DXP Enterprises, Inc. — Fiscal 2018 Form 10-K
Reporting period: Fiscal year ended December 31, 2018. The filing also presents unaudited fourth-quarter results. DXP distributes maintenance, repair and operating products and provides supply-chain services and engineered pump solutions through Service Centers, Innovative Pumping Solutions and Supply Chain Services.
Financial Results and Key Metrics
| Metric | 2018 | 2017 | Change |
|---|---|---|---|
| Sales | $1,216.2 million | $1,006.8 million | 20.8% increase |
| Gross profit | $332.2 million | $271.6 million | 22.3% increase |
| Gross margin | 27.3% | 27.0% | Up 34 basis points |
| Operating income | $68.5 million | $33.5 million | 104.4% increase |
| Net income attributable to DXP | $35.6 million | $16.9 million | 111.0% increase |
| Diluted EPS | $1.94 | $0.93 | Increase of $1.01 |
| EBITDA | $95.8 million | $61.7 million | 55.2% increase |
| EBITDA margin | 7.9% | 6.1% | Up 180 basis points |
| Cash flow from operations | $35.8 million | $12.5 million | Increase of $23.3 million |
| Free cash flow | $29.1 million | $9.7 million | Increase of $19.3 million |
- Fourth-quarter 2018 sales were $311.0 million, gross profit was $86.6 million, net income attributable to DXP was $11.1 million and diluted EPS was $0.60.
- Segment sales were $750.0 million for Service Centers, $291.7 million for Innovative Pumping Solutions and $174.5 million for Supply Chain Services.
- IPS backlog increased to $124.2 million at December 31, 2018, from $104.1 million a year earlier.
- Cash and cash equivalents were $40.3 million at year-end; including restricted cash, reported cash was $40.5 million.
- Debt totaled approximately $240.4 million net of debt issuance costs and current maturities, primarily the Term Loan B. The $85 million ABL facility had no borrowings outstanding and $79.3 million of availability after letters of credit.
- The Term Loan B interest rate was 7.3% at year-end. Approximately $246.9 million of outstanding debt bore floating rates, and the company had no interest-rate hedges.
- Net working capital was $205.2 million, compared with $170.9 million in 2017. Total shareholders’ equity was $308.3 million.
Material Changes Versus 2017
- Organic sales increased 16.1%, excluding $47.5 million of sales from the Application Specialties, Inc. acquisition. Reported sales growth was 20.8%.
- Service Centers sales increased 17.0%; excluding the acquisition, growth was 9.6%. IPS sales increased 42.9%, and SCS sales increased 8.0%.
- IPS gross margin improved approximately 314 basis points, reflecting higher utilization, capacity, pricing and demand for engineered-to-order products.
- SG&A increased 10.8% to $263.8 million, but declined to 21.7% of sales from 23.6% because sales growth exceeded expense growth.
- Interest expense increased 22.8% to $20.9 million due primarily to higher interest rates and credit-facility repricing, partially offset by a reduction in the Term Loan B LIBOR spread from 5.50% to 4.75% in June 2018.
- Cash used in investing activities increased to $17.6 million, including $10.8 million for ASI and $9.3 million of capital expenditures. Financing activities used $2.9 million, primarily for Term Loan principal repayments.
- DXP acquired ASI on January 1, 2018 for approximately $11.7 million at closing, plus potential earn-out consideration of up to $4.6 million. ASI contributed $47.5 million of sales and approximately $5.0 million of pretax earnings.
Outlook, Risks and Unusual Items
- Management stated that 2018 sales levels could continue or improve in 2019 if crude oil and natural gas prices and drilling-rig counts remain at 2018 levels. This is conditional commentary, not formal quantitative guidance.
- Demand is sensitive to oil and gas capital spending, commodity prices, industrial cycles, customer capital expenditures and general economic conditions. A downturn could reduce sales, margins and covenant compliance.
- The company was in compliance with its credit covenants at year-end. The Fixed Charge Coverage Ratio was 3.53:1.00 versus a 1.00 minimum, and the Secured Leverage Ratio was 2.24:1.00 versus a 5.25:1.00 limit for December 31, 2018. Future covenant compliance remains dependent on earnings and cash flow.
- Contractual obligations totaled approximately $412.2 million, including $247.8 million of debt payments, $85.3 million of operating lease obligations and estimated interest payments of $79.0 million.
- Goodwill and intangible assets totaled $261.3 million at year-end. No goodwill impairment was identified in the 2018 qualitative assessment, but impairment remains a risk if operating performance or valuation assumptions deteriorate.
- The company adopted ASC 606 using the modified retrospective method with no impact on opening retained earnings or reported prior-period revenue. IPS revenue is recognized over time using percentage-of-completion estimates, creating exposure to cost overruns, schedule changes and contract losses.
- DXP recorded a $4.3 million estimated contingent-consideration liability related to ASI, with potential additional payments of up to $2.8 million over the remaining earn-out period.
- Management and the independent auditor identified material weaknesses in the control environment and monitoring supporting financial reporting. The auditor issued an adverse opinion on internal control effectiveness, although the financial statement audit opinion was unqualified. The company stated that remediation efforts were underway and had not yet been operational for a sufficient period to conclude that the weaknesses were remediated.
- The company expects adoption of the lease standard to add approximately $68 million of right-of-use assets and corresponding lease liabilities in 2019, with no material expected effect on earnings or cash flows.
- The company does not expect to pay cash dividends in the foreseeable future.
Investor Verification Points
- Verify the sustainability of oil-and-gas-driven demand, IPS backlog conversion and segment margin improvement.
- Assess leverage, floating-rate exposure, Term Loan B maturity in August 2023 and compliance with tightening future leverage thresholds.
- Review remediation and testing of the material weaknesses in internal control over financial reporting.
- Evaluate working-capital requirements, inventory growth, contract assets and cash conversion relative to reported earnings.
- Review ASI earn-out obligations and the integration and profitability contribution of the acquisition.
- Consider potential goodwill or intangible-asset impairment, contract-estimate volatility and the effect of the 2019 lease-standard adoption on the balance sheet.
- Review related-party lease payments of approximately $1.4 million made to entities controlled by the chief executive officer.