DXP ENTERPRISES INC 10-Q

ITEM 1: FINANCIAL STATEMENTS DXP ENTERPRISES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (in thousands, except per share amounts) (unaudited) Three Months Ended March 31, 2023 2022 Sales $ 424,267 $ 319,411 Cost of sales 299,226 224,527 Gross profit 125,041 94,884 Selling, general and administrative expenses 89,642 73,325 Income from operations 35,399 21,559 Other (income) expense ( 469 ) 536 Interest expense 11,521 5,162 Income before income taxes 24,347 15,861 Provision for income tax expense 6,767 3,332 Net income 17,580 12,529 Net loss attributable to noncontrolling interest — ( 113 ) Net income attributable to DXP Enterprises, Inc. 17,580 12,642 Preferred stock dividend 23 23 Net income attributable to common shareholders $ 17,557 $ 12,619 Net income $ 17,580 $ 12,529 Currency translation adjustments 98 1,669 Comprehensive income $ 17,678 $ 14,198 Earnings per share (Note 9) : Basic $ 1.00 $ 0.68 Diluted $ 0.95 $ 0.65 Weighted average common shares outstanding : Basic 17,596 18,534 Diluted 18,436 19,374 The accompanying notes are an integral part of these unaudited condensed consolidated financial statements. 3 DXP ENTERPRISES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (in thousands, except share and per share data) (unaudited) March 31, 2023 December 31, 2022 ASSETS Current assets: Cash $ 58,282 $ 46,026 Restricted cash 91 91 Accounts Receivable, net of allowance of $ 8,090 and $ 7,610 311,387 320,880 Inventories 109,403 101,392 Costs and estimated profits in excess of billings 41,967 23,588 Prepaid expenses and other current assets 17,238 21,644 Income taxes receivable 972 2,493 Total current assets 539,340 516,114 Property and equipment, net 47,754 45,964 Goodwill 333,816 333,759 Other intangible assets, net 74,830 79,585 Operating lease ROU assets 52,353 57,402 Other long-term assets 5,068 4,456 Total assets $ 1,053,161 $ 1,037,280 LIABILITIES AND EQUITY Current liabilities: Current maturities of debt $ 4,369 $ 4,369 Trade accounts payable 106,320 100,784 Accrued wages and benefits 26,617 26,260 Customer advances 14,507 20,128 Billings in excess of costs and estimated profits 10,183 10,411 Federal income taxes payable 6,266 — Short-term operating lease liabilities 17,698 18,083 Other current liabilities 38,795 32,866 Total current liabilities 224,755 212,901 Long-term debt, net of unamortized debt issuance costs 408,755 409,205 Long-term operating lease liabilities 38,507 40,189 Other long-term liabilities 4,770 4,701 Deferred income taxes liability 2,090 4,892 Total long-term liabilities 454,122 458,987 Total liabilities 678,877 671,888 Commitments and contingencies ( Note 10 ) Shareholders' equity: Series A and B preferred stock, $ 1.00 par value each; 1,000,000 shares authorized each 16 16 Common stock, $ 0.01 par value, 100,000,000 shares authorized; 17,548,600 and 17,690,069 outstanding 345 345 Additional paid-in capital 214,309 213,937 Retained earnings 268,106 250,549 Accumulated other comprehensive loss ( 31,577 ) ( 31,675 ) Treasury stock, at cost 2,774,887 and 2,435,352 shares ( 76,915 ) ( 67,780 ) Total DXP Enterprises, Inc. equity 374,284 365,392 Total liabilities and equity $ 1,053,161 $ 1,037,280 The accompanying notes are an integral part of these unaudited condensed consolidated financial statements. 4 DXP ENTERPRISES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) (unaudited) Three Months Ended March 31, 2023 2022 CASH FLOWS FROM OPERATING ACTIVITIES: Net income 17,580 12,529 Reconciliation of net income to net cash provided by operating activities: Depreciation 2,024 2,517 Amortization of intangible assets and deferred financing costs 5,400 4,693 Provision for credit losses 498 ( 147 ) Fair value adjustment on contingent consideration 342 531 Restricted stock compensation expense 476 370 Deferred income taxes ( 2,799 ) 411 Changes in operating assets and liabilities, and other: Changes in Accounts receivables, net 9,070 ( 9,485 ) Accounts payable and accrued expenses 13,311 9,603 Prepaid expenses and other assets 8,844 ( 3,603 ) Inventories ( 8,006 ) ( 10,910 ) Other ( 20,291 ) ( 3,829 ) Net cash provided by operating activities $ 26,449 $ 2,680 CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of property and equipment ( 3,804 ) ( 740 ) Acquisition of business, net of cash acquired — ( 5,316 ) Net cash used in investing activities $ ( 3,804 ) $ ( 6,056 ) CASH FLOWS FROM FINANCING ACTIVITIES: Principal debt payments ( 1,092 ) ( 825 ) Preferred stock dividends paid ( 23 ) ( 23 ) Purchase of treasury stock ( 9,135 ) ( 8,315 ) Payment for employee taxes withheld from stock awards ( 104 ) ( 159 ) Net cash provided by (used in) financing activities $ ( 10,354 ) $ ( 9,322 ) Effect of foreign currency on cash ( 35 ) 268 Net change in cash and restricted cash 12,256 ( 12,430 ) Cash and restricted cash at beginning of period 46,117 49,080 Cash and restricted cash at end of period $ 58,373 $ 36,650 Supplemental schedule of non-cash investing and financing activities: Shares issued for acquisitions (Note 12) — 527 The accompanying notes are an integral part of these unaudited condensed consolidated financial statements. 5 DXP ENTERPRISES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF EQUITY (in thousands) (unaudited) Series A preferred stock Series B preferred stock Common stock Paid-in capital Retained earnings Treasury stock Non controlling interest Accum other comp loss Total equity Balance at December 31, 2021 $ 1 $ 15 $ 195 $ 206,772 $ 202,484 $ ( 33,511 ) $ 53 $ ( 29,282 ) $ 346,727 Preferred dividends paid — — — — ( 23 ) — — — ( 23 ) Restricted stock compensation expense — — — 370 — — — — 370 Tax related items for share based awards — — — ( 159 ) — — — — ( 159 ) Issuance of shares of common stock — — — 527 — — — — 527 Currency translation adjustment — — — — — — — 1,669 1,669 Purchase of treasury stock — — — — — ( 1,513 ) — — ( 1,513 ) Net income (loss) — — — — 12,642 — ( 113 ) — 12,529 Balance at March 31, 2022 $ 1 $ 15 $ 195 $ 207,510 $ 215,103 $ ( 35,024 ) $ ( 60 ) $ ( 27,613 ) $ 360,127 Series A preferred stock Series B preferred stock Common stock Paid-in capital Retained earnings Treasury stock Non controlling interest Accum other comp loss Total equity Balance at December 31, 2022 $ 1 $ 15 $ 345 $ 213,937 $ 250,549 $ ( 67,780 ) $ — $ ( 31,675 ) $ 365,392 Preferred dividends paid — — — — ( 23 ) — — — ( 23 ) Restricted stock compensation expense — — — 476 — — — — 476 Tax related items for share based awards — — — ( 104 ) — — — — ( 104 ) Currency translation adjustment — — — — — — — 98 98 Purchase of treasury stock — — — — — ( 9,135 ) — — ( 9,135 ) Net income (loss) — — — — 17,580 — — — 17,580 Balance at March 31, 2023 $ 1 $ 15 $ 345 $ 214,309 $ 268,106 $ ( 76,915 ) $ — $ ( 31,577 ) $ 374,284 The accompanying notes are an integral part of these unaudited condensed consolidated financial statements 6 DXP ENTERPRISES, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 - THE COMPANY DXP Enterprises, Inc. together with its subsidiaries (collectively "DXP," "Company," "us," "we," or "our") was incorporated in Texas on July 26, 1996. DXP Enterprises, Inc. and its subsidiaries are engaged in the business of distributing maintenance, repair and operating ("MRO") products and services to a variety of end markets and industrial customers. Additionally, DXP provides integrated, custom pump skid packages, pump remanufacturing and manufactures branded private label pumps to energy and industrial customers. The Company is organized into three business segments: Service Centers ("SC"), Supply Chain Services ("SCS") and Innovative Pumping Solutions ("IPS"). See Note 11 - Segment Reporting for discussion of the business segments. NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING AND BUSINESS POLICIES Basis of Presentation The Company's 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 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, 2022. 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 17, 2023. The results of operations for the three months ended March 31, 2023 are not necessarily indicative of results expected for the full fiscal year. In the opinion of management, the accompanying unaudited condensed consolidated financial statements reflect all normal recurring adjustments necessary for the fair statement of the Company's financial position, results of operations and cash flows for the interim periods presented. All inter-company accounts and transactions have been eliminated in consolidation. NOTE 3 - RECENT ISSUED ACCOUNTING PRONOUNCEMENTS The Company has implemented all new accounting pronouncements that are in effect and is evaluating any that may impact its financial statements, including the new Business Combinations (Topic 805) - Accounting for Contract Assets and Contract Liabilities from Contracts with Customers standard. The Company does not have any acquisitions during the current period and does not believe the new accounting pronouncement to have a material impact on its financial position or results of operations for recent acquisitions.. Accounting Pronouncements Not Yet Adopted All other new accounting pronouncements that have been issued, but not yet effective, are currently being evaluated and at this time are not expected to have a material impact on our financial position or results of operations. NOTE 4 - FAIR VALUE OF FINANCIAL ASSETS AND LIABILITIES Authoritative guidance for financial assets and liabilities measured on a recurring basis applies to all financial assets and financial liabilities that are being measured and reported on a fair value basis. Fair value, as defined in the authoritative guidance, is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The authoritative guidance affects the fair value measurement of an investment with quoted market prices in an active market for identical instruments, which must be classified in one of the following categories: Level 1 inputs come from quoted prices (unadjusted) in active markets for identical assets or liabilities. Level 2 inputs are other than quoted prices that are observable for an asset or liability. These inputs include: quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; inputs other than quoted prices that are observable for the asset or liability; and inputs that are derived principally from, or corroborated by, observable market data by correlation or other means. 7 Level 3 inputs are unobservable inputs for an asset or liability which require the Company's own assumptions. Financial assets and liabilities are classified based on the lowest level of input that is significant to the fair value measurement. Our assessment of the significance of a particular input to the fair value measurement requires judgment and may affect the valuation of the fair value of assets and liabilities and their placement within the fair value hierarchy levels. Our acquisitions may include contingent consideration as part of the purchase price. The fair value of the contingent consideration is estimated as of the acquisition date based on the present value of the contingent payments to be made using a weighted probability of possible payments. The unobservable inputs used in the determination of the fair value of the contingent consideration include management's assumptions about the likelihood of payment based on the established benchmarks, discount rates, and an internal rate of return analysis. The fair value measurement includes inputs that are Level 3 inputs as discussed above, as they are not observable in the market. Should actual results increase or decrease as compared to the assumptions used in our analysis, the fair value of the contingent consideration obligations will increase or decrease, up to the contracted limit, as applicable. Changes in the fair value of the contingent earn-out consideration are measured each reporting period and reflected in our results of operations. As of March 31, 2023, we recorded liabilities in other current and long-term liabilities for contingent consideration associated with the acquisitions of Process Machinery, Inc. ("PMI"), Burlingame Engineers, Inc. ("Burlingame"), Drydon Equipment, Inc. ("Drydon"), Cisco Air Systems, Inc. ("Cisco") and Sullivan Environmental Technologies, Inc. ("Sullivan") of $ 1.2 million, $ 0.5 million, $ 2.8 million, $ 4.8 million, and $ 1.2 million, respectively. For the Company's assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3), the following table provides a reconciliation of the beginning and ending balances for each category therein, and gains or losses recognized during the three months ended March 31, 2023: Fair Value Measurements Using Significant Unobservable Inputs (Level 3) Contingent Liability for Accrued Consideration (in thousands) *Beginning balance at December 31, 2022 $ 10,166 Changes in fair value recorded in other (income) expense, net 342 *Ending Balance at March 31, 2023 $ 10,508 Total losses included in earnings or changes to net assets, attributable to changes in unrealized losses relating to liabilities still held at March 31, 2023. $ 342 *Amounts included in other current liabilities were $ 5.7 million and $ 5.5 million for the periods ending March 31, 2023 and December 31, 2022, respectively. Amounts included in long-term liabilities were $ 4.8 million and $ 4.7 million for the periods ending March 31, 2023 and December 31, 2022, respectively. Quantitative Information about Level 3 Fair Value Measurements The significant unobservable inputs used in the fair value measurement of the Company's contingent consideration liabilities designated as Level 3 are as follows: (in thousands, unaudited) Fair value at March 31, 2023 Valuation Technique Significant Unobservable Inputs Contingent consideration: (PMI, Burlingame, Drydon, Cisco and Sullivan acquisitions) $ 10,508 Discounted cash flow and weighted probability of possible payments Annualized EBITDA and probability of achievement 8 Sensitivity to Changes in Significant Unobservable Inputs As presented in the table above, the significant unobservable inputs used in the fair value measurement of contingent consideration related to the acquisitions of PMI, Burlingame, Drydon, Cisco and Sullivan are annualized EBITDA forecasts developed by the Company's management and the probability of achievement of those EBITDA results. The discount rate used in the calculation was 8.1 percent. Changes in our unobservable inputs in isolation would result in a change to our fair value measurement. Other financial instruments not measured at fair value on the Company's unaudited condensed consolidated balance sheets at March 31, 2023 and December 31, 2022, but which require disclosure of their fair values include: cash, trade accounts receivable, trade accounts payable and accrued expenses, accrued payroll and related benefits, and the revolving line of credit and term loan debt under our syndicated credit agreement facility ( Note 8 ). The Company believes that the estimated fair value of such instruments at March 31, 2023 and December 31, 2022 approximates their carrying value as reported on the unaudited condensed consolidated balance sheets. NOTE 5 – INVENTORIES The carrying values of inventories are as follows ( in thousands ): March 31, 2023 December 31, 2022 Finished goods $ 106,039 $ 82,906 Work in process 3,364 18,486 Inventories $ 109,403 $ 101,392 NOTE 6 – CONTRACT ASSETS AND LIABILITIES Under our customized pump production and long-term water and wastewater project contracts in our IPS segment, amounts are billed as work progresses in accordance with agreed-upon contractual terms, upon various measures of performance, including achievement of certain milestones, completion of specified units, or completion of a contract. Generally, billing occurs subsequent to revenue recognition, resulting in contract assets. Our contract assets are presented as “Cost and estimated profits in excess of billings” on our unaudited condensed consolidated balance sheets. However, we sometimes receive advances or deposits from our customers before revenue is recognized, resulting in contract liabilities that are presented as “Billings in excess of costs and estimated profits” on our unaudited condensed consolidated balance sheets. Costs and estimated profits on uncompleted contracts and related amounts billed were as follows ( in thousands ): March 31, 2023 December 31, 2022 Costs incurred on uncompleted contracts $ 94,100 $ 70,329 Estimated profits, thereon 28,096 23,274 Total costs and estimated profits on uncompleted contracts 122,196 93,603 Less: billings to date 90,412 80,421 Net $ 31,784 $ 13,182 Such amounts were included in the accompanying unaudited condensed consolidated balance sheets for March 31, 2023 and December 31, 2022 under the following captions ( in thousands ): March 31, 2023 December 31, 2022 Costs and estimated profits in excess of billings $ 41,967 $ 23,588 Billings in excess of costs and estimated profits ( 10,183 ) ( 10,411 ) Translation adjustment — 5 Net $ 31,784 $ 13,182 During the three months ended March 31, 2023, $ 9.7 million of the balances that were previously classified as contract liabilities at the beginning of the period were recognized in revenues. Contract asset and liability changes were primarily due to normal activity and timing differences between our performance and customer payments. 9 NOTE 7 – INCOME TAXES Income tax expense during interim periods is based on our estimated annual effective income tax rate plus any discrete items, which are recorded in the period in which they occur. Our effective tax rate from continuing operations was a tax expense of 27.9 percent for the three months ended March 31, 2023 compared to a tax expense of 21.0 percent for the three months ended March 31, 2022. Compared to the U.S. statutory rate for the three months ended March 31, 2023, the effective tax rate was increased by state taxes, foreign taxes, nondeductible expenses, and uncertain tax positions recorded for research and development tax credits and was partially offset by research and development tax credits and other tax credits. To the extent penalties and interest would be assessed on any underpayment of income tax, such accrued amounts would be classified as a component of income tax provision (benefit) in the financial statements consistent with the Company’s policy. NOTE 8 – LONG-TERM DEBT The components of the Company's long-term debt consisted of the following ( in thousands ): March 31, 2023 December 31, 2022 Carrying Value (1) Fair Value Carrying Value (1) Fair Value ABL Revolver $ — $ — $ — $ — Term Loan B 427,041 407,824 428,133 411,008 Total long-term debt 427,041 407,824 428,133 411,008 Less: current portion ( 4,369 ) ( 4,172 ) ( 4,369 ) ( 4,194 ) Long-term debt less current maturities $ 422,672 $ 403,652 $ 423,764 $ 406,814 (1) Carrying value amounts do not include unamortized debt issuance costs of $ 13.9 million and $ 14.6 million for March 31, 2023 and December 31, 2022, respectively. Credit Agreements On July 19, 2022, the Company entered into an Amended and Restated Loan and Security Agreement (the “ABL Credit Agreement”) that provided for a $ 135.0 million asset-backed revolving line of credit (the "ABL Revolver"). The ABL Credit Agreement amends and restates the Loan and Security Agreement dated as of August 29, 2017. Subject to the conditions set forth in the ABL Credit Agreement, the ABL Revolver may be increased by up to an aggregate of $ 50.0 million, in minimum increments of $ 10.0 million. The ABL Revolver matures on July 19, 2027. As of March 31, 2023, the Company had no borrowings outstanding under the ABL Revolver. Total borrowing capacity under the ABL Revolver was $ 132.4 million, net of the letters of credit outstanding. On November 22, 2022, the Company entered into an amendment to its existing $ 330 million Senior Secured Term Loan (the "Term Loan Amendment"), borrowing an additional $ 105 million that was added to the existing $ 330 million Senior Secured Term Loan (the “Term Loan Agreement”). As of March 31, 2023 there was $ 427.0 million outstanding under the Term Loan Agreement. The Company was in compliance with all financial covenants under the ABL Revolver and Term Loan B Agreements as of March 31, 2023. 10 NOTE 9 - EARNINGS PER SHARE DATA Basic earnings per share is computed based on weighted average shares outstanding and excludes dilutive securities. Diluted earnings per share is computed including the impacts of all potentially dilutive securities. The following table sets forth the computation of basic and diluted earnings per share for the periods indicated ( in thousands, except per share data ): Three Months Ended March 31, 2023 2022 Basic: Weighted average shares outstanding 17,596 18,534 Net income attributable to DXP Enterprises, Inc. $ 17,580 $ 12,642 Convertible preferred stock dividend 23 23 Net income attributable to common shareholders $ 17,557 $ 12,619 Per share amount $ 1.00 $ 0.68 Diluted: Weighted average shares outstanding 17,596 18,534 Assumed conversion of convertible preferred stock 840 840 Total dilutive shares 18,436 19,374 Net income attributable to common shareholders $ 17,557 $ 12,619 Convertible preferred stock dividend 23 23 Net income attributable to DXP Enterprises, Inc. $ 17,580 $ 12,642 Per share amount $ 0.95 $ 0.65 NOTE 10 - COMMITMENTS AND CONTINGENCIES From time to time, the Company is a party to various legal proceedings arising in the ordinary course of business. While DXP is unable to predict the outcome or estimate the financial impact of these disputes, it believes that the ultimate resolution will not have, either individually or in the aggregate, a material adverse effect on DXP's consolidated financial position, cash flows, or results of operations. NOTE 11 - SEGMENT REPORTING The Company's reportable business segments are: Service Centers, Innovative Pumping Solutions and Supply Chain Services. The Service Centers segment is engaged in providing MRO products, equipment and integrated services, including logistics capabilities, to industrial customers. The Service Centers segment provides a wide range of MRO products in the rotating equipment, bearing, power transmission, hose, fluid power, metal working, industrial supply, safety products and safety services categories. The Innovative Pumping Solutions segment fabricates and assembles custom-made pump packages, re-manufactures pumps, manufactures branded private label pumps and provides products and process lines for the water and wastewater treatment industries. The Supply Chain Services segment provides a wide range of MRO products and manages all or part of a customer's supply chain, including warehouse and inventory management. Sales are shown net of inter-segment eliminations. The following table sets out financial information related to the Company's segments excluding amortization ( in thousands ): 11 Three Months Ended March 31, 2023 2022 SC IPS SCS Total SC IPS SCS Total Total Revenue $ 295,226 $ 61,998 $ 67,043 $ 424,267 218,797 53,058 47,556 $ 319,411 Income from operations $ 44,705 $ 10,305 $ 5,514 $ 60,524 $ 27,351 $ 7,069 $ 4,020 $ 38,440 The following table presents reconciliations of operating income for reportable segments to the consolidated income before taxes ( in thousands ): Three Months Ended March 31, 2023 2022 Income from operations for reportable segments $ 60,524 $ 38,440 Adjustment for: Amortization of intangible assets 4,758 4,235 Corporate expenses 20,367 12,646 Income from operations $ 35,399 $ 21,559 Interest expense 11,521 5,162 Other expense (income), net ( 469 ) 536 Income before income taxes $ 24,347 $ 15,861 NOTE 12 - SHARE REPURCHASE On December 15, 2022, the Company announced a new Share Repurchase Program pursuant to which it may repurchase up to $ 85.0 million worth, or 2.8 million shares of the Company's outstanding common stock over the next 24 months. During the three months ended March 31, 2023, the Company repurchased 339,535 shares of its common stock for approximately $ 9.1 million compared to 58,887 shares of its common stock for approximately $ 1.5 million for the three months ended March 31, 2022. Total consideration paid to repurchase the shares was recorded in shareholders’ equity as treasury shares. Three Months Ended March 31, Three Months Ended March 31, (in thousands, except per share data) 2023 2022 Total number of shares purchased 339.5 58.9 Amount paid $ 9,135 $ 1,511 Average price paid per share $ 27.26 $ 25.66 12 NOTE 13 - SUBSEQUENT EVENT On May 1, 2023, the Company completed the acquisition of Florida Valve & Equipment, LLC and Environmental MD, Inc., (collectively, “Florida Valve EMD”). Florida Valve EMD is a leading provider of valve and related products and services for the municipal water markets in the State of Florida. Total consideration for the transaction was approximately $ 3.0 million, funded with cash on hand. The preliminary purchase price allocation is not complete as of the date of this quarterly financial issuance and will be an ongoing process for up to one year subsequent to the closing date of the transaction. On May 1, 2023, the Company completed the acquisition of Riordan Materials Corporation (“Riordan”). Riordan is a leading provider of products for water treatment, wastewater treatment, odor control, solids handling, pumping and bio solid processes in the States of Maryland, New Jersey, Pennsylvania, Delaware and Virginia. Total consideration for the transaction was approximately $ 6.2 million, funded with cash on hand. The preliminary purchase price allocation is not complete as of the date of this quarterly financial issuance and will be an ongoing process for up to one year subsequent to the closing date of the transaction. 13