DXP Enterprises, Inc. (DXPE) Q1 2021 Earnings Report, Transcript and Summary

Welcome to DXP Enterprises, Inc. 2021 First Quarter Earnings call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions]. I would now like to turn the conference over to your host, Mr. Kent Yee, Chief Financial Officer.

Thank you, Christian. This is Kent Yee. And welcome to DXP's Q1 2021 conference call to discuss our results for the first quarter ending March 31st, 2021. Joining me today is our Chairman and CEO, David Little. Before we get started, I want to remind you that today's call is being webcast and recorded and includes forward-looking statements. Actual results may differ materially from those contemplated by these forward-looking statements. A detailed discussion of the many factors that we believe, may have a material effect on our business on an ongoing basis are contained in our SEC filings. However, DXP assumes no obligation to update that information, as a result of new information or future events. During this call, we may present both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in our earnings press release. The press release and an accompanying investor presentation are now available on our website at ir.dxpe.com. I will now turn the call over to David to provide his thoughts and a summary of our first quarter performance and financial results.

Good morning. And thank you, Kent. And thanks to everyone for joining us today on our fiscal 2021 first quarter conference call. I will begin today with some perspective on the first quarter and our relative position today and thoughts on the remainder of 2021. Kent, will then take you through the key financial details after my remarks. After his prepared comments, we will open for Q&A. Overall we had a good first quarter, that highlights good execution and a number of positive trends developing across DXP, including the continued execution of our acquisition strategy to accelerate our end-market diversification efforts, continued strength in COVID resistance and end-markets and a strong free cash flow generation. Putting aside challenging week in February with a weather perspective, we were seeing good progress in moving towards our pre-pandemic growth. And we are confident that we are in the early beginnings of returning to our pre-pandemic levels and that remains our focus. Let me thank all of our DXP stakeholders in particular all of our DXPeople for their continued hard work and grit, as we turn the corner from the global pandemic and momentum gradually begins to build in our business. We are encouraged by the improvement in market conditions and remain focused on growing our business in fiscal year 2021. DXP's industrial end-markets which is 67% of our business today, which by the way coming out of the last cycle was 51% appears to have found some legs and shows signs of positive upward movement. The ISM, PMI manufacturing index which gives us an indication of how DXP's broad industrial markets will perform continue to expand from January a 58.7% rating through March a 64% percentage rating. This is above the average for the last 12 months of 56.9% and looks to be a, positive indicator for the year should the trend continue and the impact from, COVID continue to lessen. We are excited to see momentum on this side of our business. And look forward for this to improve throughout the year. These end-markets including food and beverage, chemicals, water and wastewater, manufacturing and general industry should serve us well along with the continued execution of our acquisition strategy. Oil and gas is the remaining 33% of DXP which was 49% coming out of the last cycle and is showing mixed signs of recovery with strength in the international markets. The majority of our business that is oil and gas tends to lag increases, in the rig count and is tied closer to actual production or increased CapEx budgets. DXP will wait and see, but early signs point to flat to modest up-ticks in domestic budgets and the latest movement occurring in international CapEx spending in 2021. With regard to the broader demand recovered, underlying trends improved across the business as the quarter progressed and trends were the strongest in March. Our first quarter results reflect sequential growth and improvements in our end markets and industry indicators as discussed. Total DXP sales for Q1 increased 5.6% sequentially or were $245.6 million or $3.9 million per business day. Thank you to the 2,508 DXPeople for your hard work and dedication. This includes our recent year-end acquisitions, as this is their first quarter reporting with DXP. We are excited to have APO, Corporate Equipment, Pumping Solutions and Total Equipment with us. They each had a great first quarter and performed in line with our expectations. Keep up the great work. And we are excited to have you as a part of our DXP family. And it is always my pleasure to share your performance and financial results on your behalf. In terms of cash flow and liquidity, we generated $11.2 million of free cash flow in Q1, which continues to support our acquisition efforts. DXPeople have continued to find ways to deliver financial results and position us well for all of our stakeholders, in the face of extraordinary challenges. This is evidenced by our sequential growth closing acquisitions, and the overall teamwork of the DXPeople. We continue to build our capabilities to provide a technical set of products and services in all of our markets, which makes DXP very unique in our industry and gives us more ways to help our customers win. As we discussed during the third quarter, DXP's goal is to grow all of our markets and have a balanced end market exposure. Our bigger opportunities and targets are food and beverage, sanitary, water and wastewater, chemicals, alternative energy, refineries and military. Our recent acquisitions of Carter & Verplanck is another example of making strides in these directions. In terms of financial results, Service Centers led the way, followed by Supply Chain Services and then Innovative Pumping Solutions. The diversity of end markets and the MRO nature within Service Centers allows us to continue to remain resilient and is experiencing the first time to recover. Supply Chain continues to see improvements, as we expect activity to increase as we move through the year. We continue to experience the largest decline within our Innovative Pumping Solutions business segment. IPS is tied to capital budgets and the oil and gas industry. We see a stronger improvement in international cap budgets versus domestic. We continue to monitor expenses and make money on lower sales demand. In terms of the strength in the IPS backlog, we are now 20% below 2017 average backlog numbers and continue to see slower declines that are consistent with our customers cutting capital budgets. Our main focus within IPS is managing to these demand levels we have today and find opportunities in other markets, such as biofuels, food and beverage and water and wastewater. DXP's overall gross profit margins for the quarter were 29.2%, a 152 basis point improvement over Q4. This reflects continued improvement within IPS, despite sales decline and strong gross profit margins from our recent acquisitions. Overall, DXP produced EBITDA of $13.9 million and EBITDA as a percent of sales of 5.7%, which is consistent with a declining market environment. That said, if growth begins to pick up, we should begin to experience operating leverage, as we transition from market declines to growth. In summary, DXP's financial performance is not where we would like for it to be today. And our objective is to continue to improve and providing customer-driven solutions by being fast, convenient and technical experts. We look to continue to drive improvement in our organic sales and marketing strategies and our inorganic organic growth through acquisitions in certain geographies and industries. We continue to reiterate that the pace and magnitude of recovery going forward will vary by geography, customer type and end market. Let me conclude my remarks by saying that I am encouraged with our continued sequential improvement in sales and profitability and firmly believe that we are well positioned to continue this growth pattern into 2021. We have managed the business through uncertain times, successfully making acquisitions and producing strong free cash flow and continuing to invest in the business that will benefit our future growth. We have a tremendous team and it is an honor to overcome the collective adversity, we are all experiencing and deliver value for all of our stakeholders. With that I will now turn it back to Kent to review the financials in more detail.

Thank you, David, and thank you to everyone for joining us for our review of our first quarter 2021 financial results. Q1 financial performance reflects our second quarter of sequential sales increase, as we move past the trough impact of COVID-19 in the third quarter of 2020. Since 2020 was such an unusual year due to the pandemic, we are primarily measuring our performance based on sequential monthly and quarterly growth. Monthly results are likely to experience normal variation and move in either a positive or negative direction based upon unforeseen events like the winter storm that hit in February. However, our overall expectation is that we will see growth versus the previous month throughout the year, which should result in a significant increase in earnings as compared to last year. Overall, DXP's first quarter results were good to see. Service Centers and Supply Chain Services led the way, growing sequentially, which we will review shortly. That said, Q1 reflects the following summary takeaways. Strong first quarter sales and margin performance from recent acquisitions, gross margin improvement sequentially and year-over-year and strong quarterly free cash flow generation. Total sales for the first quarter increased sequentially 5.6% to $245.6 million. We experienced a 15.6% and 0.5% sequential sales growth in Service Centers and Supply Chain Services, respectively. Acquisitions contributed $28.4 million in sales during the quarter. As David mentioned, we are excited to have APO/CEC, Total Equipment and Pumping Solutions as part of the DXP family. Average daily sales for the first quarter were $3.9 million per day versus $3.8 million per day in Q4. Adjusting for acquisitions, average daily sales were $3.4 million per day for the first quarter. That said, the average daily sales trends during the quarter ramped from $3.8 million per day in January to $4.2 million per day in March, including the normalization of project work. Regions within our Service Centers business segment which experienced sequential sales growth include California, Texas, Gulf Coast and the Southwest. Key end markets driving the sales performance, include general industrial, food and beverage, mining, municipal and specialty chemicals. Supply Chain Services performance reflects a one-time $937,000 revenue adjustment associated with one of our customers' contract pricing. Adjusting for this, sales would have grown 3.1% sequentially, which is in line with our commentary during Q3 and Q4. Unadjusted sales grew 0.5% sequentially. SCS expects activity to continue to improve, as more customers open facilities along with vaccinations accelerate. Customers are also beginning to inquire if employees are vaccinated, which we see as a positive indicator. In terms of Innovative Pumping Solutions, we are monitoring the backlog as we continue to experience declines. As we discussed in Q4, we do see the start of a slow demand recovery and improvements in industry indicators. But the rebound in CapEx dollars is mainly tied to international projects at this point. Domestically, we see CapEx budgets essentially flat to slightly down from 2020. Our Q1 average backlog was down 20.4% from the 2017 average backlog and down 35% from the 2015 average backlog, but it's up 10.9%, compared to the 2016 monthly average backlog. We are continuing to trend slightly above 2016 levels based upon where our backlog stands at the end of the first quarter. Again, as we always comment, we are monitoring the backlog monthly and looking for new bookings always. Turning to our gross margins. DXP's total gross margins were 29.2%, 152 basis point improvement over Q4. Gross margins improved 48% from Q4 to Q1 within innovative pumping solutions as we experienced a mix shift associated with more international projects, as well as working through several municipal water and wastewater jobs and continuing to deliver on our efforts to move past lower margin jobs and make cost improvements despite the decline in the business. Service centers also experienced a 50 basis point improvement sequentially from Q4 to Q1, while supply chain services experienced a decline in gross margins that is unique and more associated with the one-time revenue adjustment mentioned in my previous comments. In terms of operating income combined all three business segments improved 25 basis points in sequential business segment operating income margins versus Q4. Total DXP operating income adjusting for the Q4 impairment expense decreased 82 basis points versus Q4 to $6.2 million. Service centers operating income margins increased 92 basis points from Q4 resulting in $22.1 million in operating income. Excluding acquisitions operating income margins increased 63 basis points sequentially. Innovative pumping solutions operating income margins declined 332 basis points sequentially, which primarily reflects higher SG&A costs, as we continue to rightsize our cost structure to demand, as well as some fixed cost absorption. Supply chain services experienced a 251 basis points decline in operating income margins primarily associated with the aforementioned one-time revenue adjustment associated with contract pricing. Our SG&A for the first quarter increased $65.4 million from Q4 this was -- increased excuse me to $65.4 million from Q4. This was primarily driven by the payout of commissions and bonuses associated with 2020 normal seasonal payroll taxes and first of the year items. Additionally, this also reflects transaction costs and other legal items. Similar to our comments in Q4, we are mindful that the contraction associated with the coronavirus is passing, and with accelerated distribution of vaccines, we are positioning DXP to respond to increased customer needs as we believe those who are in a position to respond today and tomorrow will gain the most market share. Turning to EBITDA. Q1 adjusted EBITDA was $13.9 million. Adjusted EBITDA margins were 5.7%. As we move through the COVID rebound we should experience operating leverage as David mentioned as long as we drive organic growth and maintain gross margins. In terms of tax, our effective tax rate continues to have a lot of noise this quarter similar to what happened in Q4. In Q1, DXP booked a significant reserve associated with the Texas R&D tax credits based upon the increased risk of challenge by the state. Going forward, if DXP continues to rebound we expect a normalized effective tax rate between 23% to 25%. In terms of EPS, our net income for Q1 was $411,000. Our earnings per share for the first quarter was $0.02 per diluted share. Our recent acquisitions were accretive to gross margins operating income and ultimately to earnings. Turning to the balance sheet and cash flow. In terms of working capital, our working capital increased $2.4 million from Q4 to $161 million. As a percentage of sales, this amounted to 16.9%. This primarily reflects an increase in accounts receivable and inventory. In terms of cash, we had $127.5 million in cash on the balance sheet at March 31. This is an increase of $10 million compared to Q4. Regarding CapEx, CapEx in the first quarter was $680, 000, or an increase of $538,000 from Q4 run rate levels, reflecting our ability to control capital investment and the minimal maintenance needs of our business. Turning to free cash flow. We generated solid operating cash flow during the first quarter producing $10.6 million in cash from operating activities and $11.2 million in free cash flow. This includes a $1.3 million cash inflow from the sale of assets. Return on invested capital or ROIC for the first quarter was 17%. At March 31, our fixed charge coverage ratio was 3.7:1 and our secured leverage ratio was 2.8:1. Total debt outstanding at March 31 was $329.2 million, which reflects the refinancing of our Term loan B and our first quarter of amortization. The refinancing reset our covenants and provides additional flexibility as we move forward. As a reminder -- excuse me, the new Term Loan B matures in 2027. In terms of liquidity, we remain undrawn on our ABL and have over $258.6 million in liquidity consisting of cash and the undrawn ABL. In terms of acquisitions earlier this week subsequent to the quarter-end, we closed on our acquisition of Carter & Verplanck and we anticipate closing another acquisition by the end of Q2 or early in Q3. Carter & Verplanck provides us with a platform to continue to expand our water and wastewater capabilities. Headquartered in Tampa, they ended Q1 with $4.2 million in sales. Our acquisition strategy continues to create value for DXP as evidenced by the strong quarter we had from year-end acquisitions, and we look forward to CVI's contribution in Q2. Our pipeline remains strong and is expanding in different end markets. More importantly the talent at the companies joining DXP is very high and brings expertise and valuable experience to our growing company. With that, we'll now turn the call over for questions.

[Operator Instructions] Your first question is from Tommy Moll. Your line is open.

Good morning and thanks for taking my questions.

Hey, good morning. Tommy. How are you?

Doing great. Doing great. How are you all?

Good.

Well, you gave some helpful commentary just to unpack the varying trends across the segments for first quarter plus some of the one-time kind of items that you highlighted. So- I think we're good in terms of the first quarter. I'm curious if there's anything you could point to for maybe how April looked or how you think about the progression as we go forward. You called out I think a pretty strong for -- looking back my notes pretty strong exit rate for March. But really at a segment-by-segment level you're seeing some widely varying trends. Is there anything you could do to help us understand how those may move differently would be very helpful. Thank you.

Yes, no worries. Tommy maybe what I'll do is I'll go through the sales per business day. And then maybe David could comment on kind of service centers versus IPS versus supply chain. But just in terms of the cadence just for everyone on the call during the quarter, and we did some normalization this year just because we have a heavy accounting entry we do at the end of the quarter that we felt you should normalize to get a view of the trends. And so sales per business day for January were $3.8 million -- $3.6 million in February, $4.2 million in March, and then early estimates for April show $4.6 million. And so the cadence is good and strong. But to your point there is -- we're seeing a little bit of a difference of this rebound between Service Centers, IPS and Supply Chain. And so I don't -- David if you want to share some thoughts just on kind of...

Sure. Yes Tommy, I think, the Supply Chain Services is -- we've got to point out the fact that they had an adjustment to sales that was pretty significant $900-and-some-odd-thousand. And so if you look at supply chain and add that back. And they actually had sequential growth. And which is encouraging. If you take them through last year they had some oil and gas accounts that were hit pretty hard. And then they also had some airline accounts that actually closed down some facilities et cetera. So that was the two big negatives. The positive were food and beverage and other accounts, but those other was what brought them down. And so we're seeing recovery in a small way in the oil and gas accounts. They're starting to build things again. And so that's good. And then their line accounts that we have are doing fine. And the ones we lost where we lost them last year so we'll build off of that. But sequentially from fourth quarter to first quarter is not reflected very clearly, but it's ever so slightly up. The Service Centers, kind of, the maintenance repair and operating side as people have gone back to work that part has bounced back really nicely and looks to continue. So that's very encouraging for us. And so the real -- the problem there is IPS. And IPS is where we put -- we kind of break out just a refresher. Our branches may sell capital projects, but we take that and put it in IPS. And so we really get a pure picture, which is unusual versus most companies of what our CapEx business looks like versus our maintenance and repair and operating business looks like. So when we look at IPS that's strictly CapEx. And, of course, our oil and gas trends of cut their budgets last year and looks like they're going to kind of go with the same budget this year. I guess the general attitude there is they like the price of oil it's awesome, but they're not -- because they're concerned with what the long-term future looks like et cetera. So they're being reluctant to increase those capital budgets at this point. And I'd say that about the United States because we see a little more positive activity international. The IPS business is not going to go to zero, I want you to note that. But it is less and we can adjust to less and still make some money there, but not like we have in the past.

The only other thing I would add to that Tommy is what we're also seeing in, particularly, in our California West region is there's some projects that are in that IPS segment that are water wastewater that are to come that we're excited about. And so there's -- it's predominantly oil and gas but there are some other end markets in that IPS bucket so…

Okay. Yes. Thank you, both. That's extremely helpful. Let's talk about maybe your own supply chain. There's a lot of commentary around cost inflation and this is probably more on the MRO side of your business. To what extent are you seeing that in your own supplier base? And what are some of the price/cost kind of dynamics that you've managed or plan to manage the rest of this year?

Right. So we don't sell lumber. So that's -- we won't deal with that one -- thank goodness. But we are seeing some price increases. We're seeing more than we've seen in the past and we're seeing numbers that can be pretty high. A high number would be somebody raising prices 10%. And then something more normal would be 4% to 5%. And we're seeing delivery problems and shortages. So all of those things to me is reflecting the fact that I just can't help, but think that inflation is coming. We're also getting pay raise pressures as people come back to work and unemployment goes back down. We'll see. And so -- and then -- but just let me say that some level of inflation 4%, 5% percent wouldn't kill me is good for us in distribution. So as long as you know that we can pass that on to the customer, which we normally can with proper documentation of how the costs have gone up then we can raise prices. I will continue to point out that Supply Chain Services -- our own Supply Chain Services company, it takes a little longer. So they do get some margin pressure, gross profit margin pressure because they have the right to raise those prices, but it takes a while to get that done. So it's a little bit of a lag. Whereas somebody just break something and calls us up and wants something we can give them a new price immediately.

Yes. That’s helpful. Thank you.

But I think we're dealing with all of that fine. We've -- you saw our inventory levels go back up some. We're trying to adjust to what we hope is much better volumes and these shortages. The only one we hadn't been able to fix was the same one that the auto industry has and that's these computer chips from China. We actually use those in our pump side. There are sensors that we use for understanding the operation and temperatures and stuff like that. So those have been impossible to get.

Yes. Let's move down the P&L here to your SG&A. So over the last 12 months, you've definitely taken some out of the model in response to the events we've all lived through. But now as you're at a point where potentially the rest of this year looks pretty good, or at least better than recent quarters, you may be in a position where some of that cost comes back. So what's the philosophy there? I mean, you guys are pretty disciplined on costs generally. So as your revenue potentially heads back higher, is there a rough maybe relationship on how much fixed cost for every unit of sales you add back, or how do you manage that, now that hopefully you're headed the right direction for a while?

So, I'm kind of glad you asked that question. I don't think we manage that process like we normally would, because we felt like that COVID-19 pandemic was an event and it would have a start and a stop. I don't know that necessarily there will really be a stop, but we felt like there was. So we didn't rationalize productivity to the sales volume that we were getting. We kind of -- in my opinion we kind of held on to our talent and our DXPeople. They're not easy to come by or not easy to train up. And so, we didn't really make employee reduction stuff a priority. And so therefore, I think, as you see us expand and grow the top line, you should see leverage on the bottom line. And so, I'd like to think that EBITDA could pretty easily get back to 8%. Our goal is 10% and we've been at 10%, but that's when times are really good. So I'm not targeting 10% anytime really soon, but something more in the line of 8% is appropriate. And so, since we're already doing a pretty good job on gross profit margins, 29-point-something percent is pretty good for us. 30% would be perfect, but I'll take 29-something. SG&A as a percent of sales is really too high for where we're at. But like I said, we took that on, because we wanted to be in a position to recover fast. And so, we hope we got that right.

Yes. Last question from me more from a strategic standpoint. Good to see continued progress on the tuck-in acquisition side. It sounds like at least one more you've got good visibility on. I'm curious in terms of the pipeline, what other context you could give us? How you think the rest of the year may progress? There's a potential tax law change in the works that may have an impact there. But what does the appetite and pipeline look like?

Yes. Yes, Tommy, no, you're spot on just on your earlier comments in the sense that, yes, we've got one where we've got high visibility that hopefully we get done before the end of the quarter, early Q3. And maybe, just in terms of the overall broader market dynamics I think what you see out there is, there's a lot of opportunities in the marketplace that we are chasing and that we're looking at. And then, your last point I think is spot on. I've had those conversations here recently with others, but as this tax law change begins to grab momentum, in a weird way, we saw some of that at the end of 2020 and I think we're going to see a repeat here, because now it's publicly becoming a thought process politically. And so, it always does -- potential tax changes always do create some transaction activity at some level. And we could see that towards the back end of this year, frankly, for those entrepreneurs that feel they need to get in front of it. And so, I think we already got a robust pipeline, but it could accelerate towards the back end of the year. So --

Capital gains going up.

Yes, capital gains going up and then those items. And so --

Tommy, just to be clear though, maybe in my comment that we're looking at certain geographies in certain industries, so we're being pretty selective with the direction that DXP is headed. And we like water and wastewater and we like food and beverage. And so we're -- and we like geographies that are not only gas geographies, that they're industrial geographies or municipality geographies or geographies where we're not in the appropriate business in those areas. But -- so that's kind of what we're thinking. So we're being pretty selective.

From a multiple perspective, Tommy, I think, also maybe what you've been getting at, multiples, there's some pressure on the upside. You've got more private equity guys in the sandbox. And you got sellers' expectations that don't match the profile of their business. And what I mean by that is, a lot of these businesses we look at are closer to lifestyle businesses and they don't necessarily have an aggressive growth plan, yet they want a growth multiple. And so, some of it is also matching up with what David said, the markets and geographies with obviously the right valuation. We try to be disciplined. And so, that way we're creating the value, we'd like to create out there. So...

That’s all very helpful. Thank you, both. Thanks for the time today. I’ll turn it back.

Okay.

And I'm showing no further question at this time. This does conclude our Q&A session. Thank you for participating in today's earnings conference call and have a great day.