DXP Enterprises, Inc. — Fiscal 2022 Form 10-K Summary
Business context and reporting period
DXP Enterprises distributes maintenance, repair and operating products, equipment and services across industrial, energy, food and beverage, chemical, transportation, water and wastewater markets. It operates through Service Centers (SC), Innovative Pumping Solutions (IPS), and Supply Chain Services (SCS). The filing covers the fiscal year ended December 31, 2022, with comparisons to fiscal 2021 and 2020.
At year-end, DXP operated approximately 180 facilities, including 156 service centers, four distribution centers, 16 fabrication facilities and four wastewater locations, and served customers from 95 customer facilities. The Company employed approximately 2,675 people.
Financial performance and liquidity
| Metric | 2022 | 2021 | Change |
|---|---|---|---|
| Sales | $1,480.8 million | $1,113.9 million | 32.9% increase |
| Gross profit | $422.0 million | $328.5 million | 28.5% margin vs. 29.5% |
| Operating income | $97.8 million | $39.9 million | Increase of $57.9 million |
| Net income attributable to DXP | $48.2 million | $16.5 million | Increase of $31.7 million |
| Diluted EPS | $2.47 | $0.83 | Increase of $1.64 |
| Adjusted EBITDA | $126.8 million | $70.2 million | Margin 8.6% vs. 6.3% |
| Cash flow from operations | $5.9 million | $37.1 million | Decrease of $31.2 million |
| Free cash flow | $1.0 million | $32.8 million | Decrease of $31.8 million |
Sales growth reflected pricing actions, higher demand and acquisitions. Organic sales increased 48.7% on the filing’s calculation, although management stated that much of the reported sales increase resulted from pricing, with additional contributions from volume and acquisitions.
Segment sales were $1,009.4 million for SC, $231.1 million for IPS and $240.4 million for SCS. Segment sales increased 23.6%, 65.6% and 52.3%, respectively. IPS backlog was $108.5 million at December 31, 2022, compared with $96.9 million at December 31, 2021.
Cash and restricted cash totaled $46.1 million at year-end. The Company had $132.4 million of availability under its $135.0 million ABL Revolver, with no ABL borrowings outstanding and $2.6 million of letters of credit. Total debt was $428.1 million, compared with $326.7 million at year-end 2021. The Term Loan B carried a 10.0% interest rate at year-end and matures in December 2027. Debt represented approximately 54.0% of total capitalization.
DXP generated $5.9 million of operating cash flow, used $53.4 million in investing activities and generated $44.3 million in financing activities. The Company borrowed an additional $105.0 million under the Term Loan B, spent approximately $48.5 million on acquisitions and repurchased approximately $47.9 million of stock during the year. Management stated that existing cash generation should meet normal working-capital needs for the next twelve months, but additional financing could be required for acquisitions.
Material changes versus the prior comparable period
- Sales increased $366.9 million, or 32.9%, primarily due to pricing, volume, stronger energy-related activity and acquisitions.
- Gross margin declined approximately 99 basis points to 28.5%, with pressure from product and project mix, including lower-margin oil and gas work in IPS and a lower-margin SCS customer contract.
- SG&A increased 12.3% to $324.3 million, below the rate of sales growth, reflecting higher payroll, incentive compensation and related costs.
- Interest expense increased $8.0 million to $29.1 million because of the additional Term Loan B borrowing and higher variable interest rates.
- Operating cash flow and free cash flow declined substantially as accounts receivable, inventory, deferred taxes and project work-in-process increased with higher business activity.
- DXP completed four acquisitions in 2022: Cisco Air Systems, Drydon Equipment, Sullivan Environmental Technologies and certain assets of Burlingame Engineers. Aggregate acquisition-date consideration was approximately $67.9 million, including $53.9 million of cash, $5.8 million of stock and $8.2 million of contingent consideration.
- The Company completed its prior $85.0 million share-repurchase program in December 2022 and authorized a new program for up to $85.0 million or 2.8 million shares over 24 months.
Guidance, outlook, commentary, risks and unusual items
The filing does not provide specific numerical revenue, earnings or cash-flow guidance. Management expects to pursue internal growth through cross-selling, expanded product offerings, supply-chain solutions and acquisitions. The outlook remains sensitive to industrial activity, oil and gas capital spending, commodity prices, customer demand, inflation, labor and materials availability, and interest rates.
- Internal-control material weaknesses: Management and the independent auditor concluded that internal control over financial reporting was not effective at December 31, 2022. Weaknesses involved the control environment, clearing accounts-payable discrepancies, revenue recognition and segregation of duties/user access. Management began remediation, but the weaknesses had not been fully remediated.
- Out-of-period revenue adjustment: Fourth-quarter revenue included a $21.2 million out-of-period adjustment, of which $10.6 million related to 2021. The adjustment increased 2022 income before taxes by $3.0 million. Management concluded the error was not material to prior or current financial statements.
- Contract accounting risk: IPS recognized $213.3 million of revenue under the percentage-of-completion method. Results depend on estimates of costs to complete, materials, labor productivity and overhead. Revenue recognition and estimated contract costs were identified as a critical audit matter.
- Leverage and rate risk: All of the $428.1 million of outstanding debt was subject to floating rates. A 100-basis-point change in short-term rates was estimated to affect annual pre-tax interest expense by approximately $4.3 million. The Company was in compliance with its covenants at year-end; its secured leverage ratio was 2.83x versus a 5.00x limit for December 31, 2022, and its fixed-charge coverage ratio was 3.59x.
- Acquisition and asset risk: Goodwill and intangible assets totaled $413.3 million, creating exposure to impairment if cash flows, market valuations or operating conditions deteriorate. No goodwill or long-lived-asset impairment was recorded in 2022.
- Operating and legal risks: Key risks include economic or energy-sector downturns, pricing and margin pressure, supplier authorization cancellations, competition, customer and project cancellations, cybersecurity incidents, product liability, environmental obligations, foreign-currency movements and uninsured claims.
- Other unusual item: DXP sold its interest in a variable-interest entity in November 2022 and recorded a $1.2 million loss associated with the sale.
Important facts for investors to verify
- Whether the identified internal-control weaknesses are remediated and whether further revenue, accounts-payable or contract-accounting adjustments are required.
- The sustainability of 2022 sales growth after separating pricing, volume, acquisition and organic effects.
- Whether gross-margin pressure in IPS and SCS improves or persists.
- Free-cash-flow conversion, working-capital requirements and the effect of receivables and project work-in-process on liquidity.
- The impact of higher variable interest rates and the $428.1 million Term Loan B balance on earnings and covenant headroom.
- Whether the $108.5 million IPS backlog converts to revenue and profit as expected, considering potential delays, scope changes or cancellations.
- Integration results and contingent consideration obligations from the 2022 acquisitions.
- Potential impairment sensitivity for the $413.3 million of goodwill and intangible assets.
- The pace and funding of future acquisitions and share repurchases, given limited free cash flow and increased leverage.