DXP Enterprises, Inc. — Q1 2019 Form 10-Q Summary
Business context and reporting period
DXP distributes maintenance, repair and operating products and provides related services to energy and industrial customers. It also designs custom pump packages, remanufactures pumps and manufactures private-label pumps. Reportable segments are Service Centers, Innovative Pumping Solutions and Supply Chain Services. This unaudited filing covers the three months ended March 31, 2019, compared with the three months ended March 31, 2018.
Key financial metrics
| Metric | Q1 2019 | Q1 2018 | Change |
|---|---|---|---|
| Sales | $311.2 million | $285.9 million | 8.8% increase |
| Gross profit | $84.2 million | $76.4 million | 10.1% increase |
| Gross margin | 27.1% | 26.7% | Up approximately 32 basis points |
| Income from operations | $14.8 million | $11.1 million | 32.9% increase |
| Operating margin | 4.8% | 3.9% | Up approximately 90 basis points |
| Net income attributable to DXP | $7.3 million | $4.6 million | 60.2% increase |
| Diluted EPS | $0.40 | $0.24 | Increase of $0.16 |
| Interest expense | $5.0 million | $5.0 million | Essentially unchanged |
SG&A increased 6.3% to $69.4 million, primarily from higher payroll, incentive compensation, related taxes, benefits and headcount. SG&A declined to 22.3% of sales from 22.8%, reflecting operating leverage. The effective income tax rate was 26.7% in both periods.
Segment sales were $186.2 million for Service Centers, $74.7 million for Innovative Pumping Solutions and $50.3 million for Supply Chain Services. Segment operating income, before amortization and corporate expenses, was $29.9 million, compared with $26.3 million in the prior-year period.
Cash flow, debt and liquidity
- Operating activities used $5.3 million of cash, compared with $0.8 million used in Q1 2018. The use of cash primarily reflected higher contract assets and project activity in Innovative Pumping Solutions, as well as increases in receivables and inventory.
- Investing activities used $2.3 million, including $2.3 million of capital expenditures. Q1 2018 investing cash use was $10.6 million, principally due to the ASI acquisition.
- Financing activities used $2.3 million, including $1.4 million of contingent consideration payments related to ASI and $0.8 million of principal debt payments.
- Cash and restricted cash declined by $9.8 million during the quarter to $30.7 million at March 31, 2019.
- Bank and other borrowings were approximately $240.0 million. Debt consisted principally of a Term Loan B with a $246.3 million carrying value and a $1.6 million promissory note; the ABL revolver had no borrowings outstanding.
- The $85 million ABL facility matures in August 2022. Approximately $79.6 million was available at March 31, 2019, after outstanding letters of credit.
- Management stated that available funding was adequate for working capital needs and that expected operating cash flow should meet normal needs over the next twelve months.
Material changes versus the prior comparable period
- Sales increased across all segments: Service Centers by 6.2%, Innovative Pumping Solutions by 10.4%, and Supply Chain Services by 17.2%.
- Service Centers benefited from stronger demand for rotating equipment, bearings, power transmission and metalworking products, particularly from oil and gas-related customers.
- Innovative Pumping Solutions benefited from higher utilization, improved pricing and increased oil and gas capital spending; its gross margin increased approximately 104 basis points.
- Supply Chain Services revenue increased from new customer locations, while its gross margin declined approximately 56 basis points because of new customer implementation costs. Segment operating income was approximately flat.
- Gross margin and operating margin improved, while interest expense remained stable despite the increase in earnings.
- Cash generation weakened because of working-capital investment and increased contract assets, although acquisition-related investing outflows were substantially lower than in Q1 2018.
Guidance, outlook, commentary and unusual items
- No formal quantitative earnings or revenue guidance is provided.
- Management indicated that current levels of oil and gas-related sales in Service Centers and Innovative Pumping Solutions might continue or improve if crude oil and natural gas prices and drilling activity remain at levels experienced during 2018 or Q1 2019.
- DXP adopted ASC 842 lease accounting on January 1, 2019. The adoption added approximately $72 million of right-of-use assets and lease liabilities to the balance sheet, with no material effect on earnings or cash flows. Operating lease liabilities totaled $70.7 million at March 31, 2019.
- Contingent consideration related to the ASI acquisition was $2.9 million at March 31, 2019. The company paid approximately $1.5 million of contingent consideration during the quarter and recorded a $33,000 fair-value expense.
- Management intends to pursue additional acquisitions and expects to fund them through operating cash flow, existing borrowing capacity or new debt, with possible equity issuance. Financing availability and acceptable terms are not assured.
- DXP reported a previously disclosed material weakness in internal control over financial reporting. Disclosure controls and procedures were not effective as of March 31, 2019, although management continues remediation efforts.
- Ordinary-course legal proceedings were not expected to have a material adverse effect. No material changes to previously disclosed risk factors were reported.
Important facts for investors to verify
- Whether operating cash flow improves as contract assets, receivables and inventory normalize.
- Whether oil and gas prices, drilling activity and customer capital spending sustain segment revenue and margins.
- Progress and independent testing of remediation for the material weakness in internal controls.
- Debt repayment capacity, covenant compliance and the availability of the undrawn ABL facility.
- The timing, size, funding and potential dilution from any future acquisitions.
- Actual performance of Supply Chain Services after new-customer implementation costs and the effect of ASC 842 lease obligations.