DXP Enterprises, Inc. — Form 10-Q Summary
Business Context and Reporting Period
DXP Enterprises distributes maintenance, repair and operating products and services and provides custom pump packages, pump remanufacturing and private-label pumps. Its segments are Service Centers, Innovative Pumping Solutions and Supply Chain Services. This unaudited filing covers the three and nine months ended September 30, 2020, compared with the corresponding 2019 periods.
Financial Performance and Position
- Third-quarter sales: $220.2 million, down 32.7% from $327.2 million.
- Third-quarter gross profit: $61.3 million, with a 27.8% gross margin versus 28.3% in 2019.
- Third-quarter SG&A: $53.7 million, down 24.3% year over year.
- Third-quarter impairment and other charges: $48.4 million, including $36.4 million of goodwill impairments, $4.8 million of long-lived asset impairments and $7.2 million related to inventory and work-in-progress.
- Third-quarter operating loss: $40.8 million, compared with operating income of $21.7 million; operating margin was negative 18.6% versus positive 6.6%.
- Third-quarter net loss attributable to DXP: $34.7 million, or $1.95 per diluted share, compared with net income of $13.1 million, or $0.71 per diluted share.
- Nine-month sales: $772.6 million, down 20.5% from $971.7 million.
- Nine-month gross profit: $215.0 million, with a 27.8% gross margin versus 27.7% in 2019.
- Nine-month operating loss: $23.2 million, compared with operating income of $59.4 million; operating margin was negative 3.0% versus positive 6.1%.
- Nine-month net loss attributable to DXP: $26.8 million, or $1.52 per diluted share, compared with net income of $33.9 million, or $1.84 per diluted share.
- Operating cash flow: $92.2 million for the first nine months, compared with $7.5 million in 2019, primarily reflecting collections of receivables and reduced inventory purchases.
- Capital allocation: Investing cash outflow was $20.5 million, including $14.1 million for acquisitions and $6.5 million for capital expenditures. Financing cash outflow was $27.9 million, including $26.9 million of debt repayments.
- Liquidity: Cash and restricted cash totaled $97.4 million at September 30, 2020. The company had $114.3 million of available ABL capacity, no ABL borrowings outstanding and $217.5 million of Term Loan B borrowings.
- Balance sheet: Total assets were $736.7 million and total liabilities were $413.2 million. Goodwill declined to $166.4 million from $194.1 million at December 31, 2019, principally because of impairment charges.
Material Changes Versus the Prior Comparable Period
- Sales declined across all segments: Service Centers decreased 14.9% in the quarter and 13.5% year to date; Innovative Pumping Solutions decreased 73.4% and 36.0%, respectively; and Supply Chain Services decreased 34.8% and 22.8%, respectively.
- The sharpest quarterly deterioration occurred in Innovative Pumping Solutions, reflecting reduced oil and gas capital spending, lower utilization and fixed-cost absorption pressures.
- Quarterly gross margin declined by approximately 49 basis points, primarily because of a roughly 1,076-basis-point decline in IPS gross margin. Year-to-date gross margin increased approximately 15 basis points.
- SG&A declined as management reduced payroll, incentive compensation, retirement-plan matching contributions and other discretionary costs in response to lower activity.
- Interest expense declined to $3.8 million in the quarter and $12.1 million year to date, reflecting lower LIBOR rates and reduced debt balances.
- DXP increased its ABL facility from $85.0 million to $135.0 million in March 2020 and made $26.9 million of Term Loan B principal payments during the first nine months.
- DXP acquired Turbo Machinery Repair and Pumping Systems, Inc. for total consideration of approximately $16.2 million, including $14.2 million in cash and $2.0 million in stock. The acquisitions contributed $14.8 million of Service Center sales and $1.9 million of Turbo sales during the period, as separately disclosed.
- The company entered into an at-the-market equity distribution agreement for up to $37.5 million and sold 46,000 shares for net proceeds of approximately $1.1 million during the first nine months.
Guidance, Outlook, Risks and Unusual Items
Management stated that industrial and manufacturing markets showed modest improvement from July lows during the third quarter, but activity remained below pre-pandemic levels. Customer spending and industry activity were expected to remain volatile through the remainder of 2020 as COVID-19 continued to affect demand and oil markets.
WTI averaged approximately $41 per barrel in the third quarter, and the U.S. rig count continued to decline. Management expected oil and gas-related sales, particularly IPS sales, to remain under pressure if production and pricing conditions persisted. The company continued to streamline operations and improve efficiency while focusing on its backlog.
The $48.4 million impairment charge was a significant unusual item. The impairment analysis used Level 3 assumptions, including forecast revenue, profitability, capital expenditures, discount rates and the timing of an eventual oil and gas recovery. Management disclosed that further deterioration in oil prices or market conditions could result in additional impairments, including goodwill impairments in other reporting units.
Management believed cash generated from operations and existing liquidity would meet normal working-capital needs for the next twelve months, but additional debt or equity financing could be required for acquisitions. Such financing may not be available on acceptable terms and could dilute shareholders.
- Principal risks include prolonged COVID-19 effects, lower oil and gas prices, reduced customer capital spending, recessionary conditions, supply-chain disruption, acquisition integration, financing availability and potential additional asset impairments.
- In August 2020, the company experienced a cyber-attack believed to have been orchestrated by a foreign actor. The filing states that confidential vendor, customer and employee data were not breached and remediation costs were not material.
- The company reported compliance with its ABL and Term Loan B financial covenants as of September 30, 2020.
- Management stated that ordinary-course legal proceedings were not expected to have a material adverse effect, although outcomes could not be predicted.
- Disclosure controls and procedures were evaluated as effective as of September 30, 2020.
Investor Verification Checklist
- Verify the sustainability of operating cash flow, particularly whether improved cash generation primarily reflects temporary working-capital reductions.
- Assess remaining goodwill and long-lived asset exposure to further oil-price, rig-count and COVID-19 deterioration.
- Review Term Loan B amortization, interest-rate exposure, covenant requirements and the $114.3 million of stated ABL availability.
- Monitor IPS backlog, utilization, gross margin and customer capital-spending trends.
- Evaluate whether cost reductions can offset continued revenue declines without impairing operating capacity or customer service.
- Review the performance and integration of the Turbo and PSI acquisitions and the company’s potential need for additional acquisition financing.
- Confirm the effects of the at-the-market equity program and any future issuance on share count and dilution.