DXP Enterprises, Inc. — Q1 2018 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 custom pump packages, pump remanufacturing and private-label pumps through three segments: Service Centers, Innovative Pumping Solutions and Supply Chain Services. The filing covers the unaudited three months ended March 31, 2018, compared with March 31, 2017.
On January 1, 2018, DXP acquired Application Specialties, Inc. for approximately $11.5 million, funded with $10.6 million of cash and $0.9 million of common stock. The acquisition contributed $10.6 million of sales and approximately $1.3 million of pretax earnings in the quarter.
Key Financial Metrics
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Sales | $285.9 million | $238.5 million | +19.9% |
| Gross profit | $76.4 million | $64.5 million | +18.5% |
| Gross margin | 26.7% | 27.0% | -31 basis points |
| SG&A | $65.3 million | $56.3 million | +16.0% |
| Operating income | $11.1 million | $8.2 million | +35.4% |
| Operating margin | 3.9% | 3.4% | +50 basis points |
| Net income attributable to DXP | $4.6 million | $3.1 million | +45.3% |
| Diluted EPS | $0.24 | $0.17 | +$0.07 |
| Net cash used in operating activities | $0.8 million | $2.2 million | Improved by $1.4 million |
Interest expense increased 38.0% to $5.0 million, primarily because of higher interest rates under the company’s credit facilities. The effective tax rate declined to 25.59% from 37.77%, reflecting the Tax Cuts and Jobs Act, research and development credits and other tax items.
At March 31, 2018, cash was $12.6 million and restricted cash was $0.4 million. Total assets were $654.9 million and total equity was $274.2 million. Inventories increased to $103.2 million from $91.4 million at December 31, 2017, while trade receivables were $168.2 million.
Debt and Liquidity
- Total debt was $241.6 million, including $248.8 million of Term Loan B principal, $2.5 million of equipment-related promissory notes and $9.7 million of unamortized debt issuance costs.
- The $85 million ABL facility had no borrowings outstanding. Availability was approximately $80.1 million after letters of credit, compared with $82.0 million at December 31, 2017.
- The Term Loan B bears interest at 7.4% as of March 31, 2018, matures in August 2023 and requires quarterly amortization plus specified mandatory repayments.
- The company reported a 3.44:1 fixed charge coverage ratio and a 3.43:1 secured leverage ratio, compared with applicable covenant limits of 1.00:1 and 5.75:1, respectively. DXP was in compliance with its debt covenants.
- Management stated that cash generated from operations is expected to meet normal working capital needs for the next twelve months, although additional financing may be required for acquisitions.
Material Changes Versus the Prior Comparable Period
- Sales growth reflected higher activity across all segments and the ASI acquisition. Excluding ASI, sales increased approximately 15.5%.
- Service Centers sales increased 17.9%, including ASI, supported by stronger demand for rotating equipment, bearings and metalworking products tied to oil and gas and related manufacturing markets.
- Innovative Pumping Solutions sales increased 37.9%, although segment gross margin declined approximately 30 basis points because of competitive pricing and fewer large, complex, high-margin orders.
- Supply Chain Services sales increased 5.3%, while operating income remained approximately flat as higher gross profit was offset by higher SG&A.
- Operating leverage improved: SG&A as a percentage of sales declined to 22.8% from 23.6%, while operating margin increased to 3.9% from 3.4%.
- Operating cash flow remained negative because of working capital investment, including increases of $9.1 million in inventories and $8.6 million in costs and estimated profits in excess of billings.
- Investing cash outflows increased to $10.6 million from $0.6 million, primarily due to the ASI acquisition.
Guidance, Outlook, Risks and Unusual Items
- No formal quantitative full-year earnings or revenue guidance is provided.
- Management indicated that sales trends could continue or improve during the remainder of 2018 if crude oil and natural gas prices and drilling rig counts remain at first-quarter levels.
- Key risks include oil and gas price and demand volatility, economic conditions, acquisition integration, availability of materials and labor, financing availability, interest-rate changes, regulatory requirements, cyberattacks and third-party performance.
- A 100-basis-point change in floating interest rates would change annual interest expense by approximately $2.5 million based on debt outstanding at March 31, 2018.
- Management reported material weaknesses in the control environment, management review and monitoring controls, and information technology general controls as of December 31, 2017. DXP planned to engage third-party accounting consultants during the second quarter of 2018 and stated that remediation would not be complete until the enhanced controls operated for a sufficient period and were tested.
- The company had not completed its accounting for all effects of the Tax Cuts and Jobs Act. It had recorded a provisional $1.3 million deferred-tax benefit related to the lower U.S. federal corporate tax rate.
- Routine legal proceedings were not expected to have a material adverse effect. No material changes to previously disclosed risk factors were reported.
Important Facts for Investors to Verify
- Whether the improvement in oil and gas-related demand persists and supports the company’s conditional 2018 outlook.
- Whether acquisition-related growth, including ASI, translates into sustainable margins and cash flow.
- Progress in remediating the reported material weaknesses in financial reporting and IT controls.
- Working capital requirements, particularly inventory and unbilled contract balances, and their effect on operating cash flow.
- Interest-rate exposure and the company’s ability to service and refinance the approximately $241.6 million debt balance.
- Final tax effects of the Tax Cuts and Jobs Act and any future adjustments to provisional tax accounting.