DXP ENTERPRISES INC 10-Q

ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following management discussion and analysis ("MD&A") of the financial condition and results of operations of DXP Enterprises, Inc. together with its subsidiaries (collectively "DXP," "Company," "us," "we," or "our") for the three months ended March 31, 2022 should be read in conjunction with our previous Annual Report on Form 10-K and our Quarterly Reports on Form 10-Q, and the consolidated financial statements and notes thereto included in such reports. The Company's consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America ("US GAAP"). DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS This Quarterly Report on Form 10-Q (this "Report") contains statements that constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995, as amended. These forward-looking statements include without limitation those about the Company’s expectations regarding the impact of the COVID-19 pandemic, the Ukrainian/Russia conflict and the impact on commodity prices; particularly oil and gas; the Company’s business, the Company’s future profitability, cash flow, liquidity, and growth. Such forward-looking statements can be identified by the use of forward-looking terminology such as "believes", "expects", "may", "might", "estimates", "will", "should", "could", "would", "suspect", "potential", "current", "achieve", "plans" or "anticipates" or the negative thereof or other variations thereon or comparable terminology, or by discussions of strategy. Any such forward-looking statements are not guarantees of future performance and may involve significant risks and uncertainties, and actual results may vary materially from those discussed in the forward-looking statements or historical performance as a result of various factors. These factors include the effectiveness of management's strategies and decisions, our ability to implement our internal growth and acquisition growth strategies, general economic and business conditions specific to our primary customers, changes in government regulations, our ability to effectively integrate businesses we may acquire, new or modified statutory or regulatory requirements, availability of materials and labor, inability to obtain or delay in obtaining government or third-party approvals and permits, non-performance by third parties of their contractual obligations, unforeseen hazards such as weather conditions, acts of war or terrorist acts and the governmental or military response thereto, cyber-attacks adversely affecting our operations, other geological, operating and economic considerations and declining prices and market conditions, including reduced oil and gas prices and supply or demand for maintenance, repair and operating products, equipment and service, decreases in oil and natural gas industry capital expenditure levels, which may result from decreased oil and natural gas prices or other factors, economic risks related to the long-term impact of COVID-19, our ability to manage changes and the continued health or availability of management personnel, and our ability to obtain financing on favorable terms or amend our credit facilities, as needed. This Report identifies other factors that could cause such differences. We cannot assure that these are all of the factors that could cause actual results to vary materially from the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in "Risk Factors", in our Annual Report on Form 10-K filed with the Securities and Exchange Commission on April 5, 2022. We assume no obligation and do not intend to update these forward-looking statements. Unless the context otherwise requires, references in this Report to the "Company", "DXP", "we" or "our" shall mean DXP Enterprises, Inc., a Texas corporation, together with its subsidiaries. CURRENT MARKET CONDITIONS AND OUTLOOK General DXP Enterprises, Inc. is a business-to-business distributor of maintenance, repair and operating and production ("MRO") products and services to a variety of customers in different end markets primarily across North America. Additionally, we fabricate, remanufacture and assemble custom pump packages along with manufacturing branded private label pumps. Ukrainian - Russia Conflict In February 2022, Russia invaded Ukraine. DXP has no direct exposure to Russia or Ukraine, however, the Company continues to monitor any broader impact in the global economy, including inflation and cost pressures, supply chains and energy prices. The full impact of the conflict on the Company’s business and financial results remains uncertain and will depend on the severity and duration of the war and its impact on global economic conditions. Inflation As the world recovered and reopened during fiscal 2021, and continuing into the current fiscal year, the global commodity and labor markets experienced significant inflationary pressures attributable to economic recovery and supply chain issues tightening caused by the COVID-19 pandemic and the Ukrainian-Russia conflict mentioned above. These inflationary trends increased the cost of many of the products we buy. As a distributor, we often remain neutral to inflation as those costs are generally passed 16 onto customers. The Company was able to implement these and other strategies designed to mitigate some of the adverse effects of higher costs during the first quarter of fiscal 2022 while also remaining price competitive. COVID-19 Pandemic Impact The COVID-19 pandemic began in the first quarter of 2020 and continued throughout the first quarter of fiscal 2022, causing significant disruptions in the U.S. and global markets. While the ongoing recovery continues, it has been accompanied by a resurgence in demand as industries return to regular operations, which continues to disrupt supply chains, transportation efficiency, product and labor availability. The full extent and long-term impacts on the Company’s business and financial results will depend on several uncertain and unpredictable developments including any continued spread of the virus and its variants, the availability and effectiveness of treatments and vaccines, imposition of protective public safety measures and the overall impact of government measures to combat the spread of the virus. We are not able to predict whether our customers will continue to operate at their current or historical levels, and such decreases in their operations would have a negative impact on our business. We are also unable to predict how long the COVID-19 pandemic will last and the impact of the pandemic on future demand for our products and services. For additional discussion of the potential impact of the COVID-19 pandemic on our business, see Part I, Item 1A: Risk Factors in the Company’s 2021 Form 10-K. Matters Affecting Comparability There were 64 business days in the three months ended March 31, 2022 and 63 business days in the three months ended March 31, 2021. Outlook Service Centers & Supply Chain Services Segments The replacement and mission-critical nature of our products and services within the Company's Service Centers and Supply Chain Services business segments and industrial and manufacturing environments and processes drives a demand and outlook that are correlated with global, national and regional industrial production, capacity utilization and long-term GDP growth. Long-term economic conditions remain uncertain with regard to COVID-19 and its impact on various end markets, however, recent order activity improved as markets strengthened and restrictions and mandates were lifted. In the first quarter of 2022, we had approximately $266.4 million in sales in our Service Centers and Supply Chain Services segment, an increase of approximately 19.8 percent over the first quarter of 2021. We expect financial results to continually improve with interim periods of potential setback should new variants arise or other economic headwinds prevail. Innovative Pumping Solutions Segment In the first quarter of 2022, we had approximately $53.1 million in sales in our Innovative Pumping Solutions segment, an increase of approximately $29.8 million over the first quarter of 2021, of which $9.1 million was associated with recent acquisitions in the water and wastewater market. Beginning in the latter half of 2021, we began to see an improvement in the demand for oil and natural gas as the roll out of the COVID-19 vaccinations gradually improved around the globe and pandemic restrictions eased. The increasing optimism related to oil & gas demand recovery led to higher commodity prices. Although demand levels remained below pre-pandemic levels, there is growing confidence of returning to 2019 levels in the coming years. In the first quarter of 2022, the Ukrainian-Russia conflict caused further disruption in the global oil and gas supply and spurred price increases around the world. These forces contributed to higher spend by oil and gas producers and thus an increase in oil & gas projects within our Innovative Pumping Solutions segment. We expect to benefit from the increased activity throughout 2022. 17 RESULTS OF OPERATIONS (in thousands, except percentages and per share data) DXP is organized into three business segments: Service Centers ("SC"), Supply Chain Services ("SCS") and Innovative Pumping Solutions ("IPS"). The Service Centers are engaged in providing maintenance, repair and operating ("MRO") products, equipment and integrated services, including technical expertise and logistics capabilities, to industrial customers with the ability to provide same day delivery. The Service Centers provide a wide range of MRO products and services in the rotating equipment, bearing, power transmission, hose, fluid power, metal working, industrial supply and safety product and service categories. The SCS segment provides a wide range of MRO products and manages all or part of our customer's supply chain function, and inventory management. The IPS segment fabricates and assembles integrated pump system packages custom made to customer specifications, remanufactures pumps and manufactures branded private label pumps. Three Months Ended March 31, 2022 % 2021 % Sales $ 319,411 100.0 % $ 245,587 100.0 % Cost of sales 224,527 70.3 % 173,957 70.8 % Gross profit $ 94,884 29.7 % $ 71,630 29.2 % Selling, general and administrative expenses 73,325 23.0 % 65,397 26.6 % Impairment and other charges — — % — — % Income from operations $ 21,559 6.7 % $ 6,233 2.5 % Other (income) expense, net 536 0.2 % (430) (0.2) % Interest expense 5,162 1.6 % 5,243 2.1 % Income before income taxes $ 15,861 5.0 % $ 1,420 0.6 % Provision for income taxes 3,332 1.0 % 1,261 0.5 % Net income $ 12,529 3.9 % $ 159 0.1 % Net loss attributable to noncontrolling interest (113) — (212) — Net income attributable to DXP Enterprises, Inc. $ 12,642 4.0 % $ 371 0.2 % Per share amounts attributable to DXP Enterprises, Inc. Basic earnings per share 0.68 $ 0.02 Diluted earnings per share 0.65 $ 0.02 Three Months Ended March 31, 2022 compared to Three Months Ended March 31, 2021 SALES. Sales for the three months ended March 31, 2022 increased $73.8 million, or 30.1 percent, to approximately $319.4 million from $245.6 million for the prior year's corresponding period. Sales from businesses acquired for three months ended March 31, 2022, accounted for $13.1 million of the sales for the three months ended March 31, 2022. This overall sales increase is the result of an increase in sales in our SC, IPS and SCS segments of $32.4 million, $29.8 million and $11.6 million, respectively. The fluctuations in sales are further explained in our business segment discussions below. Three Months Ended March 31, 2022 2021 Change Change% Sales by Business Segment (in thousands, except change %) Service Centers $ 218,797 $ 186,369 $ 32,428 17.4 % Innovative Pumping Solutions 53,058 23,245 29,813 128.3 % Supply Chain Services 47,556 35,973 11,583 32.2 % Total DXP Sales $ 319,411 $ 245,587 $ 73,824 30.1 % 18 Service Centers segment. Sales for the SC segment increased by approximately $32.4 million, or 17.4 percent for the three months ended March 31, 2022 compared to the prior year's corresponding period. Excluding $4.0 million of Service Centers segment sales associated with recent acquisitions, sales increased $28.4 million from the prior year's corresponding period. This sales increase is primarily the result of increased sales of rotating equipment, safety supplies, metal working, and bearings and power transmission products to customers engaged in variety of markets as a result of the lifting of pandemic restrictions and a return to normal production and activity. Innovative Pumping Solutions segment . Sales for the IPS segment increased by $29.8 million, or 128.3 percent, for the three months ended March 31, 2022 compared to the prior year's corresponding period. Excluding $9.1 million of IPS segment sales from recent acquisitions, IPS segment sales increased $20.7 million from the prior year's corresponding period. This increase was primarily the result of an increase in the capital spending by oil and gas producers and related businesses. Supply Chain Services segment. Sales for the SCS segment increased by $11.6 million, or 32.2 percent, for the three months ended March 31, 2022, compared to the prior year's corresponding period. The improved sales is primarily related to increased sales to customers in the food & beverage, general manufacturing and aerospace industries as pandemic restrictions subsided and the economy rebounded. GROSS PROFIT. Gross profit as a percentage of sales for the three months ended March 31, 2022 was 29.7 percent versus 29.2 percent in the prior year's corresponding period. Excluding the impact of the businesses acquired, gross profit as a percentage of sales was 29.5 percent. The increase in the gross profit percentage excluding the businesses acquired is primarily the result of an increase in overall project activity within our IPS segment. Service Centers segment. As a percentage of sales, the first quarter gross profit percentage for the SC segment increased approximately 127 basis points. Adjusting for the businesses acquired, gross profit as a percentage of sales increased approximately 133 basis points from the prior year's corresponding period. This was primarily was a result of volume increases and product mix. Gross profit for the SC segment, excluding businesses acquired, increased $11.3 million, or 20.4 percent, during the three months ended March 31, 2022 compared to the prior year’s corresponding period. Innovative Pumping Solutions segment. As a percentage of sales, the first quarter gross profit percentage for the IPS segment decreased approximately 493 basis points. Adjusting for the business acquired, gross profit as a percentage of sales decreased approximately 645 basis points from the prior year's corresponding period. The decrease in gross profit percentage is primarily due to a mix shift (higher margin international work and domestic water and wastewater projects). Gross profit dollars increased $4.4 million compared to the prior year corresponding period, excluding business acquired, primarily as a result of an increase in project work as a result of an increase in capital spending by our customers. Supply Chain Services segment. Gross profit as a percentage of sales for the SCS segment increased approximately 80 basis points compared to the prior year's corresponding period. Gross profit for the first quarter of 2022 increased $3.0 million or 36.8% compared to the prior year's corresponding period. SELLING, GENERAL AND ADMINISTRATIVE ("SG&A"). Selling, general and administrative expense for the three months ended March 31, 2022 increased by approximately $7.9 million, or 12.1%, to $73.3 million from $65.4 million for the prior year's corresponding period. Selling, general and administrative expense from businesses acquired accounted for $2.2 million. Excluding expenses from businesses acquired, SG&A for the quarter increased by $5.7 million, or 8.7%. The increase in SG&A excluding businesses acquired is primarily the result of increased payroll, incentive compensation and related taxes and 401(k) expenses as a result of increased business activity associated with recovery from the negative economic impacts of the COVID-19 pandemic. OPERATING INCOME. Operating income for the first quarter of 2022 increased by $15.3 million to $21.6 million, from $6.2 million in the prior year's corresponding period. This increase in operating income is primarily related to the aforementioned increased business activity across all segments. INTEREST EXPENSE. Interest expense for the first quarter of 2022 increased $0.1 million compared with the prior year's corresponding period . 19 INCOME TAXES. Our effective tax rate from continuing operations was a tax expense of 21.0 percent for the three months ended March 31, 2022 compared to a tax expense of 90.9 percent for the three months ended March 31, 2021. Compared to the U.S. statutory rate for the three months ended March 31, 2022, the effective tax rate was increased by state taxes, foreign taxes, nondeductible expenses, and uncertain tax positions recorded due to tax authorities’ auditing of research and development tax credits. The effective tax rate was decreased by research and development tax credits and other tax credits. Compared to the U.S. statutory rate for the three months ended March 31, 2021, the effective tax rate was increased by state taxes, foreign taxes, nondeductible expenses, and uncertain tax positions recorded due to tax authorities’ auditing of research and development tax credits. The effective tax rate was decreased by research and development tax credits and other tax credits. LIQUIDITY AND CAPITAL RESOURCES General Overview As of March 31, 2022, we had cash and restricted cash of $36.7 million and credit facility availability of $132.2 million. We have a $135.0 million asset-based loan ("ABL") facility, partially offset by letters of credit of $2.8 million, that is due to mature in August 2022, under which we had no borrowings outstanding as of March 31, 2022 and a Term Loan B with $325.9 million in borrowings. The Company intends to amend and extend the ABL prior to the August deadline. Our primary source of capital is cash flow from operations, supplemented as necessary by bank borrowings or other sources of financing. As a distributor of MRO products and services and fabricator of custom pumps and packages, working capital can fluctuate as a result of changes in inventory levels, accounts receivable and costs in excess of billings for project work. Additional cash is required for capital items for information technology, warehouse equipment, leasehold improvements, pump manufacturing equipment and safety services equipment. We also require cash to pay our lease obligations and to service our debt. The following table summarizes our net cash flows generated by operating activities, net cash used in investing activities and net cash used in financing activities for the periods presented (in thousands) : Three Months Ended March 31, 2022 2021 Net Cash Provided by (Used in): Operating Activities $ 2,680 $ 8,577 Investing Activities (6,056) 617 Financing Activities (9,322) (1,365) Effect of Foreign Currency 268 204 Net Change in Cash $ (12,430) $ 8,033 Operating Activities The Company generated $2.7 million of cash from operating activities during the three months ended March 31, 2022 compared to $8.6 million of cash generated during the prior year's corresponding period. The $5.9 million decrease in the amount of cash provided between the two periods was primarily driven by the increase in project work activity during the period. Cash is generally used to fund project costs in excess of amounts billed. Investing Activities For the three months ended March 31, 2022, net cash used in investing activities was $6.1 million compared to $0.6 million cash generated during the prior year’s corresponding period. This $6.7 million increase was primarily driven by the purchase of Drydon and Burlingame in March 2022. The prior year period also benefited from the sale of a corporate asset totaling $1.3 million without comparable activity in the current year. Financing Activities For the three months ended March 31, 2022, net cash used in financing activities was $9.3 million, compared to net cash used in financing activities of $1.4 million during the prior year’s corresponding period. The activity in the period was primarily attributed to share repurchase installment payment of $6.8 million related to shares repurchased in 2021 and share purchases in 2022 of $1.5 million. 20 On May 12, 2021, the Company announced that its Board of Directors authorized a share repurchase program (the “program”) under which up to $85.0 million or 1.5 million shares of its outstanding common stock may be acquired in the open market over the next 24 months at the discretion of management. During the three months ended March 31, 2022 we purchased 59 thousand shares for approximately $1.5 million. Such consideration was funded with existing cash balances and an agreement to pay sellers over four equal quarterly installments beginning on June 15, 2021. The remaining installment of $6.8 million was included in other current liabilities as of March 31, 2022. We believe this is adequate funding to support working capital needs within the business. Funding Commitments We intend to pursue additional acquisition targets, but the timing, size or success of any acquisition and the related potential capital commitments cannot be determined with certainty. We continue to expect to fund future acquisitions primarily with cash flows from operations and borrowings, including the undrawn portion of the credit facility or new debt issuances, but may also issue additional equity either directly or in connection with acquisitions. There can be no assurance that additional financing for acquisitions will be available at terms acceptable to the Company. The Company believes cash generated from operations will meet normal working capital needs during the next twelve months. However, the Company may require additional debt outside of our credit facilities or equity financing to fund potential acquisitions. Such additional financings may include additional bank debt or the public or private sale of debt or equity securities. In connection with any such financing, the Company may issue securities that dilute the interests of our shareholders. DISCUSSION OF SIGNIFICANT ACCOUNTING AND BUSINESS POLICIES Critical accounting and business policies are those that are both most important to the portrayal of a company's financial position and results of operations, and require management's subjective or complex judgments. These policies have been discussed with the Audit Committee of the Board of Directors of DXP. The Company's unaudited condensed financial statements are prepared in accordance with accounting principles generally accepted in the United States of America ("US GAAP"). The accompanying unaudited Condensed Consolidated Financial Statements include the accounts of the Company, its wholly owned subsidiaries and its variable interest entity ("VIE"). The accompanying unaudited Condensed Consolidated Financial Statements have been prepared on substantially the same basis as our annual Consolidated Financial Statements and should be read in conjunction with our annual report on Form 10-K for the year ended December 31, 2021. For a more complete discussion of our significant accounting policies and business practices, refer to the consolidated annual report on Form 10-K filed with the Securities and Exchange Commission on April 5, 2022. The results of operations for the three months ended March 31, 2022 are not necessarily indicative of results expected for the full fiscal year. RECENT ACCOUNTING PRONOUNCEMENTS See Note 3 - Recent Accounting Pronouncements to the Condensed Consolidated Financial Statements for information regarding recent accounting pronouncements. ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. For quantitative and qualitative disclosures about market risk, see Item 7A, 'Quantitative and Qualitative Disclosures About Market Risk,' of our Annual Report on Form 10-K for the year ended December 31, 2021. Our exposures to market risk have not changed materially since December 31, 2021. 21