DXP Enterprises, Inc. — Form 10-Q Summary
Business Context and Reporting Period
DXP distributes maintenance, repair and operating products and services to industrial customers and provides custom pump packages, pump remanufacturing and private-label pumps. Its segments are Service Centers, Innovative Pumping Solutions and Supply Chain Services. The filing covers the three and six months ended June 30, 2017; financial statements are unaudited.
Key Financial Metrics
| Metric | Q2 2017 | Q2 2016 | Six Months 2017 | Six Months 2016 |
|---|---|---|---|---|
| Sales | $250.7 million | $256.2 million | $489.2 million | $509.8 million |
| Gross profit | $68.9 million | $71.6 million | $133.5 million | $140.4 million |
| Gross margin | 27.5% | 27.9% | 27.3% | 27.5% |
| SG&A | $58.7 million | $62.8 million | $115.0 million | $133.6 million |
| Operating income | $10.3 million | $8.8 million | $18.5 million | $6.8 million |
| Operating margin | 4.1% | 3.5% | 3.8% | 1.3% |
| Net income attributable to DXP | $4.1 million | $5.2 million | $7.3 million | $0.1 million |
| Diluted EPS | $0.23 | $0.34 | $0.40 | $0.00 |
| Interest expense | $4.0 million | $4.0 million | $7.6 million | $7.4 million |
Cash provided by operating activities was $7.9 million for the six months ended June 30, 2017, compared with $11.4 million in the prior-year period. Investing cash outflow was $1.1 million, primarily for property and equipment. Financing cash outflow was $5.9 million, reflecting debt borrowings and repayments, debt issuance fees, dividends and employee tax withholding. Cash increased to $2.5 million from $1.6 million at December 31, 2016.
At June 30, 2017, total debt was $220.3 million, consisting primarily of $162.6 million outstanding on the revolving facility and a $55.2 million term loan. The facility had $20.9 million of borrowing availability, carried a weighted-average interest rate of approximately 6.2%, and matured on March 31, 2018. Total assets were $612.5 million, including $160.4 million of net receivables and $90.7 million of inventory. Current liabilities were $340.6 million, substantially because debt was classified as current due to the facility maturity.
Material Changes Versus Comparable Period
- Second-quarter sales declined 2.2%, while six-month sales declined 4.0%. A business sold in October 2016 accounted for $7.8 million and $15.6 million of the respective declines.
- Excluding the sold business, second-quarter same-store sales increased 0.9%, while six-month same-store sales decreased 1.0%.
- Operating income increased 15.9% in the second quarter and 170% for the six-month period, primarily due to lower SG&A following headcount, compensation and other cost reductions.
- Second-quarter SG&A decreased 6.5% and six-month SG&A decreased 13.9%. SG&A as a percentage of sales improved to 23.4% from 24.5% in the quarter and to 23.5% from 26.2% for six months.
- Gross margin declined 45 basis points in the quarter and 27 basis points for six months. Service Centers improved, but IPS experienced substantial margin pressure from competitive pricing and a large breakeven sale; SCS margins also declined due to lower-margin product sales.
- Service Centers sales increased 1.8% in the quarter but declined 4.8% for six months, with operating income improving materially. IPS sales declined 18.2% in the quarter and 8.1% for six months, while SCS sales increased 3.6% and 4.5%, respectively.
- Operating cash flow declined by $3.6 million, primarily because receivables, inventory and other working capital uses increased.
Guidance, Outlook, Risks and Unusual Items
- Management expected oilfield-related demand to continue or improve during the remainder of 2017 if crude oil and natural gas prices and drilling activity remained at second-quarter levels. No formal revenue or earnings guidance was provided.
- Management expected compliance with applicable credit-facility covenants through March 31, 2018, but stated that operating cash flow would not be sufficient to repay the facility at maturity.
- DXP planned to seek alternative financing, potentially including bank debt, institutional debt, an asset-based revolving loan, or public or private debt or equity. Equity financing could substantially dilute shareholders, and refinancing may not be available on attractive terms.
- At June 30, 2017, the asset coverage ratio was 1.16 to 1.00, against a required minimum of 0.95 to 1.00. Defined EBITDA was $70.0 million and defined leverage was 3.16 to 1.00. Certain leverage and fixed-charge covenants were suspended through March 31, 2018.
- The company reported material weaknesses in internal control over financial reporting, including income-tax accounting, account reconciliations, revenue and contract documentation, information technology general controls and monitoring activities. Remediation efforts were underway but were not yet complete.
- Management disclosed ordinary-course legal proceedings but did not expect them to have a material adverse effect. No material changes to previously disclosed risk factors were reported.
- DXP consolidates a variable interest entity despite owning 47.5%; the VIE had approximately $5.3 million of assets at June 30, 2017 and included former executives and employees among other equity owners.
Investor Verification Priorities
- Verify the company’s ability to refinance or otherwise repay the $217.9 million classified as current debt before the March 31, 2018 maturity.
- Monitor borrowing availability, asset coverage, minimum EBITDA requirements and interest-rate exposure under the credit facility.
- Assess whether Service Centers and SCS growth can offset IPS sales and margin volatility.
- Review working-capital trends, particularly receivables, inventory and operating cash conversion.
- Track remediation and auditor assessments of the disclosed material weaknesses in internal controls.
- Confirm the sustainability of SG&A reductions and whether they can offset potential oil-and-gas demand or pricing pressure.