Earnings Call Transcript - GIC Q4 2022

Operator, Operator

Good day and welcome to the Global Industrial Company Fourth Quarter 2022 Earnings Call. I would like to turn the call over to Mike Smargiassi of Investor Relations. Please proceed.

Mike Smargiassi, Investor Relations

Thank you, and welcome to the Global Industrial Fourth 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 the 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. Overall, 2022 was an outstanding year for Global Industrial as we executed on our strategy and delivered a record financial performance for total revenue, as well as gross and operating margin. For the full year, organic growth contributed over $100 million in additional revenue, resulting in 9.7% growth and bringing total revenue to $1.17 billion. Gross margin improved 90 basis points to 36.1%. We generated over $105 million of operating income, an increase of 19.5% and delivered a 9% operating margin, a 70 basis point improvement from 2021. With the strong financial performance in 2022, today we announced an increase in the quarterly recurring dividend for the seventh consecutive year. 2022 started off with strong double-digit revenue gains while the second half of the year reflected the impact of increased economic headwinds and a diminishing price benefit as we left price increases taken in mid to late 2021. As a result, fourth quarter revenue was off modestly with flat price to volume comparisons from the year-ago period. Demand was muted across categories and sales channels, and we have seen this trend continue into 2023. We were very pleased with the proactive management of gross margin in the quarter as we recorded a 30 basis point improvement on a sequential basis and remain confident in our ability to manage our margin profile in the current cycle. Looking back on the last year, we successfully executed on a number of initiatives that we believe set us up well for 2023 and beyond. First, we strengthened our managed sales organization as we expanded the team and made investments in tools and technology to enhance productivity and performance. We added a new customer acquisition engine focused on enterprise accounts and launched market verticals in hospitality and healthcare. These efforts are off to a great start and we're excited about what we see. Moving forward, we're focused on capturing share through customer acquisition and retention, deepening our existing relationships, and expanding our lineup of exclusive branded items. Second, marketing leadership. We executed against our fully integrated brand marketing campaign, which has allowed us to activate our branding across everything we do from our website to emails, trade shows, and copywriting to our NASCAR sponsorship. I believe we have one of the most exciting brands in the market today and one that truly speaks to our customers and the products and solutions we provide. During the year, we also repositioned the private brand offering as Global Industrial exclusive brands with the tagline 'Made to Exceed'. As the market continues to shift from winning with product availability to a price and value focus, we believe we're well positioned with our exclusive brand offering. Recently, we launched a new marketing campaign focused on operational efficiency, a message that is timely given the current economic environment and one that aligns with the efforts we see from our customers and within our company to drive efficiencies and enhance operational performance. Third, we continue to elevate the customer experience with the launch of a new website designed to drive personalization. We are now optimizing this new platform with enhancements to further improve the digital shopping experience. On the service side, we have initiatives across the company to optimize satisfaction and loyalty at every customer touchpoint. From the training of customer service representatives to expanding self-service options, we are committed to delivering a five-star customer service experience. Fourth, distribution and supply chain. Our operations and merchandising teams delivered exceptional availability, reduced back orders, and improved lead times during the year. In addition, we opened a new distribution center in Toronto that allows us to receive direct imports into Canada, provide for the shipment of more products directly to our customers, and foster our continued growth. Overall, we're off to a much better stocking position this year, which will help us enhance service levels and deliver value to customers. We have a number of initiatives planned for 2023, including a focus on shipping quality that will minimize damages, as well as efforts to increase same-day shipping volume and fully capture ocean and domestic freight savings, which will help us pass more savings to our customers. Finally, I'm proud of the release of our inaugural ESG report last fall, which reflects the commitment of the board, executive team, and our associates to the mission of responsible stewardship. We look forward to updating you on our progress later this year. In closing, we believe we have a strong game plan for 2023 and a clear vision for our team to execute. While uncertainty remains in the economic outlook, we are optimistic and excited about the opportunities we see for growth. We'll continue to invest in core strategic areas of the business that support our customer-centric strategy and help drive operational leverage. This includes pricing intelligence and analytics, productivity and cost management, and a company-wide focus on margin optimization. I have been impressed by the nimbleness we have demonstrated and continue to show our ability to drive operational excellence. With strong cash flow from operations and an exceptional balance sheet, we remain well-positioned to execute on our strategy, invest in our growth drivers, evaluate strategic M&A opportunities, and build long-term value for our stakeholders. I will now turn the call over to Tex.

Tex Clark, CFO

Thank you, Barry. Fourth quarter revenue was $260.5 million, down 0.6% over Q4 of last year. Average daily sales were down 2.2%. The quarter included one extra day; however, I would note that the day fell on the Friday before the New Year's holiday, a historically low volume sales day, which had limited impact on our results. U.S. revenue was down 0.2%, while revenue in Canada improved approximately 2.5% in local currency. Price volume was neutral in the quarter, in contrast to pricing benefits recognized throughout late 2021 and most of 2022. The private brand offering has been an area of focus and opportunity during 2022, representing approximately 50% of total sales. Public sector volume was robust in the quarter and a nice rebound from Q3, which was the close of the federal fiscal year. The heating and winter seasonal category was soft, reflecting a relatively mild winter for much of the U.S. Demand was consistent throughout the quarter, and we have seen a continuation of fourth quarter sales trends into the start of 2023. Overall, we perceive customers to be guarded in their buying decisions, and the pricing environment remains competitive. Gross profit for the quarter was $93.8 million, down 3.3% from last year. Gross margin was 36%, an increase of 30 basis points on a sequential quarter basis, but down 100 basis points from the prior year. Last year in the fourth quarter, we delivered record gross margin, benefiting early in the business cycle from strong price realization and lower cost FIFO inventory sell-through, both of which have fully waned. We will also face strong margin comparisons in the first quarter of 2023, but we believe we have shown an ability to manage through the challenges of the current environment. Maintaining our margin profile remains the key focus of our team. We have seen some early benefits from lower ocean supply chain costs; however, we expect variability throughout the year as we work through select inventory with higher total landed costs and manage a dynamic pricing environment. We continue to believe that long-term margin gains are achievable as we drive a higher balance of private brand sales, optimize fulfillment, and leverage fixed costs. Selling, distribution, and administrative spending in the quarter was $76.1 million or 29.2% of net sales, an increase of 210 basis points from last year. SD&A primarily reflects the fixed cost nature of the business, investments in the expansion of our Canada distribution center network, including approximately $1.1 million in incremental costs, as well as planned marketing investment to support new verticals and to remain top of mind when our customers search for our products. We also recorded increased compensation expense primarily related to $1.1 million of incremental variable compensation, reflecting the strong full year results compared to 2021. We continue to maintain strong cost controls and in January took steps to right-size our cost structure, including a reduction in force, which will reduce annualized costs by approximately $6 million. We expect to record a one-time severance expense of approximately $1.1 million in the first quarter. Operating income from continuing operations was $17.7 million in the fourth quarter, and operating margin was 6.8%. During the quarter, we generated cash flow from continuing operations of $26.3 million. Total depreciation and amortization expense in the quarter was $1.1 million, while capital expenditures were $2.5 million. We expect 2023 capital expenditures in the range of $6 million to $8 million, which includes primarily maintenance-related investments and equipment within our distribution network. Let me now turn to our balance sheet. We have a strong and liquid balance sheet with a current ratio of 2.1 to 1. As of December 31, we had over $28 million in cash and minimal debt. During the quarter, we expanded our credit facility by $50 million to $125 million and currently have $111.7 million of excess availability under the facility. The continued improvement in our debt position reflects decreased working capital needs as inventory levels normalized and total inventory landed costs moderate. We maintain significant flexibility to fully execute on our strategic plan and to continue to fund our quarterly dividend. As a result, our board of directors declared a quarterly dividend of $0.20 per share of common stock. This reflects an increase of 11.1% from our previous quarterly dividend. This concludes our prepared remarks today. Operator, please open the call for questions.

Operator, Operator

We will now begin the question-and-answer session. Our first question comes from Ryan Merkel with William Blair. Please go ahead.

Ryan Merkel, Analyst

Hey, good afternoon and thanks for taking the questions.

Barry Litwin, CEO

Hey Ryan.

Ryan Merkel, Analyst

I wanted to ask a question on sales in the fourth quarter. Any chance you can provide a little more detail, either by products or end market? And for the managed and non-managed accounts, that would be helpful. Thanks.

Barry Litwin, CEO

Yes, Ryan, I'll give you a little bit of insight there relative to fourth quarter revenue. So we certainly saw price benefits wane in the period. I think if you look back, we probably captured price benefits really early on in the cycle. I think to your question on customer mix, there are a couple of things we found: one, I think the SMB basis for us appeared to be a little bit more cautious during the period versus some of the large national accounts that we've seen, so that was one trend we saw. And as you know, we've talked, we're continuing to kind of diversify our overall customer base as it pertains to some of the enterprise business, but we still are a fairly heavy SMB-based business. The other factor was really around some of the winter seasonal softness that we mentioned in the opening. That tends to be a fairly strong private brand category for us, particularly around heating. As we know, the weather has been really mild throughout the U.S. and that had some pressure as well.

Ryan Merkel, Analyst

Got it. Okay. I think you said demand is down low single digits into the start of '23. I just want to confirm if I've heard that right and just confirm sales aren't getting a whole lot worse here.

Barry Litwin, CEO

Yes, I mean, I think our demand trend right now certainly continues into Q1. We've certainly seen some muted sales across categories and sales channels. I think we've seen the same type of approach around customers being a little bit more guarded right now as the pricing environment remains fairly competitive.

Ryan Merkel, Analyst

Got it. Okay. Last one for me. I know you're not giving guidance here, but just curious what your outlook is for the MRO market '23. I think some of the larger players are thinking down low single digits, but curious how you're thinking about '23?

Barry Litwin, CEO

Yes, I mean, I think we kind of look at the same indicators. We look at industry stats around MDM and obviously the economy in terms of what we're looking at. I mean, I think we went in certainly with an optimistic approach around some of the sales initiatives and investments that we put in place. But certainly, we're taking a fairly cautious tone relative to the MRO market. Right now, I'm hopeful that we start to see some better performance in the industry itself towards the back half of the year. I mean, we tend to follow the PMI index as well, so you could see a fairly change in the ISM between this year and last year at the same time. But we still are confident that we have a significant number of initiatives in place to help drive overall long-term growth, particularly around our category and private brand expansion. Certainly, the benefit that our one-to-one sales organization has in terms of driving good, solid relationships and insight to our customers. We're going to continue to invest into some new sales channels mentioned last year, certainly continuing on through this year to help us exploit some newer markets.

Ryan Merkel, Analyst

Thanks.

Operator, Operator

The next question comes from Anthony Lebiedzinski with Sidoti & Company. Please go ahead.

Anthony Lebiedzinski, Analyst

Good afternoon. And thank you for taking the questions. So first, for Q4 gross margin, can you go over the various considerations regarding the gross margin? And Barry, you talked about focusing on margin optimization. Can you give us a sense of how we should think about gross margins for the balance of the year? That'd be great.

Tex Clark, CFO

Yes, Barry, just let me jump in real quickly to reconcile that. Absolutely. Hey, Anthony. Good afternoon. So again, when we think about the overall margin gross margin profile of 36% this year, absolutely they are 36% in Q4 and 36.1% for the full year. We saw some again, like we mentioned, we saw sequential improvement from Q3 to Q4, which isn't always a normalized seasonal trend for us. But we thought we did a little bit better in Q4 than Q3. However, when we look at a year-over-year basis, last year in Q4, we were fully entrenched in some early price moves that we had made, primarily related to inflation in the ocean transportation rates, which drove higher selling prices but also allowed higher gross margins because we could capture that, as we were still working through inventory that had landed prior to some of those pretty significant increases in costs we saw. So that really benefited both Q4 and Q1, 2022, where we saw margins of 37% plus in each Q4 and Q1. While we did see that year-over-year decline, that sequential increase gives us strong confidence that we're able to manage through some of the continued pricing dynamics in the market along with some higher domestic and ocean freight that we had mentioned. While the ocean freight costs are coming down, we've seen that in all the different public settings that will benefit the organization but does take time to work through because obviously, we're working through inventory turns to get to that lower-cost inventory that will be able to take advantage of and obviously also pass through back to our customers as we move throughout the course of the year. I'm not sure if that answers your question from our end. Barry, if you want to join anything more.

Barry Litwin, CEO

No, I think those were definitely well covered.

Tex Clark, CFO

Okay.

Anthony Lebiedzinski, Analyst

All right. Terrific. And then as far as inventories, they're down from the second-quarter peak. How should we think about inventories as we look? I know you're looking to certainly work those down. I assume as the year progresses, but is there a goal in mind as far as dollar amount you want to get to by the end of the year? Or maybe inventory turns? How should we just think about inventory management?

Tex Clark, CFO

Yes, I'll take that again Barry as well. Overall inventory, well, we don't have a specific goal on target inventory numbers. We set goals internally based on things such as bill rates and what overall stocking levels we need to have for our customers to deliver our product on time for what they need. Given that while the supply chain costs have come down, overall, as the disruption in the supply chain is out of the market in terms of lead times, both from our overseas suppliers as well as domestic movements here in the States, that's allowed us to improve that they are to lower their safety stock requirements and have allowed us to normalize inventory as we move throughout 2022. We would expect that to continue into 2023, and while we may have some seasonal buys that happen from time to time, we do not anticipate that our inventory levels will expense any material way in 2023.

Anthony Lebiedzinski, Analyst

Got it, thanks. And the last question for me is just overall, what is your appetite for acquisitions? It's been a few years since you've done anything as far as M&A. Just wondering if you could comment on that, that would be great.

Barry Litwin, CEO

Yes, great question, Anthony. I know that we've been fairly consistent in our policy around M&A, and certainly we continue to keep ourselves open to opportunities. We're looking at businesses that can either add category strength to us, strengthen selling channels, or enhance customers—all of those make sense for us. As I mentioned, we certainly have been looking in the market for some time. We're trying to find the right valuation and the right fit, most importantly for the company. It is certainly in our strategy to continue to address that, and we'll continue to do so going forward. So I appreciate you asking the question.

Anthony Lebiedzinski, Analyst

Got it. Well, thank you very much, and best of luck.

Tex Clark, CFO

Thank you, Anthony.

Operator, Operator

This concludes our question-and-answer session. The conference has also now concluded. Thank you for attending today's presentation. You may all now disconnect.