DXP Enterprises, Inc. — Form 10-Q Summary
Business context and reporting period
DXP Enterprises distributes maintenance, repair and operating products and services to industrial customers and provides custom pump packages, pump remanufacturing and branded private-label pumps. Operations are organized into Service Centers, Innovative Pumping Solutions and Supply Chain Services. This unaudited filing covers the three months ended March 31, 2017, compared with the three months ended March 31, 2016.
Key financial metrics
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Sales | $238.5 million | $253.6 million | Down 5.9% |
| Gross profit | $64.5 million | $68.8 million | Down 6.3% |
| Gross margin | 27.0% | 27.1% | Down approximately 9 basis points |
| SG&A expense | $56.3 million | $70.8 million | Down 20.5% |
| Operating income | $8.2 million | $(2.0) million | Improved $10.2 million |
| Interest expense | $3.7 million | $3.4 million | Up 7.2% |
| Net income attributable to DXP | $3.1 million | $(5.1) million | Improved $8.2 million |
| Diluted EPS | $0.17 | $(0.35) | Improved $0.52 |
| Cash flow from operations | $(2.2) million | $(7.6) million | Improved $5.4 million |
At March 31, 2017, cash was $1.0 million, total assets were $605.3 million and total equity was $253.6 million. Total debt was $227.2 million, including $224.7 million classified as current because the credit facility matures on March 31, 2018. The company had $29.9 million available under its credit facility, compared with $37.3 million at December 31, 2016.
Working-capital balances included $157.0 million of net accounts receivable and $84.3 million of inventory. Days sales outstanding increased to 62.5 days from 61.1 days, while inventory turns increased to 8.4 from 7.0. Investing cash outflow was $0.6 million, primarily for capital expenditures. Financing activities provided $2.2 million, largely reflecting debt proceeds and repayments.
Material changes versus the prior comparable period
- Sales declined $15.0 million. A business sold in 2016 accounted for $7.8 million of the decline; same-store sales decreased approximately 3.0%.
- Service Centers sales declined 11.2%, primarily due to weaker demand from upstream oil and gas and related manufacturing customers. Same-store sales declined 6.9%.
- Innovative Pumping Solutions sales increased 3.4%, supported by higher oil and gas capital spending, while Supply Chain Services sales increased 5.5%.
- SG&A declined $14.5 million, reflecting headcount, salary, incentive compensation and other cost reductions implemented primarily in late 2016.
- Operating income returned to profitability, largely because the reduction in SG&A more than offset lower sales.
- Debt classification changed materially: substantially all facility debt was reclassified as current because of the March 31, 2018 maturity. Total debt increased modestly from $224.7 million at December 31, 2016 to $227.2 million.
- The company adopted ASU 2016-09 and ASU 2015-17 in 2017. The stock-compensation guidance produced approximately $0.1 million of excess tax expense in the quarter; deferred tax balances were reclassified as noncurrent.
Guidance, outlook, risks and unusual items
Management stated that oil and gas-related sales could continue at, or improve from, first-quarter levels if crude oil and natural gas prices and drilling activity remain at first-quarter 2017 levels. Management did not provide formal full-year revenue or earnings guidance in the filing.
Management expects operating cash flow to meet normal working-capital needs and expects compliance with credit-facility covenants through March 31, 2018. However, DXP does not have sufficient cash to repay the facility at maturity and plans to seek alternative financing, potentially including additional bank debt, institutional debt or equity, and/or an asset-based revolving loan. Refinancing may be unavailable on attractive terms and an equity issuance could substantially dilute shareholders. Management believes refinancing before maturity is probable, and the board has approved a refinancing plan.
- The facility carried approximately $224.7 million of borrowings at a weighted-average interest rate of approximately 6.0%, with substantially all assets pledged as collateral.
- At March 31, 2017, the asset coverage ratio was 1.18 to 1.00 against a required minimum of 0.95 to 1.00. Defined EBITDA was $69.2 million, versus a minimum covenant amount of $43.3 million for the quarter.
- Interest-rate exposure is significant: a 100-basis-point change in floating rates would have changed annual interest expense by approximately $2.3 million based on March 31, 2017 debt.
- Disclosure controls and procedures were ineffective because of material weaknesses in internal control over financial reporting. Deficiencies involved income-tax accounting, account reviews and reconciliations, revenue recognition and contract controls, approval processes, fixed assets, leases, payroll access, information-technology general controls and documentation of control operations.
- Management initiated remediation efforts, including enhanced tax resources and procedures, improved close and reconciliation controls, stronger IT access and segregation-of-duties controls, and improved control documentation. The weaknesses had not been fully remediated as of March 31, 2017.
- The company reported ordinary-course legal proceedings but stated that their resolution is not expected to have a material adverse effect. No material changes to previously reported risk factors were identified.
Facts investors should verify
- Progress, terms and timing of refinancing the credit facility before its March 31, 2018 maturity.
- Compliance with minimum EBITDA, asset coverage and other applicable covenants as operating conditions change.
- Availability under the revolving facility and the company’s ability to fund working capital with only $1.0 million of cash at quarter-end.
- Whether oil and gas market recovery supports sustained growth in IPS and SCS and a recovery in Service Centers demand.
- Whether cost reductions are sustainable without impairing revenue generation or customer service.
- Remediation and independent testing of the disclosed material weaknesses in internal control over financial reporting.
- Potential dilution and shareholder terms if equity is used in the refinancing.