Earnings Call Transcript - GIC Q1 2022

Operator, Operator

Good afternoon, ladies and gentlemen, and welcome to Global Industrial's First Quarter 2022 Earnings Call. At this time, I would like to turn the conference over to Mike Smargiassi of the Plunkett Group. Please go ahead.

Mike Smargiassi, Moderator

Thank you. And welcome to the Global Industrial first quarter 2022 earnings call. Leading today's call will be Barry Litwin, Chief Executive Officer; and Tex Clark, Senior Vice President and Chief Financial Officer. Formal remarks will be followed by a question-and-answer session. Today's discussion may include certain forward-looking statements. It should be understood that actual results could differ materially from those projected due to a number of factors, including those described under the Forward-Looking Statements caption and under Risk Factors in the company's annual report on Form 10-K and quarterly reports on Form 10-Q. The press release is available on the company's website and has been filed with the SEC on a Form 8-K. This call is a property of Global Industrial Company. I will now turn the call over to Barry Litwin.

Barry Litwin, CEO

Thanks, Mike. Good afternoon, everyone. And thank you for joining us. We delivered an exceptional first quarter performance with record revenue and profitability, driven by strong demand and excellent execution across the business. Revenue of $288 million was a quarterly record and improved nearly 15% over the prior year. For the third consecutive quarter, we delivered record gross margin, which reached 37.4% in the quarter. And we generated over $29 million in operating income as operating margin surpassed 10%. Looking at our results on a 12-month basis, we achieved double-digit operating margin for the first time. I'm very pleased with how we have started 2022. It was truly a terrific quarter for Global Industrial and reflects the continued implementation of the ACE strategy; and most importantly, the commitment and efforts of our associates who made it happen. Our focus on the customer continues to guide everything we do. We are making further investments that will position us to expand market share and capitalize on our growth opportunities. From sales and marketing to digital technology, procurement, and distribution, we are enhancing the service we provide and elevating the customer experience. In the second quarter, we expect to launch a new digital e-commerce platform on both desktop and mobile that will redefine how we engage and interact with customers across all digital channels. We remain committed to digital leadership, and this is a ground-up undertaking designed to provide a completely new user interface and customer experience. Our extended one-to-one managed sales organization continues to lead our growth. The team is making continued progress in the development of larger accounts as we look to grow, share of wallet, and build new customer relationships. Our NASCAR sponsorship in partnership with Richard Childress Racing and Austin Hill is helping to drive brand awareness and increase customer and associate engagement. It has been exciting to be a part of the 2022 NASCAR season and to capitalize on the benefits this national platform brings to Global Industrial. In Canada, we have seen tremendous growth, which has caused us to exceed the capacity of the current distribution network. In order to support our continued expansion, I'm pleased to announce we have entered into a long-term lease for a new state-of-the-art distribution center in the Greater Toronto area. Operations in Canada have historically been serviced through a cross-stock fulfillment model relying on our U.S. distribution network. And this new facility, which is expected to begin operating this fall, will allow us to better service customers by significantly shortening delivery times. Finally, we will be hosting our Annual Global Industrial National Trade Show on June 17th in New Orleans. This is an exciting event with more than 100 vendors that will showcase our industrial solutions, know-how, and leadership team. In closing, we had a terrific start to the year with record revenue and profitability. Customer demand remains strong, and we believe we are well positioned for long-term growth. We continue to focus on operational excellence, embracing digital transformation, and investing in our people, private brand, and operations. Execution of our ACE strategy is strengthening our customer-focused culture, driving top-line growth and delivering sustainable improvements in profitability. We continue to elevate our position as a trusted partner to our customers and remain excited about what the rest of 2022 has in store. I'll now turn the call over to Tex.

Tex Clark, CFO

Thank you, Barry. In the first quarter, revenue is $288.6 million, a quarterly record, and increased 14.9% on a GAAP basis over Q1 of last year. U.S. revenue increased over 14%, while Canada revenue improved nearly 22% in local currency. Overall, sales trends were strong throughout the quarter, while open orders increased modestly due to growth in customer demand. We continue to make progress in fulfilling back order positions and are making inventory investments in key product categories to support our growth. Gross profit for the quarter was $107.8 million, up 39.5% from last year. Gross margin was a quarterly record of 37.4%, an improvement of 660 basis points from the prior year, and up 40 basis points on a consecutive quarter basis. This was our third consecutive quarter of record gross margins. Gross margin improvement in the quarter reflects the impact of normalized freight margins as compared to the cost incurred in Q1 2021 related to the transition of a new LTL freight partner last year, a continued increase in our balance of sale of our higher margin private brands, the beneficial impact of price rationalization in an inflationary environment, and a reduction in inventory adjustments as compared to a large PPE write-down incurred last year. In the face of ongoing supply chain and inflationary challenges, we continue to implement mitigation strategies, which have proven effective. This includes driving higher margin sourcing channels, pricing analytics, and freight optimization. While we do experience seasonal revenue and margin variations due to product and customer mix, we continue to believe that annual margin gains are sustainable. Given the ongoing benefit we recognize from an increasing balance of private brand sales. Selling, distribution, and administrative spending for the quarter was $78.3 million or 27.1% of net sales, an improvement of 110 basis points as a percentage of sales from last year. SG&A primarily reflects targeted expense management and fixed cost leverage on sales growth. We continue to maintain strong cost controls but expect to see higher levels of SG&A as 2022 progresses as we make growth-related investments in key ACE focused areas, including the new distribution center in Canada. We will also see the impact of a company-wide distribution center wage adjustment that was implemented early in the second quarter. Operating income from continuing operations was $29.5 million in the first quarter, a more than fourfold improvement from the year-ago period. Operating margin expanded 760 basis points to 10.2%, our third consecutive double-digit operating margin performance. Total depreciation and amortization expense in the quarter was $0.9 million, while capital expenditures were $1.1 million. We continue to expect 2022 capital expenditures in the range of $7 million to $9 million, which includes the new Canada DC. Let me now turn to our balance sheet. We have a stronger liquid balance sheet with a current ratio of 1.7 to 1. As of March 31, we had over $14 million in cash, approximately $25 million of debt, and availability of approximately $46 million under our $75 million credit facility. Our debt position reflects increased borrowings to meet working capital needs related to inventory investments to support longer lead times in our supply chain, as well as the value of inflationary costs within our inventory. We maintain significant flexibility to fully execute on our strategic plan and continue to fund our quarterly dividend. As a result, our Board of Directors declared a quarterly dividend of $0.18 per share of common stock, and we anticipate continuing a regular quarterly dividend in the future. This concludes our prepared remarks today. Operator, please open the call for questions.

Operator, Operator

Your first question comes from Paul Dirks from William Blair.

Unidentified Analyst, Analyst

So a few questions for me. First of all, on the top-line, is there a way to frame if any of the first quarter sales growth was at all a catch up from some of the constrained periods we saw in the third quarter and the fourth quarter of last year?

Barry Litwin, CEO

I'll kind of take real quick my view on that. I will tell you, I think I believe that what we're seeing is current sales demand flowing both from just overall business demand we're seeing in the market right now and expansion of our sales organization. We're definitely starting to see that revenue flow through. The open orders for us have been fairly consistent flat over the last several periods. So our volume right now is still speaking to some fairly robust demand that we're seeing in the market.

Tex Clark, CFO

Yes, I'll just add to that. Yes, as Barry mentioned, the open order value, really kind of orders that we were taking last period, actually was modestly up but very small. We actually did a pretty good job of reducing some back orders, but new customer demand filled that up. And so we didn't see a large catch up on that open order, which disproportionately benefited Q1. It has been fairly stable for the last six months, not eroding. But we have not seen a big catch up in that yet. So that yes, just as Barry mentioned.

Unidentified Analyst, Analyst

No, that's helpful. Is it fair to say that the robust demand and the velocity of orders has continued here at least so far into April and perhaps into early May?

Barry Litwin, CEO

Obviously, we don't give a lot of guidance in terms of current performance, but we continue to see a very robust demand market for ourselves right now. And I've definitely have good confidence going forward in terms of just the general market conditions for us. So that would be my view on it.

Unidentified Analyst, Analyst

Okay. That's helpful. I noticed that the inventory balance is up about 50% year-over-year, and there seems to be more short-term debt to support that. Can you clarify how much of that increase is due to price versus volume? Also, are you reducing any key product lines or categories at this time?

Tex Clark, CFO

Certainly. Yes, inventory has indeed increased, and there are two main factors contributing to this. First, the costs associated with ocean freight have raised our inventory's value in distribution centers. Secondly, in the fourth quarter, we made a significant effort to ensure product availability for our customers, as it has become a crucial factor for sales success. To maintain stock levels and address longer lead times, we had to increase our safety stock, which impacted inventory levels in transit, on the water, and in our distribution centers. This has resulted in a deliberate investment to stay prepared. In terms of fill rates, we are witnessing steady improvements compared to last year and the beginning of 2022. While we are not yet back to pre-pandemic levels, there is a consistent upward trend. However, this inventory buildup is influenced by both the increased product due to extended lead times and the higher costs. We are utilizing our working capital revolver to fund this inventory, which we consider a prudent decision. Although we are drawing more from it than before, we don't feel that this negatively affects the company's liquidity.

Unidentified Analyst, Analyst

No, that's helpful. Two more for me. Regarding the gross margin performance in the quarter, obviously, very impressive. Excluding the inventory charge in the prior year quarter, you guys are up 550 basis points. Is there a way to bucket either in terms of magnitude or with numbers, how much of that expansion was driven by the freight carrier performance, how much is driven by inventory profits, and how much was driven by other factors such as your price optimization tools and private label expansion?

Tex Clark, CFO

Yes, Barry, I'll try to take that if you want to add any details please do so. So, Paul, let's take out the inventory adjustment we mentioned last year for the PPE product. The main factor year-over-year is the full year ramp-up from the LTL transition we implemented last year through our dealer partner. This had a significant impact in the first quarter of last year. By the end of the second quarter, things normalized and remained strong through Q3 and Q4. Our freight margins have been quite consistent in the first quarter this year, and at a normalized level, that's the largest contributor. The next significant contributor is the balance of sales from our private label, which shows real staying power. As we invest in our private label, we're focused on high-quality products for our customers, which also results in high margins and a substantial margin differential when analyzing sales of those items. This represents the second major factor in margin improvement. The third factor relates to our pricing analytics and the careful decisions we make about how we price products for customers, how we handle discounts in our managed organization, and overall how we manage our product portfolio to ensure we maintain a balance between revenue and gross margin rate. So, that encompasses the third contributor when we consider the overall impact.

Barry Litwin, CEO

One piece I'd also add as it relates to the second piece around private label balance of sale. And I think, given price inflation that's in the market when I look across the peer set, I do think that we've been looking at private label balance of sale shift as part of ACE strategy for the last couple of years. So I think, it is really starting to come into its own. And I would suspect that we have a good outlook in terms of where we think private label balance of sale can go for us. And I think that's always going to be a positive gain for us, even as pricing starts to adjust in the long-term, I think that's going to be one of the keys for us and why we feel good about sustainment around gross profit levels.

Unidentified Analyst, Analyst

No absolutely, certainly encouraging to hear. Last one for me. In the first quarter, of course, the higher volume and price helped and you guys performed well in the SG&A line. At the same time, too, with the incremental investments coming into the Canada DC facility. Is it your expectation that you'll be able to continue to lever SG&A expenses in the second quarter and over the balance of the year?

Barry Litwin, CEO

I think that we'll be able to do that. I think SG&A across the board, I mean, we're definitely looking for gaining higher efficiency across the sales organization and the marketing organization relative to SG&A investment. From the Canada facility, those numbers are put into our CapEx. And we're definitely looking at the acceleration of our Canadian business to help offset and drive some of those costs. So I do think we have a pretty good feel for continuing SG&A leverage in the business. And as the market grows and continues to expand, we also want to be able to invest incrementally into the market where we see opportunity. But right now, we've been pretty pleased with the overall efficiency, particularly in sales, marketing, and what we think the DC can help drive in terms of increases in our Canadian business.

Operator, Operator

Your next question comes from Anthony Lebiedzinski from Sidoti & Company.

Anthony Lebiedzinski, Analyst

So the first question, as far as gross margins, seasonally speaking, looks like your Q2 and Q3 have been the highest gross margins for the year. Do you expect that same type of seasonality to happen this year as well?

Tex Clark, CFO

Yes, Anthony, I'll address that. The margin variation we often see in the summer primarily relates to product mix. During the summer months, we tend to sell more cooling and outdoor products that are key to our category sales. These products generally have a higher proportion of private label items and a better overall margin for us. We anticipate this trend to persist as we enter the summer selling season. However, there is considerable market fluctuation. While I'm somewhat cautious, we recognize that fuel surcharges in the transportation sector are significantly high, impacting everyone. Therefore, we will proceed carefully and ensure our pricing remains competitive. If the typical seasonal pattern holds, there may be some upside, but we are still facing uncertainty due to external factors affecting gross margins.

Anthony Lebiedzinski, Analyst

For sure, absolutely. So you guys do a fair amount of imports from China. Have you been impacted by the lockdowns there? And obviously your inventory is much higher versus last year, but just want to get a better sense of that as to what you're seeing as health of your inventory, especially for your top performing products?

Barry Litwin, CEO

Yes. I think we've been very attentive to supply chain challenges over the last year since we began this in 2021. We've definitely noticed some improvement, as mentioned earlier. Our in-stock rates are continuing to rise, which should positively impact our conversion rates and sales growth moving forward. Regarding the effects of the shutdowns in China, we are closely monitoring the situation. So far, we haven't experienced any significant impact, but we are managing it daily as part of our operations.

Anthony Lebiedzinski, Analyst

And then, just overall, as far as your longer term outlook, as far as acquisitions, is that something you guys are still looking at? I mean I know you have a little bit of debt on your balance sheet, but it doesn't seem like that should impact your ability to look at M&A. Is that fair to say?

Barry Litwin, CEO

Yes, we are definitely exploring strategic acquisitions that can help us grow our category and customer base, while we also focus on our organic growth strategy. Our main goal is to continue driving ACE and achieving strong market performance. We are actively considering acquisitions that align with our objectives, and we believe we have sufficient cash resources to pursue any potential deals that may arise.

Operator, Operator

That does conclude our conference today. Thank you for attending today's presentation. You may now disconnect.