.3% | $905.2 million, up 22.1% |
| Gross profit | $84.1 million; 27.3% margin | $245.6 million; 27.1% margin |
| Income from operations | $16.8 million; 5.5% margin | $48.0 million; 5.3% margin |
| Net income attributable to DXP | $8.4 million | $24.5 million |
| Diluted EPS | $0.46 | $1.33 |
| Operating cash flow | Not separately provided | $9.8 million |
At September 30, 2018, cash and restricted cash totaled approximately $16.4 million. Accounts receivable were $183.5 million and inventories were $116.5 million. Total assets were $681.8 million and total equity was $297.4 million.
Total debt was approximately $249.6 million before unamortized debt issuance costs, consisting primarily of a $247.5 million Term Loan B and a $2.1 million promissory note. There were no ABL Revolver borrowings, and approximately $79.9 million of borrowing capacity was available. DXP was in compliance with its financial covenants. The Term Loan B interest rate was 7.0% at quarter-end.
Cash flow from operations of $9.8 million was offset by $16.0 million of investing outflows and $3.0 million of financing outflows, resulting in a $9.2 million decrease in cash during the nine-month period. Investing outflows included $10.8 million for the ASI acquisition and $7.7 million of capital expenditures. Days sales outstanding improved to 58.3 days from 63.2 days, while inventory turns were 7.6 versus 8.5.
Material changes versus the prior comparable period
- Third-quarter sales increased $56.1 million, with approximately $12.1 million attributable to the ASI acquisition. Excluding ASI, sales increased 17.5%.
- Nine-month sales increased $164.0 million, including $35.0 million from ASI. Excluding ASI, sales increased 17.4%.
- Third-quarter operating income increased $10.3 million to $16.8 million; the operating margin expanded to 5.5% from 2.6%.
- Nine-month operating income increased $23.0 million to $48.0 million; the operating margin expanded to 5.3% from 3.4%.
- Third-quarter gross margin increased 71 basis points. Excluding ASI, management reported a 106-basis-point improvement, primarily reflecting stronger IPS performance.
- IPS sales increased 50.2% in the third quarter and 51.2% for the nine-month period, driven by higher oil and gas capital spending, drilling activity and improved pricing and utilization.
- SG&A increased 11.3% in the third quarter and 12.7% for the nine-month period, but declined as a percentage of sales because revenue growth exceeded expense growth.
- Nine-month interest expense increased 26.9%, primarily because of higher rates under the 2017 credit facilities and higher LIBOR, partially offset by lower third-quarter interest expense versus the prior year.
- The June 2018 repricing amendment reduced the Term Loan B LIBOR spread from 5.50% to 4.75%.
Guidance, outlook, commentary, risks and unusual items
Management did not provide formal numerical financial guidance. Management stated that current IPS and Service Center sales levels might continue or improve through the remainder of 2018 if crude oil and natural gas prices and drilling rig counts remain at levels experienced during the first nine months or third quarter.
DXP acquired Application Specialties, Inc. on January 1, 2018, for total estimated consideration of $15.7 million, including $10.8 million of cash, $0.9 million of DXP stock and approximately $4.0 million of estimated contingent consideration. ASI contributed $35.0 million of sales and approximately $4.1 million of pretax earnings during the nine months. Future contingent consideration could total up to an additional $3.1 million, and changes in its fair value may create volatility in future earnings.
The Tax Cuts and Jobs Act accounting remained provisional at September 30, 2018. The company had not completed its analysis and expected to finalize calculations during the fourth quarter. The nine-month effective tax rate was 26.9%, compared with 22.6% in the prior-year period.
Management identified material weaknesses in the control environment, management review and monitoring controls, and information technology general controls. Third-party consultants were engaged during the second quarter to assist with remediation. The weaknesses had not been fully remediated as of the filing date.
Key risks include sensitivity to oil and gas prices, drilling activity and customer capital spending; acquisition integration and financing risks; floating-rate debt exposure; working-capital requirements; potential dilution from future financing; cybersecurity and operational disruptions; and the possibility that legal proceedings or contingencies could develop adversely. Management believes ordinary-course legal proceedings are unlikely to have a material adverse effect.
DXP adopted the new revenue recognition standard using the modified retrospective method with no material impact. The company expected adoption of the new lease standard in 2019 to materially increase balance-sheet assets and liabilities, although it did not expect a material effect on operating results.
Important facts for investors to verify
- Whether oil and gas activity, pricing and drilling-rig counts supported continued IPS and Service Center growth after September 30, 2018.
- ASI’s performance against EBITDA benchmarks and the resulting contingent consideration liability and future cash requirements.
- Progress toward remediation and testing of the disclosed material weaknesses in internal controls.
- Term Loan B refinancing, amortization and interest-rate exposure, including the estimated effect of a 100-basis-point LIBOR change of approximately $2.5 million in annual interest expense.
- Whether operating cash flow is sufficient to fund inventory, receivables, capital expenditures, debt service and planned acquisitions without additional borrowing or equity issuance.
- Final accounting conclusions under the Tax Cuts and Jobs Act and the balance-sheet effects of the new lease standard.