DXP Enterprises, Inc. — Q3 2016 Form 10-Q Summary
Business context and reporting period
DXP distributes maintenance, repair and operating products and services to industrial customers, provides integrated pump packages and pump remanufacturing, and manufactures private-label pumps. Reportable segments are Service Centers, Innovative Pumping Solutions, and Supply Chain Services. The filing covers the three and nine months ended September 30, 2016; results are unaudited.
Financial performance and position
| Metric | Q3 2016 | Q3 2015 | 9M 2016 | 9M 2015 |
|---|---|---|---|---|
| Sales | $230.0 million | $303.1 million | $739.8 million | $968.4 million |
| Gross profit | $63.8 million | $85.7 million | $204.2 million | $275.1 million |
| Gross margin | 27.7% | 28.3% | 27.6% | 28.4% |
| Operating income (loss) | $4.9 million | $(55.6) million | $11.8 million | $(23.5) million |
| Net income (loss) attributable to DXP | $0.3 million | $(52.4) million | $0.3 million | $(35.6) million |
| Diluted EPS | $0.02 | $(3.64) | $0.02 | $(2.48) |
| Operating cash flow | Not separately provided | Not separately provided | $35.5 million | $74.8 million |
SG&A was $58.9 million in Q3 and $192.5 million for the first nine months, down 21.6% and 17.1%, respectively, year over year. Cost reductions primarily reflected lower headcount, compensation, travel, vehicle, legal, and other operating expenses. Interest expense increased to $4.3 million in Q3 and $11.7 million for the first nine months, driven primarily by higher interest rates.
At September 30, 2016, cash was $3.4 million, trade receivables were $153.0 million, inventories were $98.2 million, and total assets were $649.7 million. Total debt was $318.3 million, including $115.2 million classified as current. The company had approximately $20.2 million available under its credit facility.
Material changes versus the prior comparable period
- Q3 sales decreased 24.1%; nine-month sales decreased 23.6%. Same-store sales declined 25.1% in Q3 and 25.2% year to date, excluding contributions from 2015 acquisitions.
- Sales declines were concentrated in the Service Centers and Innovative Pumping Solutions segments, reflecting weaker oil and gas activity, lower capital spending, and reduced demand from related manufacturing customers.
- Q3 gross margin declined approximately 55 basis points; nine-month gross margin declined approximately 80 basis points. IPS experienced significant margin pressure from competitive pricing and underabsorbed manufacturing overhead.
- Reported operating results improved from 2015 because the prior-year periods included a $58.9 million impairment charge and a $7.3 million B27 settlement. Excluding those items, Q3 2016 operating income declined $5.7 million and nine-month operating income declined $30.9 million.
- Operating cash flow fell by $39.3 million year over year to $35.5 million, primarily because of lower earnings and a smaller reduction in accounts receivable.
- Days sales outstanding increased to 65.4 days from 60.1 days, while inventory turns declined to 6.7 from 8.0.
Guidance, outlook, risks and unusual items
- Management expects oil and gas-related weakness to continue through the remainder of 2016 if crude oil and natural gas prices remain at or below third-quarter levels.
- Management expects operating cash flow to meet normal working-capital needs for the next twelve months and expects covenant compliance through June 30, 2017. However, the company states that it will need to amend its credit facility or obtain alternative financing within the next eighteen months because the facility matures March 31, 2018 and covenants become more restrictive after June 30, 2017.
- The facility had $315.5 million borrowed at a weighted-average interest rate of approximately 5.65%. The September 30 leverage ratio was 6.14x, fixed-charge coverage was 0.67x, and asset coverage was 1.05x. Leverage and fixed-charge covenants were waived through June 30, 2017, but the company remains exposed to liquidity, refinancing, covenant, and potential dilution risks.
- In October 2016, DXP paid $55 million of mandatory prepayments and $24.5 million of scheduled principal payments. Term debt declined from $137.5 million at September 30 to $74.5 million at October 31.
- DXP sold a non-core business for approximately $31 million in cash on October 3, 2016 and issued 2.484 million common shares for net proceeds of $46.2 million on October 31, 2016. Proceeds were primarily used to reduce debt.
- Management identified a material weakness in internal control over financial reporting related to accounting for income taxes, including deferred tax assets and liabilities and the income tax provision. Remediation efforts were underway but the weakness had not been fully remediated as of September 30, 2016.
- The company reports ordinary-course litigation but does not expect the ultimate resolution to have a material adverse effect. It also identifies further deterioration in the oil and gas sector and difficulty refinancing or amending the credit facility as significant risks.
Important facts for investors to verify
- Progress toward refinancing or amending the credit facility before covenant restrictions tighten and before the March 31, 2018 maturity.
- Compliance with the minimum EBITDA, asset coverage, and other applicable credit-facility requirements after the covenant holiday expires.
- Whether oil and gas market weakness continues to pressure sales, IPS margins, Service Centers demand, and cash generation.
- The effect of the October 2016 equity issuance and asset sale on debt balances, shareholder dilution, and future earnings.
- Remediation and auditor or management conclusions regarding the material weakness in income-tax controls.
- Recoverability of the approximately $197.2 million goodwill balance and $99.7 million of net intangible assets amid declining operating performance.