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. Reportable segments are Service Centers, Supply Chain Services and Innovative Pumping Solutions. This unaudited filing covers the three and nine months ended September 30, 2017; comparisons are with the corresponding 2016 periods.
Financial Performance and Position
| Metric | Q3 2017 | Q3 2016 | 9M 2017 | 9M 2016 |
|---|---|---|---|---|
| Sales | $251.9 million | $230.0 million | $741.2 million | $739.8 million |
| Gross profit | $67.0 million | $63.8 million | $200.4 million | $204.2 million |
| Gross margin | 26.6% | 27.7% | 27.0% | 27.6% |
| SG&A | $60.5 million | $58.9 million | $175.4 million | $192.5 million |
| Operating income | $6.5 million | $4.9 million | $25.0 million | $11.8 million |
| Net income attributable to DXP | $3.0 million | $0.3 million | $10.2 million | $0.3 million |
| Diluted EPS | $0.16 | $0.02 | $0.56 | $0.02 |
Operating margin was 2.6% in the third quarter and 3.4% for the first nine months, compared with 2.1% and 1.6%, respectively, in the prior-year periods. Interest expense was $4.9 million in the third quarter and $12.6 million year to date. The third-quarter tax provision was a $1.2 million benefit, producing a 67.8% effective tax benefit rate; the nine-month tax expense was $2.9 million, or a 22.6% effective tax rate.
Cash provided by operating activities was $8.5 million for the first nine months, down from $35.7 million in 2016, primarily because accounts receivable, contract assets and inventory consumed more working capital. Capital expenditures were $2.2 million. Cash, including $3.6 million of restricted cash, totaled $23.1 million at September 30, 2017.
Total debt was $242.4 million, compared with $224.7 million at December 31, 2016. The company had $81.0 million of borrowing availability, compared with $37.3 million at year-end 2016. Total assets were $635.1 million and total equity was $261.6 million at September 30, 2017.
Material Changes Versus the Prior Comparable Period
- Third-quarter sales increased 9.5%; excluding the business sold in October 2016, same-store sales increased 13.0%.
- For the first nine months, reported sales increased only 0.2%, but same-store sales increased 3.4% after excluding the sold business.
- Gross margin declined 116 basis points in the third quarter and 57 basis points year to date. IPS margins were pressured by competitive pricing and fewer large, high-margin orders; SCS margins declined because of greater lower-margin product sales.
- Year-to-date SG&A declined 8.9%, reflecting cost reductions, lower headcount and lower incentive compensation. Operating income increased 112% year to date.
- Service Centers and IPS benefited from stronger oil and gas-related demand. IPS third-quarter sales increased 28.1%, while nine-month IPS operating income declined 4.3% because of lower margins.
- On August 29, 2017, DXP replaced its prior credit facility with a $250 million Senior Secured Term Loan B and an $85 million ABL facility. The refinancing increased availability but also resulted in $0.6 million of debt issuance cost write-offs and higher debt issuance costs overall.
- DXP early adopted restricted-cash presentation guidance, classifying $3.6 million as restricted cash required as collateral for letters of credit.
Guidance, Outlook, Risks and Unusual Items
Management expected cash generated from operations to meet normal working-capital needs over the next twelve months and expected compliance with the ABL and Term Loan financial covenants through September 30, 2018. Management indicated that oil and gas-related demand could continue or improve through the remainder of 2017 if crude oil and natural gas prices and drilling activity remained at third-quarter levels. The filing does not provide formal revenue or earnings guidance.
The Term Loan B matures in August 2023 and the ABL facility matures in August 2022. The Term Loan had a 6.7% interest rate at September 30, 2017, and substantially all company assets secure both facilities. The secured leverage ratio was 3.61:1.00, against a 5.75:1.00 covenant limit beginning December 31, 2017. The company remains exposed to floating-rate debt; a 100-basis-point change in rates was estimated to affect annual interest expense by approximately $2.5 million based on 2017 debt levels.
Material risks include oil and gas price and drilling-cycle volatility, margin pressure, working-capital requirements, refinancing and covenant compliance, interest-rate exposure, acquisition integration, and the effectiveness of internal controls. Management reported material weaknesses in the control environment, monitoring, income-tax accounting, financial reporting processes and information-technology general controls. Tax-control remediation was implemented, but the weaknesses were not considered fully remediated until the new controls operate and are tested for a sufficient period.
Legal proceedings arise in the ordinary course of business; management believed their ultimate resolution would not have a material adverse effect. The filing states that no material changes occurred to previously disclosed risk factors. The unusual third-quarter tax benefit and debt-cost write-off should be considered when assessing earnings quality.
Important Facts for Investors to Verify
- Reconcile reported growth with same-store growth after the October 2016 business sale.
- Assess whether IPS and SCS margin pressure persists and whether oil and gas demand supports management’s outlook.
- Review cash conversion, particularly the increase in receivables, contract assets and inventory, against reported earnings.
- Verify Term Loan B and ABL covenant calculations, borrowing availability and required amortization or excess-cash-flow repayments.
- Evaluate the impact of floating interest rates and the sustainability of interest expense.
- Track remediation and auditor or management conclusions regarding the disclosed material weaknesses in internal controls.
- Separate recurring tax performance from the third-quarter tax benefit and consider the effect of amortization and debt-related charges on earnings.