Mac McConnell - Senior Vice President, Finance and Chief Financial Officer David Little - Chief Executive Officer.

Matt Duncan - Stephens.

Good day and welcome to DXP Enterprises Inc. Third Quarter Conference Call. All lines are currently in a listen-only mode. [Operator Instructions] Please note today’s call is being recorded. It is now my pleasure to turn the conference over to Mac McConnell, Senior Vice President of Finance and Chief Financial Officer..

Thank you. This is Mac McConnell, CFO of DXP. Good evening and thank you for joining us. Welcome to DXP’s third quarter conference call. David Little, our CEO will also speak to you and answer your questions. Before I begin, I want to remind you that today’s discussion will include forward-looking statements.

We want to caution you that such statements are predictions, and actual events or results can differ materially. A detailed discussion of the many factors that we believe may have a material effect on our business on an ongoing basis is contained in our SEC filings, but DXP assumes no obligation to update that information.

I will begin with a summary of DXP’s third quarter 2015 results, David Little will share his thoughts regarding the quarter, then we will be happy to answer questions. Sales for the third quarter of 2015 decreased 21.7% to $303.1 million from $387.1 million for the third quarter of 2014.

After excluding third quarter 2015 sales of $2.2 million from businesses acquired, sales for the third quarter decreased $86.2 million, or 22.3%, on a same-store sales basis.

This decrease was primarily the result of declines in sales to customers engaged in the upstream oil and gas industry or manufacturing equipment for the upstream oil and gas industry. The strength of the U.S. dollar contributed to the sales decline. Sales of our Canadian operations were $32 million for the third quarter of 2015.

The change in the exchange rate reduced sales by approximately $4.8 million. Sales by our Service Centers segment in the third quarter of 2015 decreased $55.7 million or 21.9% to $199.3 million compared to $255 million of sales for the third quarter of 2014.

After excluding 2015 Service Centers segment sales of $2.2 million from acquired businesses, Service Centers segment sales for the third quarter of 2015 decreased $57.9 million, or 22.7%, from the third quarter of 2014 on a same-store sales basis.

This sales decrease is primarily the result of decreased sales of bearings, rotating equipment, metal working products and safety services to customers engaged in the upstream oil and gas market or manufacturing equipment for the upstream oil and gas market. The strength of the U.S. dollar also contributed to the sales decline.

Service Centers sales for our Canadian operations were $26.9 million. The change in the exchange rate reduced sales by $4 million compared to the 2014 exchange rate. Sales of Innovative Pumping Solution products decreased $27.2 million or 30.7% to $61.5 million compared to $88.6 million for the 2014 third quarter.

This decrease was primarily the result of a decline in capital spending by oil and gas producers and related businesses. Sales for Supply Chain Services decreased $1.1 million or 2.5% to $42.3 million compared to $43.4 million for the 2014 third quarter.

This decrease in sales is primarily related to decreased sales to customers in the oilfield services and oilfield equipment manufacturing and truck manufacturing industries. When compared to the second quarter of 2015, sales for the third quarter of 2015 decreased $20.6 million or 6.4%.

Excluding $1.1 million of third quarter sales for Cortech, acquired on September 1, 2015, sales for the third quarter declined $21.7 million, or 6.7%, from the second quarter on a same-store sales basis. This decrease was primarily the result of sales to customers engaged in the upstream oil and gas industry and related industries.

Third quarter 2015 sales by our Service Centers segment decreased $14.8 million or 6.9% compared to the second quarter of 2015. Excluding Cortech sales, Service Centers segment sales declined 7.4% from the second quarter of 2015. Third quarter 2015 sales for Supply Chain Services decreased $400,000 or 0.8% compared to the second quarter of 2015.

Third quarter 2015 sales of Innovative Pumping Solutions products decreased $5.4 million or 8.1% compared to the second quarter of 2015. The decline in IPS sales in the third quarter is a result of reduced capital spending by our oil and gas related customers.

Gross profit as a percentage of sales for the third quarter of 2015 decreased by approximately 100 basis points from the third quarter of 2014. On a same-store sales basis, gross profit as a percentage of sales decreased by approximately 110 basis points.

The decrease is primarily the result of the approximate 400 basis point decline in the gross profit percentage for the IPS segment.

The 400 basis point decline from the third quarter of 2014 and the gross profit percentage for the IPS segment is primarily the result of product mix, competitive pressures resulting in lower margin orders and unabsorbed manufacturing and fabrication overhead.

Approximately $750,000 or 125 basis points of the IPS gross profit margin decline resulted from unabsorbed manufacturing overhead at our new ANSI pump and casting manufacturing facilities.

The third quarter profit percentage for Supply Chain Services increased 170 basis points, primarily as a result of decreased sales of lower margin products to oil and gas and truck manufacturing customers.

The third quarter gross profit percentage for the Service Centers segment decreased approximately 45 basis points on a same-store sales basis from the third quarter of 2014, primarily as a result of lower sales of higher-margin Safety Services and metal working products.

Gross profit as a percentage of the sales for the third quarter of 2015 increased approximately 7 basis points from the second quarter of 2015. This increase is primarily the result of the approximate 160 basis point increase in the gross profit percentage for the IPS segment.

The increase is primarily the result of better product mix and the lack of cost overages experienced in the IPS segment in the second quarter. SG&A for the third quarter of 2015 decreased $7.5 million or 9.1% from the third quarter of 2014.

After excluding third quarter expenses from acquired businesses of $1 million, SG&A decreased $8.5 million or 10.3% on a same-store sales basis. The decline in SG&A is primarily the result of a $4 million decline in incentive compensation and cost control measures, including headcount reductions.

As a percentage of sales, the third quarter 2015 expense increased approximately 350 basis points to 24.8% of sales from 21.3% for the prior corresponding period because sales declined by 21.7% and SG&A declined by 9.1%. SG&A for the third quarter of 2015 decreased $2.2 million or 2.9% from the second quarter of 2015.

After excluding third quarter expenses from the acquired business, Cortech – of $600,000 for Cortech, SG&A decreased $2.8 million or 3.6% from the second quarter. This decline in SG&A is the result of cost control measures, including headcount reductions.

As a percentage of sales, SG&A increased approximately 90 basis points from the second quarter of 2015 because sales declined sequentially 6.4% and SG&A declined sequentially 2.9%. Corporate SG&A for the third quarter of 2015 increased $360,000 or 3.1% from the third quarter of 2014 and increased $600,000 or 5.2% from the second quarter of 2016.

The year-over-year increase and the sequential increase are primarily the result of increased legal fees associated with the Goulds arbitration and the B27 working capital dispute.

As a result of the decline in crude oil prices during the third quarter of 2015, DXP performed an interim impairment test and recognized preliminary impairment expense of $57.8 million of the goodwill associated with the acquisition of B27.

Additionally, DXP recorded $1.1 million of impairment expense during the third quarter of 2015 to write-off an intangible asset related to the ITT Goulds distribution agreement, which was terminated by ITT Goulds during the quarter.

During the third quarter of 2015, the accounting expert issued his report on the working capital dispute between DXP and the sellers of B27. The report required DXP to pay the sellers of B27 an additional $11.3 million, because the time period to allow adjustments of purchase accounting had expired, $7.3 million of the payment was expensed.

The remaining $4 million of the required payment represents tax refunds which are expected to be received during 2016. Interest expense for the third quarter of 2015 decreased 20.2% from the third quarter of 2014 due to paying down debt during 2014 and 2015.

Third quarter 2015 interest expense increased 1.5% from the second quarter due to the midpoint 25 mid – sorry, due to the mid quarter 25 basis point increase in the interest rate as a result of the increased leverage ratio. Total long-term debt decreased approximately $1 million during the third quarter of 2015.

This debt pay down is after paying $10.5 million for the acquisition of Cortech, $11.3 million in connection with the working capital dispute with the sellers of B27, $4.7 million for capital expenditures related to our new ANSI pump offering and $1 million of legal fees related to the disputes with ITT Goulds and the sellers of B27.

Third quarter EBITDA for bank purposes was $20.2 million. Our bank leverage ratio was 3.58 to 1 at September 30, 2015. At September 30, 2015, our borrowings under the credit facility were at a rate of approximately 2.45%. At September 30, 2015, total debt outstanding was $378.5 million.

Availability under the most restrictive covenant of the credit facility was $31.4 million. Because our leverage ratio has increased from below 3.5 to 1 to greater than 3.5 to 1, our interest rate will increase 25 basis points beginning in the middle of November.

Capital expenditures were approximately $5.2 million for the quarter, $4.7 million of which were for our new pump and casting manufacturing facilities. $6.5 million of our 2015 capital expenditures were for these two facilities. Cash on the balance sheet at September 30, 2015, was $8.1 million.

Net cash provided by operating activities was $21.2 million for the third quarter of 2015. Accounts receivable and inventory balances were $187.5 million and $108.1 million respectively at September 30, 2015. Now, I would like to turn the call over to David Little..

a decelerating economy; negligible price inflation; overall margin pressure, specifically from upstream oil and gas; a softening industrial sector; weak demand from mining and agricultural customers; and the Canadian exchange rate. Kind of sounds like a perfect storm there.

The cumulative effect of these headwinds impeded efforts to grow at historic growth – organic growth rates, while impacting operating margins. That said, during Q3, we closed the Cortech acquisition, which we’re excited to add 3 new rotating equipment locations in western – on the West Coast in California.

Cortech provides us with end-market diversification, higher margin sales, technical expertise as well as access to the third largest oil production market in the United States.

Cortech, plus our previously announced Tool Supply acquisition, contributed $2.2 million in sales during the quarter, and we anticipate a greater contribution from Cortech in the fourth quarter as they were only part of the team for one month during this quarter.

From a product perspective, DXP Service Centers experienced a revenue decline from Rotating Equipment, Metal Working, Safety Products and Services, Bearing and Power Transmission product divisions. On a more positive note, all of our divisions, with the exception of Metal Working, experienced an increase in gross margins.

The softness we experienced from sales perspective were primarily driven by the upstream drilling development and completion market, as well as OEM oil and gas production customers. Moving into the fourth quarter of 2015, we anticipate a continued deceleration in these markets that we have already experienced soft demand in.

This environment provides us with a unique opportunity to provide technical and business solutions to customers who are looking to improve productivity and lower their overall operating costs. Our strategy moving forward will be to focus on 4 main business concentrations to deliver value.

First, we are thrilled to announce the creation of our Rotating Equipment National Sales Organization by making DXP the first North American rotating equipment distributor to have this presence. This will provide consistency for our rotating equipment products, services and pricing throughout North America oil and gas sector.

Our national sales efforts will focus on improving reliability through leveraging our industry leading service and repair capabilities and reducing the meantime between repairs.

Second, our superior Vendor Managed Inventory program will continue to offer our customers inventory management services through supplier reductions, focusing on productivity and cost savings. Third, our metalworking and rotating equipment private labeling programs will also pass on cost savings to the end users while driving margins for DXP.

Finally, our concentration on DXP employee development and training will continue to stay at the forefront of our minds. Our entire sales organization attended our impact selling process training and we are now rolling out a supplemental negotiations training to prepare them to maintain margins during this current economic downturn.

We look forward to helping our customers successfully manage through this tepid and uncertain economic environment. Data points, we have 150 Service Centers in the United States. We have 34 additional ones in Canada and one Service Center in Dubai.

Total Service Centers is 185, super centers 42, super centers in progress six; distribution centers eight and we are in 35 states. DXP Innovative Pumping Solutions, Innovative Pumping Solutions sales decreased 8.1% sequentially and 30.7% compared to 2014.

This was primarily driven by project delays or push-outs, reduced capital budgets and customers continuing to utilize existing equipment before investing in new packages. That said, the majority of the upstream products being quoted and sold in the Bakken continued to be associated with our multiple LACT units design.

There has been a resurgence in opportunities associated with salt water injection market as well as production facility and terminal pump packages. IPS high-energy multistage remanufacturing equipment and re-rate business remains consistent.

This equipment is being primarily utilized in the midstream sector along with gathering systems and boasts – booster stations applications in the crude oil and LNG application requirements. CapEx related expenditures in the reman market have been affected by the continued volatility in oil prices.

Our mining projects continue to be depressed as we mentioned in Q1 and Q2, driven by the continuing low cost of commodity prices. Offshore upstream production continues to remain soft. Gross profit margins in IPS saw improvement in the third quarter. During the quarter, IPS experienced 158 basis points sequential increase from the second quarter.

Operating income as a percent of sales increased 115 basis points sequentially and decreased 691 basis points from the same period of 2014. This was a result of product mix and the previously mentioned cost overages and unabsorbed overhead.

Also, we are still working through improvements in Natpro in conjunction with the weak Canadian market conditions in the midst of our operating changes.

As we move through the remainder of 2015, we are going to leverage our North American IPS footprint and facilities, manage costs efficiently and manage with an awareness that volume in our business is either getting delayed or pulling back based upon oil price volatility and our customers focusing on their greatest yielding assets and cash flow.

We presently have 12 fabrication centers. DXP Supply Chain Services, DXP Supply Chain Services experienced a 2.5% decrease in revenue year-over-year and 0.82% decrease sequentially. That said, operating income as a percent of sales increased 27 basis points sequentially and 46 basis points for the same period in 2014.

SCS was able to continue to grow the bottom line in the third quarter despite these slight revenue declines. This was mainly due to the margin enhancements and operational excellence in order to lean out our costs in our supply chain. In Q3, SCS continued to see the effects of weak energy, heavy manufacturing, trucking and mining industries.

We see – we predict to see the industrial market continue to be on a downward slope over the next two quarters. As noted from previous Q4 releases, this is a slow time for SCS because of the reduced number of billing days due to weather as well as the holidays.

Many of our customers that are affected by these markets are using this time to shutter their operations for weeks at a time over the holiday in order to control costs. However, customer feedback is predicting a brighter 2016, particularly in the latter half of the year.

The SCS team feels confident that with the addition of new sites in Q2 and Q3, they should remain relatively flat in Q4 despite the impact of the slowdown in the industrial market. SCS continued its organic growth strategy around gaining market share in slow times by bringing customers value-added solutions and guaranteed cost savings.

This is proving to have continued success in winning additional sites with existing and new customers. We are also continually diversifying our customer base to achieve balance to withstand the current economic outlook. In closing, DXP is excited about the opportunities surrounding our rotating equipment product division.

We will continue to be customer-driven experts in the markets we serve. We will strategically invest in DXP’s future and we will take market share through organic and inorganic initiatives. We are positioning DXP for the eventual market turn, and we will continue to provide the excellent service that customers deserve.

So with that, we will now take questions..

[Operator Instructions] And we will take our first question from Matt Duncan with Stephens. Please go ahead..

Hi guys..

Hi Matt..

So David obviously, I am sure you know where I am going to start here, let’s talk a little bit about this breakup with Goulds and the launch of your home brand, can you talk a little bit about how you guys are going to position your product in the marketplace, how you plan to compete with Goulds and talk about your manufacturing capabilities, do you have the capacity to serve all of the demand that you had for Goulds pumps with your own line today?.

Okay. I will try to remember those six questions. This is really an exciting time for DXP. We have – Goulds has had very stringent handcuffs on us, told us where we could and couldn’t sell, who we could and couldn’t buy. And so – and other pump manufacturers just simply don’t have those kind of restraints.

We all understand territorial restrictions, but if you are assigned a territory, we understand that, if you are not in – if your area of responsibility is not that territory, well then you should be able to sell something else. And because we are trying to take care of customers that are global customers. These aren’t little customers.

These are Fortune 500, Fortune 1000 customers and they are global customers and they want standardization. They want somebody that can take care of their needs. And so this allows us to build our national sales team, call on corporate America, go out and really give the customer what they want. To do that, we had to unhitch ourselves with Goulds.

And to be fair, Goulds wanted to unhitch themselves with us. And so we went about how do we go about replacing Goulds’ breadth of product, because they are a good company, there is nothing wrong with Goulds. Their philosophy is a little prehistoric, but their product is really good.

So we bought B27, who makes an API 610 product, which is really a big, big product. Somebody that’s really, really good and in that business is somebody like Flowserve. And so it was an easy step for them to put together a manufacturing state-of-the-art system to make quality, quick, price-competitive ANSI products.

Then we filled in with some other private label people on some other types of things and other products that Goulds has, and we just have a wonderful, complete offering. And so we can take care of any kind of pumping application, or at least 98%. So that’s pretty exciting for us.

We’ve designed the factory today to be able to replace all of the business that DXP did with Goulds, and literally, that’s – to give you an idea, that’s like three CNC machines and a robot, and so to double that capacity is just a matter of adding three more machines and another robot.

So it’s not difficult, it’s – frankly, it’s not even that expensive. So I don’t think capacity is a problem. In the positioning of the product, that was one of your questions and it was a really good one. Because what we want to do is we want to be – we want to give the customers what they would like to have.

And what they would like to have is quality at a better price and a faster delivery. So that’s where we’re going to position this product, is quality, frankly, as good or better, faster and at a better price. So that’s where we want to position it.

There are people that have copied Goulds pumps, multiple people have copied Goulds pumps and they’re having it made in China. This is all being made and controlled in America, from the foundry to the finished product. And so there’s a lot of low-quality, cheaper stuff, really cheap, but that’s not the position we want.

We want to be in a position of better, quicker and a better price than Goulds, but a fair price and not a cheap price..

Sure. I appreciate all the detail. That was very helpful, David.

So what is the quarterly revenue run rate that you had in Goulds pumps? And how quickly do you think you can transition that to your line? Or is it just too early to know? Are you still kind of trying to go to the customer base and educate them on your product?.

Well, we are having great success. And most of the success is that – we just – we can do it quicker. I like to describe it this way, with modern technology you can build one of something as inexpensive as it used to be when you had to have capacity that you were building 1,000 of something.

So you have a – you are running through 1,000 of something and you have this long run, and you did it because it was cheaper to do that. Setup time, all the things associated with that. Now you can build one of something that I believe you can build it just as inexpensive as building 1,000.

Plus, let’s just say something goes wrong, nobody’s perfect, so the world is not perfect.

So if something goes wrong, well, when you go to the end of the line and you have to start over, would you rather go to an end of the line of somebody building 1,000 of something, or would you rather go to the end of the line that you’re next to get fixed? And so speed, speed is what we’re all about, and we have just examples of where – a perfect example, a customer called, and it was frankly a Goulds account.

And Goulds – they wanted a super duplex impeller, and Goulds told them it would take 18 months. And they were going, look, you don’t understand, we are down. We’ve got to have this item. So for whatever reason, I’m not sure why, but they called us. And we didn’t have a super duplex impeller either.

But we were able to say, look, what – we will give you this stainless steel impeller, and we’ll have your super duplex in a week. Well, it doesn’t take many of those examples for the word to get out, and for the customers to – I mean, they just loved us. They were like, you are kidding, you can do that? and we go, of course we can.

And so we’re excited where we’re headed. We are early in the game, so I don’t think I’m prepared to predict when the crossover will come. We were doing $2 million to $3 million worth of purchases from Goulds a month. And so when does that – when does it that we crossover and we’re exceeding that.

But remember, we had a very restricted territory and a very restricted area that we could do business in. And now the world’s our oyster, so we expect that to happen..

Sure, okay. And then just last thing, if I may and then I’ll hop back in queue.

Just, Mac, on business trends as we move through the quarter, what did the month-to-month sales trend look like? And how does it looking headed into October?.

Look to the monthly sales schedule. So there are 64 business days in the quarter, so the sales per day were $4,736,000. And they started out in July, they were at $4,450,000, August, $5,015,000, September, $4,755,000..

And do you have October there handy?.

October would be estimates..

Sure..

And the estimates is $4,003,000..

Right. I will hop back in queue. Thanks, guys..

[Operator Instructions] And we’ll go back to Matt Duncan with Stephens..

Alright. Okay, well let’s look a little bit more at the balance sheet, Mac.

How much debt did you pay down in the quarter? I think you gave a debt balance, but what was the actual debt reduction in the quarter?.

The actual debt reduction was $1 million..

Okay. And then looking out, I think what people are going to be most focused on is if we look out and predict – project forward, EBITDA seems to be still declining based on the sales patterns that we’re talking about.

Are you guys at all concerned about maybe bumping into your debt covenants again, or do you think you’re going to be able to pay debt down fast enough to stay clear of those?.

We believe we’re going to be able to – we still expect to pay down debt. I mean, we – I kind of went through the litany of even though we only paid down $1 million, we made a $10.5 million acquisition. We paid $11.3 million on a working capital dispute. We spent $1 million on legal fees.

We bought $4.7 million worth of equipment for our new ANSI pump manufacturing facilities..

Okay.

What was the non-controlling interest item that showed up on the income statement this time?.

That’s our foundry. We own 47.5% of – I mean we consider it our foundry. And it’s also assumed that because we’re the sole customer and have the right to buy the rest of it that we actually control it. So it’s fully consolidated in our financial statements..

Would you assume that you will buy the rest of it so that we get rid of this non-controlling interest line?.

Yes..

When do you think that will happen?.

Next year. I’m not the person that decides that. So....

Sure. Sure, okay. Just back on the pump manufacturing for a minute, I don’t know, David, did you give out a sales number that you had that you were getting from Goulds? I don’t remember if you gave out a number or not, or if even you want to, maybe for competitive reasons you’d rather not..

Well, we were doing a – I mean, I have – we were doing about $3 million worth of purchases from Goulds..

Per month? Is that the – is that per month?.

Per month, yes. And so that would equate into – and then you have a lot of value adds, all that, that goes on with that, so it’s – so don’t take this as just the kind of the margin we made on Goulds, because we don’t make this much. But that was probably $5 million worth of revenues. I’m guessing a little bit on that..

Okay. What about sales force? Do you have the sales force capability to sort of rep this product truly nationally? Or are there some holes in the footprint that you may look to fill in? I’m assuming that Cortech probably fits that bill.

But are there other spots where you might need to do other small acquisitions or greenfield new offices to be able to sell your pump line?.

So, yes. We want to have – we want to be the Motion Industries of rotating equipment. So they have – so we look at them as an example. They have 500 stores across North America. So we don’t – it isn’t quite the same in the sense that a – pumps will travel further than a bearing that’s needed immediately.

So, we won’t need 500, but we need to build out the network. So what we have with the products that we have is the ability to now go out – and we don’t have Goulds telling us we can’t buy somebody.

So we have the ability – and I say tell us, there was always the threat of, well, if you buy somebody, we’ll cancel you, okay? So we won’t have the – they can’t tell us we can’t buy somebody, but you get my point. If you do, you run the risk of being canceled. So, our targets to buy people, now is somewhat unlimited and certainly unrestricted.

So yes, we plan on doing that. We also have the ability to do possible Greenfield startups now, so to do some of this more on an organic basis. And I think let’s not miss the point. We are an $800 million rotating equipment company, $800 million.

So when we talk about purchases of $3 million, or we talk about sales of $5 million, we’re not talking about a very big number. So that’s – so I don’t want to get too caught up in that we’re just replacing Goulds, so because that’s not really what we are trying to do.

What we’re trying to do is to capture 20 plants of this chemical customer across North America. And when we do that and we sell him all of his pumping needs, that deal in itself may be $20 million. And that’s the kind of – that’s the numbers we are talking about.

We are not talking about oh, we are making a little bit of ANSI pumps over here to replace Goulds. That’s not the objective. I mean, it is the objective. It’s certainly the objective to some of my salesmen probably right now, but they would like to feel comfortable that they can replace Goulds with something. And so we’ve done this for them, by the way.

I mean, we’ve – Goulds wanted to take accounts away and so we said no, and it wasn’t fair to our salesmen and the relationships we have built up over the years. And so we have given our salesmen more than a fighting chance and a way to grow beyond their abilities in the past and they are fired up and excited and we are having success..

Okay, great. I appreciate the help. Thanks..

[Operator Instructions].

Everybody is traveling today. Let’s go home..

Yes. It appears we have no further questions at this time..

Alright. Thanks to everybody on the call..

Thanks..

This concludes today’s conference. You may now disconnect your lines and have a wonderful evening..