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, 2023 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 long-term impacts of the COVID-19 pandemic, the prolonged Ukrainian/Russia conflict and its 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, but are not limited to, 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 17, 2023. 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 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. Inflation Reduction Act In August 2022, the Inflation Reduction Act of 2022 (IRA) was signed into United States (U.S.) law. The IRA establishes a new 15% corporate minimum tax and a new 1% excise tax on stock repurchases, effective after December 31, 2022. In addition, the IRA contains provisions relating to climate change, energy and health care. Based on the Company's current analysis of the provisions, the Company does not anticipate a material impact to the consolidated financial statements as a result of the IRA. 14 Inflation 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, among other factors. 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 on to customers. The Company was able to pass price increases on to customers and implement other strategies designed to mitigate some of the adverse effects of higher costs during the three months ended March 31, 2023. Outlook Service Centers and 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. The Company's recent order activity improved as markets strengthened. For the three months ended March 31, 2023, we had approximately $362.3 million in sales in our Service Centers and Supply Chain Services segments, an increase of approximately 36.0 percent compared to the three months ended March 31, 2022. Our performance has been strengthened by price increases from our vendors and suppliers that we typically pass through to our customers. During 2022 and into the first quarter of 2023 we have benefited from these price increases. As we move into the second quarter and second half of 2023, we expect the impact of these price increases to moderate. Innovative Pumping Solutions Segment For the three months ended March 31, 2023, we had approximately $62.0 million in sales in our Innovative Pumping Solutions segment, an increase of approximately $8.9 million compared to the three months ended March 31, 2022, of which $3.3 million was associated with recent acquisitions in the water and wastewater markets. Beginning in the second 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 and 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 spending by oil and gas producers, and thus, an increase in oil and gas projects within our Innovative Pumping Solutions segment. We expect to benefit from the increased oil and gas activity throughout 2023. Additionally, we expect to benefit from the recent water and wastewater acquisitions as we continue to scale this platform both organically and by positioning DXP Water to bid on projects that historically may have not been available to the separate acquisitions on a standalone basis. 15 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 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 provides products and services to the water and wastewater market and 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, 2023 % 2022 % Sales $ 424,267 100.0 % $ 319,411 100.0 % Cost of sales 299,226 70.5 % 224,527 70.3 % Gross profit $ 125,041 29.5 % $ 94,884 29.7 % Selling, general and administrative expenses 89,642 21.1 % 73,325 23.0 % Income from operations $ 35,399 8.3 % $ 21,559 6.7 % Other expense (income), net (469) (0.1) % 536 0.2 % Interest expense 11,521 2.7 % 5,162 1.6 % Income before income taxes $ 24,347 5.7 % $ 15,861 5.0 % Provision for income tax expense (benefit) 6,767 1.6 % 3,332 1.0 % Net income $ 17,580 4.1 % $ 12,529 3.9 % Net loss attributable to noncontrolling interest — — (113) — Net income attributable to DXP Enterprises, Inc. $ 17,580 4.1 % $ 12,642 4.0 % Per share amounts attributable to DXP Enterprises, Inc. Basic earnings per share 1.00 $ 0.68 Diluted earnings per share 0.95 $ 0.65 Three Months Ended March 31, 2023 compared to Three Months Ended March 31, 2022 SALES. Sales for the three months ended March 31, 2023 increased $104.9 million, or 32.8 percent, to approximately $424.3 million from $319.4 million for the prior year's corresponding period. Sales from businesses acquired in 2022 for three months ended March 31, 2023, accounted for $9.3 million of the sales. This overall sales increase is the result of an increase in sales in our SC, IPS and SCS segments of $76.4 million, $8.9 million, and $19.5 million, respectively. The fluctuations in sales are further explained in our business segment discussions below. Three Months Ended March 31, 2023 2022 Change Change% Sales by Business Segment (in thousands, except change %) Service Centers $ 295,226 $ 218,797 $ 76,429 34.9 % Innovative Pumping Solutions 61,998 53,058 8,940 16.8 % Supply Chain Services 67,043 47,556 19,487 41.0 % Total DXP Sales $ 424,267 $ 319,411 $ 104,856 32.8 % 16 Service Centers segment. Sales for the SC segment increased by approximately $76.4 million, or 34.9 percent, for the three months ended March 31, 2023, compared to the prior year's corresponding period. Excluding $6.0 million of SC segment sales associated with acquisitions in the prior period, sales increased $70.4 million from the prior year's corresponding period. This sales increase is primarily the result of increased sales of rotating equipment and bearings and power transmission products to customers engaged in variety of markets. Innovative Pumping Solutions segment . Sales for the IPS segment increased by $8.9 million, or 16.9 percent, for the three months ended March 31, 2023, compared to the prior year's corresponding period. Excluding $3.3 million of IPS segment sales from acquisitions in the prior period, IPS segment sales increased $5.6 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 $19.5 million, or 41.0 percent, for the three months ended March 31, 2023, compared to the prior year's corresponding period. The improved sales are primarily related to the addition of a new customer in the diversified chemicals market, as well as sales increases in the medical technology, food and beverage and oil and gas markets. GROSS PROFIT. Gross profit as a percentage of sales for the three months ended March 31, 2023 was 29.5 percent versus 29.7 percent in the prior year's corresponding period. Excluding the impact of the businesses acquired in the prior period, gross profit as a percentage of sales was 29.2 percent. The decrease in the gross profit percentage excluding the businesses acquired is primarily the result of a decrease in gross profit within our SCS segment. Service Centers segment. As a percentage of sales, for the three months ended March 31, 2023 gross profit percentage for the SC segment increased approximately 20 basis points. Excluding for the businesses acquired in the prior period, gross profit as a percentage of sales decreased approximately 30 basis points from the prior year's corresponding period. This was primarily the result of product mix. Gross profit for the SC segment, excluding businesses acquired in the prior period, increased $20.9 million, or 30.9 percent, during the three months ended March 31, 2023 compared to the prior year’s corresponding period. Innovative Pumping Solutions segment. As a percentage of sales, for the three months ended March 31, 2023 gross profit percentage for the IPS segment increased approximately 185 basis points. Excluding for the businesses acquired, gross profit as a percentage of sales increased approximately 235 basis points from the prior year's corresponding period. The aforementioned increase in gross profit percentage as a percentage of sales is primarily due to the addition of higher water and wastewater projects versus lower margin oil and gas work and gross margin improvements within oil and gas. Gross profit increased $3.1 million compared to the prior year corresponding period, excluding business acquired, primarily as a result of an increase in project work caused by an increase in capital spending by our customers. Supply Chain Services segment. As a percentage of sales, for the three months ended March 31, 2023 gross profit percentage for the SCS segment decreased approximately 375 basis points compared to the prior year's corresponding period. Gross profit for the first quarter of 2023 increased $2.1 million, or 18.8 percent, compared to the prior year's corresponding period primarily due to the addition of a new customer in the diversified chemicals market. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES ("SG&A"). SG&A for the three months ended March 31, 2023 increased by approximately $16.3 million, or 22.3 percent, to $89.6 million from $73.3 million for the prior year's corresponding period. SG&A from businesses acquired accounted for $2.0 million. Excluding expenses from businesses acquired, SG&A for the quarter increased by $14.3 million, or 19.5 percent, compared to the prior year's corresponding period. 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. OPERATING INCOME. Operating income for the first quarter of 2023 increased by $13.8 million to $35.4 million, from $21.6 million in the prior year's corresponding period. This increase in operating income is related to the aforementioned increase in business activity across all segments and reduction in SG&A as a percentage of sales in the current period versus the prior year's corresponding period. INTEREST EXPENSE. Interest expense for the first quarter of 2023 increased $6.4 million compared to the prior year's corresponding period. This increase was primarily due to the Company borrowing an additional $105.0 million on its Term Loan B during the fourth quarter of 2022 and incurring higher than average interest rates on such debt due to changes in the macroeconomic environment and the associated increasing interest rate policy by the U.S. Federal Reserve Bank. 17 INCOME TAXES. 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. LIQUIDITY AND CAPITAL RESOURCES General Overview As of March 31, 2023, we had cash and restricted cash of $58.4 million and credit facility availability of $132.4 million. We have a $135.0 million asset backed revolving line of credit (the "ABL Revolver"), partially offset by letters of credit of $2.6 million. We had no borrowings outstanding on our ABL Revolver as of March 31, 2023. We had $427.0 million in borrowings on our Term Loan B as of March 31, 2023. On July 19, 2022, the Company amended and extended the maturity date of the ABL Revolver to July 19, 2027. 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, 2023 2022 Net Cash Provided by (Used in): Operating Activities $ 26,449 $ 2,680 Investing Activities (3,804) (6,056) Financing Activities (10,354) (9,322) Effect of Foreign Currency (35) 268 Net Change in Cash $ 12,256 $ (12,430) Operating Activities The Company generated $26.4 million of cash from operating activities during the three months ended March 31, 2023 compared to $2.7 million of cash generated during the prior year's corresponding period. The $23.8 million increase in the amount of cash provided between the two periods was primarily due to increased business activity. Investing Activities For the three months ended March 31, 2023, net cash used in investing activities was $3.8 million compared to a $6.1 million use of cash during the prior year’s corresponding period. This $2.3 million decrease was primarily driven by a reduction in the total purchase price paid for acquisitions during the three months ended March 31, 2022 of $5.3 million without comparable activity during the three months ended March 31, 2023. The decrease was partially offset by purchases of property and equipment of $3.8 million for the three months ended March 31, 2023 compared to $740 thousand for the three months ended March 31, 2022. Financing Activities For the three months ended March 31, 2023, net cash used in financing activities was $10.4 million, compared to net cash used in financing activities of $9.3 million during the prior year’s corresponding period. The increase was primarily due to an increase of $0.8 million in share repurchases. 18 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 it has adequate funding and liquidity to meet its 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 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. 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, 2022. Our exposures to market risk have not changed materially since December 31, 2022. 19