DXP Enterprises, Inc. 2016 Form 10-K Summary
Business Context and Reporting Period
Annual report for the fiscal year ended December 31, 2016, filed March 31, 2017. DXP distributes maintenance, repair and operating products and services and provides custom pumping solutions to energy and industrial customers. Operations are organized into Service Centers, Supply Chain Services and Innovative Pumping Solutions, with 178 locations and approximately 2,453 employees at year-end.
Financial Performance and Position
| Metric | 2016 | 2015 | Change |
|---|---|---|---|
| Sales | $962.1 million | $1,247.0 million | Down 22.9% |
| Gross profit / margin | $264.8 million / 27.5% | $352.0 million / 28.2% | Margin down 70 bps |
| Operating income (loss) | $19.3 million | $(27.9) million | Improved; 2015 included $68.7 million impairment and $7.3 million B27 settlement |
| Income before taxes | $9.7 million | $(38.9) million | Improved |
| Net income attributable to DXP | $7.7 million | $(38.5) million | Returned to profitability |
| Diluted EPS | $0.49 | $(2.68) | Improved |
| Cash flow from operations | $48.0 million | $98.0 million | Down $50.0 million |
| Capital expenditures | $4.9 million | $14.0 million | Down $9.1 million |
Service Centers generated $621.0 million of sales, or 64.6% of total sales; Innovative Pumping Solutions generated $187.1 million, or 19.4%; and Supply Chain Services generated $154.0 million, or 16.0%. Segment operating income excluding amortization was $47.6 million, $9.9 million and $15.4 million, respectively.
At December 31, 2016, cash was $1.6 million, total assets were $611.5 million, shareholders’ equity was $252.5 million, and goodwill plus other intangible assets totaled $282.4 million. Accounts receivable days increased to 65.0 from 56.9, while inventory turns remained 7.7.
Debt, Liquidity and Capital Resources
- Total debt, including current maturities and net of debt issuance costs, was $224.7 million, down $124.8 million from 2015. Approximately $221.1 million carried floating interest rates.
- The credit facility consisted of a $74.5 million term loan and a $205 million revolving facility. Revolving borrowings were $147.6 million, and available borrowing capacity was $37.3 million at year-end.
- The facility’s weighted average borrowing rate was approximately 5.89%; a 100-basis-point increase in floating rates would increase annual interest expense by approximately $2.2 million.
- The facility matures March 31, 2018. The company stated that it likely would need to amend the facility or obtain alternative financing within the next 12 months.
- At year-end, the Asset Coverage Ratio was 1.18 to 1.00 against a 0.95 minimum. Defined EBITDA was $59.7 million, versus a $39.9 million minimum for December 31, 2016. The reported leverage ratio was 3.78 to 1.00 and fixed-charge coverage was 0.77 to 1.00, although covenant holidays applied through March 31, 2018 for those measures.
Material Changes Versus the Prior Comparable Period
- Sales declined $285.0 million, primarily because of lower oil and gas capital spending and weaker demand from oilfield, manufacturing and related customers. Same-store sales declined 23.6%.
- Service Centers sales declined 24.9%, IPS sales declined 26.6%, and SCS sales declined 7.0%. SCS operating income increased 8.7% because of improved gross margin and lower SG&A.
- Gross margin declined as IPS and Service Centers experienced lower margins. IPS also recorded $3.7 million of unabsorbed manufacturing overhead related to the ANSI pump manufacturing start-up.
- SG&A decreased 19.2%, including a $39.0 million reduction in payroll, variable compensation, payroll taxes and 401(k) expense. Employee headcount declined 24.1%.
- DXP sold Vertex Corporate Holdings for approximately $31 million in cash and used the proceeds primarily to reduce debt.
- DXP raised approximately $51.9 million through common-stock issuances, including a September equity distribution and an October offering, with proceeds used to reduce debt.
- No goodwill impairment was recorded in 2016, compared with $68.7 million of impairment expense in 2015. Goodwill and intangible assets remain subject to future impairment risk.
Outlook, Commentary, Risks and Unusual Items
Management stated that the energy market remained depressed in 2016. If crude oil and natural gas prices returned to, or fell below, levels experienced during the first nine months of 2016, management expected Service Centers and IPS sales to remain at or decline from 2016 levels during 2017. Capital expenditures for 2017 were expected to be within the 2015–2016 range, although no specific forecast amount was provided.
- Major risks include oil and gas industry spending, economic cyclicality, competitive pricing and margin pressure, loss of supplier authorizations, customer credit deterioration, foreign currency exposure, cyber risk and adverse weather.
- Further energy-sector weakness could reduce EBITDA and impair compliance with financial covenants. Refinancing risk is significant because the credit facility matures in March 2018 and substantial debt payments are scheduled in 2017 and 2018.
- The company had material weaknesses in internal control over financial reporting, including income-tax accounting, account reviews, revenue recognition and contract accounting, purchase accounting, leases, payroll access, IT general controls and documentation of control operation. Management had begun remediation, but the weaknesses were not considered fully remediated.
- The auditors issued an unqualified opinion on the financial statements but an adverse opinion on the effectiveness of internal control over financial reporting.
- Fourth-quarter 2016 included an $8.6 million correction to accumulated deferred-tax-asset errors recorded in other comprehensive income. The company concluded the errors were not material to the previously reported annual financial statements.
- Legal proceedings arise in the ordinary course; management believes their ultimate resolution will not materially affect financial position, cash flows or results of operations.
Investor Verification Checklist
- Verify the company’s ability to refinance or amend the credit facility before its March 31, 2018 maturity and satisfy required debt amortization.
- Monitor minimum EBITDA, asset coverage and other covenant compliance as the covenant holidays expire.
- Assess whether oil and gas activity, rig counts and customer capital spending support recovery in Service Centers and IPS sales.
- Review progress and external auditor conclusions regarding remediation of the material internal-control weaknesses.
- Evaluate receivables collection trends, particularly the increase to 65.0 days of sales outstanding and exposure to energy-sector customers.
- Assess potential goodwill or intangible-asset impairment if forecasts, commodity prices or reporting-unit cash flows deteriorate.
- Confirm the effect of equity issuances and any future financing on share dilution, liquidity and leverage.