DXP Enterprises, Inc. Form 10-Q Summary
Business Context and Reporting Period
DXP distributes maintenance, repair and operating products and provides related services to energy and industrial customers. It also fabricates custom pump packages, remanufactures pumps and manufactures private-label pumps. Reportable segments are Service Centers, Innovative Pumping Solutions and Supply Chain Services. This unaudited report covers the three and six months ended June 30, 2018, compared with the corresponding 2017 periods.
Financial Performance and Position
| Metric | Q2 2018 | Q2 2017 | Six Months 2018 | Six Months 2017 |
|---|---|---|---|---|
| Sales | $311.2 million | $250.7 million | $597.2 million | $489.2 million |
| Gross profit | $85.1 million | $68.9 million | $161.6 million | $133.5 million |
| Gross margin | 27.3% | 27.5% | 27.1% | 27.3% |
| Operating income | $20.1 million | $10.3 million | $31.2 million | $18.5 million |
| Operating margin | 6.4% | 4.1% | 5.2% | 3.8% |
| Net income attributable to DXP | $11.6 million | $4.1 million | $16.1 million | $7.3 million |
| Diluted EPS | $0.63 | $0.23 | $0.88 | $0.40 |
Sales increased 24.1% in the quarter and 22.1% year to date. Operating income increased 95.6% in the quarter and 68.8% year to date. SG&A grew more slowly than sales, reducing SG&A as a percentage of sales to 20.9% in the quarter from 23.4% and to 21.8% year to date from 23.5%.
Interest expense increased to $6.1 million in the quarter and $11.2 million year to date, primarily because of higher borrowing rates. Effective tax rates declined to 24.62% in the quarter and 25.21% year to date, compared with 36.07% and 36.81%, respectively, in the prior-year periods.
Cash used in operating activities was $7.0 million for the first six months of 2018, compared with $7.9 million of cash generated in the prior-year period. Working-capital investment included increases of $14.5 million in accounts receivable, $16.7 million in inventories and $11.1 million in costs and estimated profits in excess of billings.
Investing cash use was $13.6 million, including $10.8 million for the ASI acquisition and $5.5 million for property and equipment, partly offset by $2.7 million of proceeds from fixed-asset sales. Financing cash use was $1.9 million, primarily from debt repayments. Cash and restricted cash totaled $2.9 million at June 30, 2018, down from $25.6 million at December 31, 2017.
At June 30, 2018, total debt was $250.4 million, including $248.1 million of Term Loan B borrowings and $2.3 million of promissory notes. The ABL Revolver had no borrowings and approximately $80.0 million of availability, including the effect of letters of credit. DXP reported compliance with all applicable covenants; its consolidated Fixed Charge Coverage Ratio was 3.33 to 1.00 and Secured Leverage Ratio was 3.22 to 1.00.
Material Changes Versus the Prior Comparable Period
- Q2 sales increased $60.5 million, including $12.4 million from ASI; excluding ASI, sales increased 19.2%.
- Six-month sales increased $107.9 million, including $23.0 million from ASI; excluding ASI, sales increased 17.4%.
- IPS sales increased 67.0% in the quarter and 51.7% year to date, driven by higher oil and gas capital spending, drilling activity and oil prices.
- Service Centers sales increased 17.5% in the quarter and 17.7% year to date, including ASI contributions. Supply Chain Services sales increased 4.6% and 5.0%, respectively.
- IPS profitability improved materially, with second-quarter operating income increasing $7.2 million, or 410%, and six-month operating income increasing $10.1 million, or 191%.
- Overall gross margin declined modestly because of acquisition mix, vendor price increases and sales mix, although the underlying margin excluding ASI improved according to management.
- Days sales outstanding improved to 57.4 days from 61.5 days, while inventory turns increased slightly to 8.2 from 8.0.
Guidance, Outlook, Risks and Unusual Items
The filing does not provide formal quantitative earnings or revenue guidance. Management stated that current IPS and oil-and-gas-related Service Centers sales levels might continue or improve during the remainder of 2018 if crude oil and natural gas prices and drilling rig counts remain at first-half levels.
DXP acquired Application Specialties, Inc. on January 1, 2018, for total consideration of $15.7 million, including $10.8 million of cash, $0.9 million of stock and $4.0 million of estimated contingent consideration. ASI contributed $23.0 million of sales and approximately $2.6 million of pretax earnings during the first six months. Up to $4.6 million of additional contingent consideration may become payable through 2020, and changes in its estimated value may create future earnings volatility.
On June 25, 2018, DXP repriced its Term Loan B, reducing the LIBOR margin from 5.50% to 4.75%. The repricing generated approximately $0.9 million of third-party fees and accelerated $60,000 of deferred debt issuance costs, both recorded as additional interest expense. A 100-basis-point change in floating interest rates would affect annual interest expense by approximately $2.5 million based on debt outstanding at June 30, 2018.
The company adopted the new revenue recognition standard using the modified retrospective method with no impact to opening retained earnings or reported revenue. Tax accounting related to the Tax Cuts and Jobs Act remained provisional; DXP had recorded a provisional $1.3 million deferred-tax benefit and continued evaluating the law's effects.
Management disclosed material weaknesses in the control environment, management review controls, key control activities and information technology general controls. Third-party consultants were engaged during the quarter, but the weaknesses will not be considered remediated until controls have operated long enough for management to test them. Principal business risks include oil and gas market volatility, interest-rate exposure, acquisition integration, financing availability, working-capital requirements, cyberattacks, legal proceedings and control remediation.
Important Facts for Investors to Verify
- Whether oil and gas prices, drilling activity and customer capital spending sustain the strong IPS and Service Centers growth.
- Conversion of reported earnings into operating cash flow as inventories and contract assets continue to grow.
- Term Loan B leverage, floating-rate exposure, covenant headroom and the effect of the repricing on future interest expense.
- ASI integration, EBITDA performance and potential contingent consideration payments of up to $4.6 million.
- Progress and eventual effectiveness of remediation plans for the disclosed material weaknesses in financial reporting controls.
- Final measurement of Tax Cuts and Jobs Act effects and any resulting changes to deferred taxes or effective tax rates.
- Potential earnings volatility from project estimates, contingent consideration, foreign-currency translation and oil-and-gas market conditions.