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 and six months ended June 30, 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 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 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; 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 across North America and Dubai. 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 six months ended June 30, 2023. Outlook Service Centers and Innovative Pumping Solutions Segments The replacement and mission-critical nature of our products and services within the Company's Service Centers and Innovative Pumping Solutions 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 June 30, 2023 and six months ended June 30, 2023, we had approximately $361.9 million and $719.1 million in sales in our Service Centers and Innovative Pumping Solutions segments, an increase of approximately 17.2 percent and 23.8 percent compared to the three months ended June 30, 2022 and the six months ended June 30, 2022, respectively. Our performance has been strengthened by price increases from our vendors and suppliers During the six months ended June 30, 2023, $7.3 million was associated with recent acquisitions in the water and wastewater markets. We expect to benefit from the increased oil and gas activity throughout the remainder of 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. Supply Chain Services Segment For the three months ended June 30, 2023 and six months ended June 30, 2023, we had approximately $66.2 million and $133.2 million in sales in our Supply Chain Services segment, an increase of approximately 12.3 percent and 25.1 percent compared to the three months ended June 30, 2022 and the six months ended June 30, 2022, respectively. Our performance compared to the previous six month period has benefited from the addition of a new diversified chemical customer that recently reach its one-year anniversary during the second quarter of 2023. As we move forward, we expect our performance to be driven by either the addition of new customers or an increase in spend by our existing customers. 15 RESULTS OF OPERATIONS (in thousands, except percentages and per share data) DXP is organized into three business segments: Service Centers ("SC"), Innovative Pumping Solutions ("IPS"), and Supply Chain Services ("SCS"). 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 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. 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. Three Months Ended June 30, 2023 % 2022 % Sales $ 428,040 100.0% $ 367,812 100.0% Cost of sales 296,188 69.2% 263,550 71.7% Gross profit 131,852 30.8% 104,262 28.3% Selling, general and administrative expenses 94,372 22.0% 78,342 21.3% Income from operations 37,480 8.8% 25,920 7.0% Other expense (income), net (242) (0.1)% 839 0.2% Interest expense 11,863 2.8% 5,615 1.5% Income before income taxes 25,859 6.0% 19,466 5.3% Provision for income tax expense 6,805 1.6% 4,973 1.4% Net income 19,054 4.5% 14,493 3.9% Net income attributable to noncontrolling interest — — 60 — Net income attributable to DXP Enterprises, Inc. $ 19,054 4.5% $ 14,433 3.9% Per share amounts attributable to DXP Enterprises, Inc. Basic earnings per share $ 1.11 $ 0.77 Diluted earnings per share $ 1.06 $ 0.74 Three Months Ended June 30, 2023 compared to Three Months Ended June 30, 2022 SALES. Sales for the three months ended June 30, 2023 increased $60.2 million, or 16.4 percent, to approximately $428.0 million from $367.8 million for the prior year's corresponding period. Sales from acquisitions for three months ended June 30, 2023, accounted for $7.3 million compared to $17.8 million for the three months ended June 30, 2022. The overall increase in sales was the result of an increase in sales in our SC, IPS and SCS segments of $47.3 million, $5.7 million, and $7.2 million, respectively. The fluctuations in sales are further explained in our business segment discussions below. Three Months Ended June 30, 2023 2022 Change Change% Sales by Business Segment (in thousands, except change %) Service Centers $ 298,432 $ 251,098 $ 47,334 18.9 % Innovative Pumping Solutions 63,441 57,788 5,653 9.8 % Supply Chain Services 66,167 58,926 7,241 12.3 % Total DXP Sales $ 428,040 $ 367,812 $ 60,228 16.4 % 16 Service Centers segment. Sales for the SC segment increased by approximately $47.3 million, or 18.9 percent, for the three months ended June 30, 2023, compared to the prior year's corresponding period. Sales from acquisitions for the SC segment was $4.5 million during the three months ended June 30, 2023 compared to $12.5 million for the three months ended June 30, 2022. Total sales for the SC segment excluding acquisitions increased $55.4 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 a variety of end markets. Innovative Pumping Solutions segment . Sales for the IPS segment increased by $5.7 million, or 9.8 percent, for the three months ended June 30, 2023, compared to the prior year's corresponding period. Sales from acquisitions for the IPS segment was $2.8 million during the three months ended June 30, 2023 compared to $5.3 million for the three months ended June 30, 2022. Total sales for the IPS segment excluding acquisitions increased $8.1 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 renewable sectors. Supply Chain Services segment. Sales for the SCS segment increased by $7.2 million, or 12.3 percent, for the three months ended June 30, 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 June 30, 2023 was 30.8 percent versus 28.3 percent in the prior year's corresponding period. The increase in the gross profit percentage is primarily the result of an increase in gross profit within our IPS segment in our water/wastewater division. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES ("SG&A"). SG&A for the three months ended June 30, 2023 increased by approximately $16.0 million, or 20.5 percent, to $94.4 million from $78.3 million for the prior year's corresponding period. The increase in SG&A 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 second quarter of 2023 increased by $11.6 million to $37.5 million, from $25.9 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. INTEREST EXPENSE. Interest expense for the second quarter of 2023 increased $6.2 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 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. INCOME TAXES. Our effective tax rate from continuing operations was a tax expense of 26.3 percent for the three months ended June 30, 2023, compared to a tax expense of 25.5 percent for the three months ended June 30, 2022. Compared to the U.S. statutory rate for the three months ended June 30, 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. 17 Six Months Ended June 30, 2023 compared to Six Months Ended June 30, 2022 Six Months Ended June 30, 2023 % 2022 % Sales $ 852,307 100.0% $ 687,223 100.0% Cost of sales 595,414 69.9% 488,076 71.0% Gross profit $ 256,893 30.1% $ 199,147 29.0% Selling, general and administrative expenses 184,014 21.6% 151,667 22.1% Income from operations $ 72,879 8.6% $ 47,480 6.9% Other (income) expense, net (712) (0.1)% 1,377 0.2% Interest expense 23,384 2.7% 10,777 1.6% Income before income taxes $ 50,207 5.9% $ 35,326 5.1% Provision for income taxes 13,573 1.6% 8,305 1.2% Net income $ 36,634 4.3% $ 27,021 3.9% Net loss attributable to noncontrolling interest — — (53) —% Net income attributable to DXP Enterprises, Inc. $ 36,634 4.3% $ 27,074 3.9% Per share amounts attributable to DXP Enterprises, Inc. Basic earnings per share $ 2.10 $ 1.45 Diluted earnings per share $ 2.01 $ 1.39 SALES. Sales for the six months ended June 30, 2023 increased $165.1 million, or 24.0 percent, to approximately $852.3 million from $687.2 million for the prior year's corresponding period. Sales from businesses acquired accounted for $26.4 million of sales for the six months ended June 30, 2023 compared to $30.9 million for the six months ended June 30, 2022 . The overall increase in sales was the result of an increase in sales within our SC, IPS and SCS segments of $123.8 million, $14.6 million and $26.7 million, respectively. The fluctuations in sales are further explained in our business segment discussions below. Six Months Ended June 30, 2023 2022 Change Change% Sales by Business Segment (in thousands, except change %) Service Centers 593,658 469,894 $ 123,764 26.3 % Innovative Pumping Solutions 125,439 110,846 14,593 13.2 % Supply Chain Services 133,210 106,483 26,727 25.1 % Total DXP Sales $ 852,307 $ 687,223 $ 165,084 24.0 % Service Centers segment. Sales for the SC segment increased by $123.8 million, or 26.3 percent for the six months ended June 30, 2023, compared to the prior year's corresponding period. Sales from acquisitions for the SC segment was $19.1 million during the six months ended June 30, 2023 compared to $16.5 million for the six months ended June 30, 2022. Total sales for the SC segment excluding acquisitions increased $121.2 million from the prior year's corresponding period. This sales increase is primarily the result of increased sales of rotating equipment and bearings product lines to customers engaged in operating and maintenance services in the general industrial, diversified chemical, and oil & gas markets in connection with increased capital spending by oil and gas producers. 18 Innovative Pumping Solutions segment . Sales for the IPS segment increased by $14.6 million, or 13.2 percent for the six months ended June 30, 2023 compared to the prior year's corresponding period. Sales from acquisitions for the IPS segment was $7.3 million during the six months ended June 30, 2023 compared to $14.4 million for the six months ended June 30, 2022. Total sales for the IPS segment excluding acquisitions increased $21.7 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 renewable Supply Chain Services segment. Sales for the SCS segment increased by $26.7 million, or 25.1 percent, for the six months ended June 30, 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 six months ended June 30, 2023 increased by approximately 116 basis points from the prior year's corresponding period. The increase in the gross profit percentage is primarily the result of an approximate 113 basis points and 335 basis points increase in the gross profit percentage in our SC and IPS segments partially offset by an approximate 72 basis points decrease in our SCS segment, respectively. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES ("SG&A"). SG&A for the six months ended June 30, 2023 increased by approximately $32.3 million, or 21.3 percent, to $184.0 million from $151.7 million for the prior year's corresponding period. The increase in SG&A 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 six months ended June 30, 2023 increased by $25.4 million or 53.5% to $72.9 million from $47.5 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 six months ended June 30, 2023 increased $12.6 million compared with the prior year's corresponding period. This increase was primarily due to the Company borrowing an additional $105.0 million on its Term Loan 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. INCOME TAXES. Our effective tax rate from continuing operations was a tax expense of 27.0 percent for the six months ended June 30, 2023, compared to a tax expense of 23.5 percent for the six months ended June 30, 2022. Compared to the U.S. statutory rate for the six months ended June 30, 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 June 30, 2023, we had cash and restricted cash of $15.6 million and credit facility availability of $132.3 million. We have a $135.0 million asset-backed line of credit (the "ABL Revolver"), partially offset by letters of credit of $2.7 million. We had no borrowings outstanding on our ABL Revolver as of June 30, 2023. We had $425.9 million in borrowings on our Term Loan as of June 30, 2023. 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 and safety services equipment. We also require cash to pay our lease obligations and to service our debt. 19 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) : Six Months Ended June 30, 2023 2022 Net Cash Provided by (Used in): Operating Activities $ 24,017 $ 5,686 Investing Activities (14,105) (45,965) Financing Activities (40,165) 12,023 Effect of Foreign Currency (240) (159) Net Change in Cash $ (30,493) $ (28,415) Operating Activities The Company generated $24.0 million of cash from operating activities during the six months ended June 30, 2023 compared to $5.7 million of cash generated during the prior year's corresponding period. The $18.3 million increase in the amount of cash provided by operating activities between the two periods was primarily due to increased business activity and higher sales at a higher margin partially offset by a decrease of progress billings as compared to the prior period. Investing Activities For the six months ended June 30, 2023, net cash used in investing activities was $14.1 million compared to a $46.0 million use of cash during the prior year’s corresponding period. This $31.9 million decrease was primarily driven by a reduction in the total purchase price paid for acquisitions during the six months ended June 30, 2023 of $8.5 million compared to $44.1 million during the six months ended June 30, 2022. The decrease was partially offset by purchases of property and equipment of $5.6 million for the six months ended June 30, 2023 compared to $1.8 million for the six months ended June 30, 2022. Financing Activities For the six months ended June 30, 2023, net cash used in financing activities was $40.2 million, compared to net cash provided by financing activities of $12.0 million during the prior year’s corresponding period. The increase was primarily due to an increase of $33.6 million in share repurchases for the six months ended June 30, 2023 compared to $15.1 million for the six months ended June 30, 2022. During the six months ended June 30, 2022, the Company had $29.1 million outstanding under the ABL Revolver compared to no borrowings outstanding during the six months ended June 30, 2023. The Company paid contingent consideration of $4.0 million for the six months ended June 30, 2023 without comparable activity in the prior period. 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. 20 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 six months ended June 30, 2023 are not necessarily indicative of results expected for the full fiscal year. RECENT ACCOUNTING PRONOUNCEMENTS See Note 3 - Recently Issued 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. 21