David Little - Chairman and CEO Mac McConnell - SVP of Finance and CFO.
Matt Duncan - Stephens Inc. Ryan Merkel - William Blair Ryan Cieslak - Keybanc Capital Markets Joe Mondillo - Sidoti & Company.
Good day and welcome to DXP Enterprises Incorporated Fourth Quarter and Year-end Conference Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Mac McConnell, Senior Vice President of Finance. Please go ahead sir..
Thank you. This is Mac McConnell, CFO of DXP. Good evening and thank you for joining us. Welcome to DXP’s fourth quarter conference call. David Little, our CEO will also speak to you and answer your questions. Before we 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 fourth quarter 2015 results, David Little will share his thoughts regarding the quarter results, then we will be happy to answer questions. Sales for the fourth quarter of 2015 decreased 27.2% to $278.7 million from $382.5 million for the fourth quarter of 2014.
After excluding fourth quarter 2015 sales of $5.7 million for businesses acquired, sales for the fourth quarter decreased $109.5 million or 28.6% on a same-store sales basis.
This decrease was primarily the result of declines to sales to customers engaged in the upstream oil and gas industry, our manufacturing equipment for the upstream oil and gas industry. The strength of the US dollar contributed to sales decline. Sales for our Canadian operations were $29.5 million for the fourth quarter of 2015.
The change in the exchange rate reduced sales by approximately $4.6 million. Sales by our Service Center segment in the fourth quarter of 2015 decreased $65.1 million or 25.8% to $187.4 million compared to $252.5 million of sales for the fourth quarter of 2014.
After excluding 2015 Service Center segment sales of $5.7 million from acquired businesses, Service Center segment sales for the fourth quarter of 2015 decreased $70.8 million or 28% from the fourth quarter of 2014 on a same-store sales basis.
This sales decrease is primarily the result of decreased sales of bearing, rotating equipment, metalworking products and safety services to customers engaged in the oil and gas business. The strength of the US dollar also contributed to the sales decline. Service Center sales for our Canadian operations were $25.6 million.
The change in the exchange rate reduced sales by approximately $4 million compared to the 2014 exchange rate. Sales of Innovative Pumping Solutions products decreased $36.9 million or 41.4% to $52.2 million compared to $89.1 million for the 2014 fourth 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 $1.9 million or 4.6% to $39.1 million compared to $41 million for the 2014 fourth quarter.
The decrease is primarily related to decreased sales to customers in the oilfield services and oilfield equipment manufacturing and truck manufacturing industries. When compared to the third quarter of 2015, sales for the fourth quarter of 2015 decreased $24.4 million or 8%.
Excluding $3.2 million of fourth quarter sales for Cortech on a same-store sales basis, sales for the fourth quarter declined $27.6 million or 9.1% from the third quarter. This decrease again is primarily the result of declines in sales to customers engaged in the upstream oil and gas business - industry - related industries.
Fourth quarter 2015 sales by our Service Center segment decreased $11.9 million or 6% compared to the third quarter of 2015. Excluding Cortech sales on a same-store sales basis, Service Center segment sales declined 7.6% from the third quarter of 2015.
Fourth quarter of 2015 sales for Supply Chain Services decreased $3.2 million or 7.6% compared to the third quarter of 2015. Fourth quarter 2015 sales of Innovative Pumping Solutions product decreased $9.3 million or 15.1% compared to the third quarter of 2015.
The decline in IPS sales in the fourth quarter again is the result of reduced capital spending by our oil and gas related customers. Gross profit as a percentage of sales for the fourth quarter of 2015 decreased by approximately 30 basis points from the fourth quarter of 2014.
On a same-store sales basis, gross profit as a percentage of sales decreased by approximately 60 basis points. This decrease is primarily the result of the approximate 540 basis point decline in the gross profit percentage for the IPS segment.
The 540 basis point decline from the fourth 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 $1.7 million or 325 basis points of the IPS gross profit margin decline resulted from unabsorbed manufacturing overhead at our new ANSI pump and casting manufacturing facilities.
The fourth-quarter gross profit percentage for the Supply Chain Services segment increased 115 basis points primarily as a result of decreased sales of lower margin products to oil and gas and truck manufacturing customers.
The fourth-quarter gross profit percentage for the Service Center segment increased approximately 50 basis points on a same-store sales basis from the fourth quarter of 2014. Partially as a result of higher margin sales of repair and maintenance products making up a higher percentage of sales.
Gross profit as a percentage of sales for the fourth quarter of 2015 decreased approximately 70 basis points from the third quarter of 2015. This decrease is primarily the result of the approximate 750 basis points decrease in gross profit percentage for the IPS segment.
This decrease is partially the result of $1 million increase in unabsorbed manufacturing overhead at our ANSI pump and casting manufacturing facilities. SG&A for the fourth quarter of 2015 decreased $9.6 million or 11.8% from the fourth quarter of 2014.
After excluding fourth quarter expenses from acquired businesses of $2.3 million, SG&A decreased $11.9 million or 14.6% on a same-store sales basis.
The decline in SG&A is partially the result of $4.5 million decline in incentive compensation, $900,000 less amortization expense and a $1.3 million reduction due to currency translation and other cost-control measures including headcount reductions.
As a percentage of sales, the fourth-quarter 2015 expense increased approximately 440 basis points to 25.6% from 21.2% for the prior corresponding period because sales declined by 27.1% but SG&A declined - only declined by 11.8%. SG&A for the fourth quarter of 2015 decreased $3.6 million or 4.8% from the third quarter of 2015.
After excluding fourth-quarter expenses from acquired businesses of $1.3 million for Cortech, SG&A decreased $4.9 million or 6.5%. This decline in SG&A is the result of $1.4 million less incentive compensation, $500,000 less amortization express and cost-control measures including headcount reductions.
As a percentage of sales, SG&A increased approximately 90 basis points from the third quarter of 2015 because sales declined 8% and SG&A only declined 4.8%. Corporate SG&A for the fourth quarter of 2015 decreased $1 million or 8.9% from the fourth quarter of 2014 and decreased $1.7 million or 14.1% from the third quarter of 2015.
The year-over-year decrease is primarily the result of reduced incentive compensation. The sequential decrease is primarily the result of lower legal fees associated with arbitration hearing which was held during the third quarter and the dispute was finalized in the fourth quarter.
As a result of the decline in oil prices and DXP stock price during the fourth quarter of 2015, DXP performed an interim impairment test and recognized impairment expense of $9.8 million of the goodwill associated with the acquisition of B27.
Interest expense for the fourth quarter of 2015 decreased 3.3% from the fourth quarter of 2014, due to the effect of paying down debt in 2015 which was partially offset by increased interest rates. Total long-term debt decreased by $27 million during the fourth quarter of 2015. Fourth-quarter free cash flow was $20.9 million.
Fourth-quarter EBIDTA for bank purposes was $14.7 million. Our leverage ratio was 4.02 to 1 at December 31, 2015. At December 31, 2015, our borrowings under credit facility were at a rate of approximately 2.67%. At December 31, 2015 total outstanding debt was $351,600,000.
Availability under the most restrictive covenant of our credit facility was $19.7 million. DXP is currently working with our banks to amend our credit facility to provide D XP more financial flexibility.
Because our leverage ratio has increased during the quarter from below 3.5 times to 1 to greater than 4.0 times, is 0 to 1, our interest rate will increase by 50 basis points beginning at the end of March. Capital expenditures were approximately $2.3 million for the quarter. Cash on the balance sheet at December 31, 2015 was $1.7 million.
Net cash provided by operating activities was $23.2 million for the fourth quarter of 2015. Accounts receivable at December 31 was $162.9 million and the December 31 inventory balance was $103.8 million. Now I’d like to turn the call over to David Little..
Thanks Mac and thanks everyone on the conference call today. I would like to personally thank all of our DX people for their efforts this year. DXP collectively confronted a challenging economic environment of an upstream oil and gas depression which started 20 plus months ago and a surprising industrial recession.
Note that in my opinion these conditions do not normally go together. When oil and gas prices are down, other parts of the industrial market are supposed to benefit, My point is that there are signs that the industrial recession is turning more positive in United States and Canada.
Upstream oil and gas is still in a decline especially on the CapEx side. However maintenance, repair and operating expenditures are more consistent. We have and are taking transformative actions to position DXP for the future.
That said, we remain focused on executing our sales strategies, improving cost efficiencies, managing working capital effectively, strong cash flow generation as we navigate the prolonged down cycle and upstream oil and gas.
On a more specific front we have and continue to consolidate administration, facilities and management to drive efficiencies and reduce costs. Our sales growth objectives include capturing additional fabrication work on capital projects where in the past, some of our sales professionals only sold to pump.
We are starting downstream safety turnarounds, our sales professionals are expected to spend time hunting new customers because there are no customers or territorial restrictions with our PumpWorks brand, which is a superior pump with a faster delivery than our competitors.
Targeting customers that want cost savings in their MRO supply chain, DXP’s Supply Chain Services group has the answer.
Of course we continue to sell - cross sell multiple product divisions to capture more of each customer span, plus we have new sales efforts with pay incentives to capture and build relationships with new customers and expand new geographies.
Also as we continue to move forward with our suppliers like Grundfos, IDEX, John Crane, Pentair, Peerless, PSG, PumpWorks, Sundyne and Xylem to name a few, DXP and its partners look forward to creating the best solution for the customer on competitive pricing, accelerated delivery, aftermarket service and quality of product.
The PumpWorks brand is composed of four distinct groups, PumpWorks Industrial, ANSI and Industrial pumps, PumpWorks 610, API 610 pumps, PumpWorks Reman [ph] remanufacturing of API pumps and PumpWorks Casting.
Each of these groups attack a specific market and support both our service centers and IPS segments with industrial best lead times and 100% made in the United States with quality and competitive pricing. The PumpWorks Industrial product line is fully launched and the customers respond has surpassed our expectations.
Our business model of distributor customer service and local inventory combined with the muscle of American OEM operation have proven a robust backlog and increased front-end activity. While service, quality and price are critical ingredients, we win many orders in our industry with superior features.
Our existing and new customers are eager to adopt the advanced design features of our pump. We are not discounting these product lines furthermore we have orders and serious interest of our ANSI product line with many top tier chemical, petrochemical and certainly oil and gas customers.
PumpWorks 610 products continues to expand their market share with a rollout of the DXP national sales force. The API product has been impacted by the downturn in oil and gas but we are using this opportunity to rebalance our API focus to downstream and the Middle East where activity is higher.
Our Dubai sales office is responding to record demand in the Middle East region as oil production continues to set new records. We will emerge from this down cycle with enhanced market share and a larger customer base that will demand our services quality and delivery.
To complement our OEM operations, we are continuing to focus on service, effort and sale. Utilizing our industry best footprint which includes five tier 3 shops facilities, 12 tier 2 facilities and 100 tier 1 repair facilities in North America.
In January, DXP launched an aftermarket initiative that will utilize our size to better service each customer and add superior capabilities including rapid spare parts manufacturing using our in-house boundary PumpWorks Casting rotating equipment repair and build service to generally counter cyclical - which are generally counter cyclical to capital purchases and we believe these efforts will provide revenues stability in down markets.
DXP is uniquely positioned to capitalize on this opportunity with its people, presence and technology. I really like the direction of our company. We will get past this downturn. We are winning market share and our financial results will result in significant gains for [indiscernible] when the economy returns.
As we looked at our financial performance, the fourth quarter continued to reflect the challenges we saw all year as we witnessed a further step down in oil prices from the third quarter. The continued decline in oil prices and volatility impacted our customers operating and capital spending decisions.
DXP's fiscal 2015 sales were $1.2 billion or 16.9% decline over fiscal 2014. This outperformed the 61.3% decline year-over-year in North American rig count and performance of similar peers with like exposure. Supply Chain Services sales grew 1%, while Service Centers declined 16.3% and Innovative Pumping Solutions declined 26.8%.
During the year, we were able to hold gross profit margins within the Service Centers and the Supply Chain Services segment. The IPS gross margin margins were under market pressure and down 210 basis points. Overall, DXP produced an adjusted EBITDA of $81.3 million and free cash flow of $96.3 million, excluding certain items.
We remain pleased with our ability to generate cash and manage our resources effectively. Additionally, we completed two acquisitions in 2015, Tool Supply and Cortech Engineering, helped grow our metalworking and rotating equipment product divisions while providing us with new geography in Western United States.
Total employees for the fiscal year were approximately 3,234. Looking at 2016, we do not anticipate any meaningful recovery in our key end markets.
Notwithstanding the challenging economic environment, we will be driving a higher level of accountability and a greater sense of urgency throughout the organization to improve our competitive position and operational execution.
I am grateful for the hard work and dedication of our employees and I'm confident in their ability to navigate the tough roads ahead. We remain resolved in our focus on reducing cost, improving execution and doing more with less. That said, we also value our most important asset, our DXP people.
So it is our goal to keep everyone to be ready - to keep as many people as possible to be ready for the next upturn in the market we serve. We firmly believe we will create significant value over the next 12 to 14 months by growing our bottom line and producing strong cash flow.
As mentioned, DXP's 2015 financial performance reflected the dynamics within our end markets and the challenges to match cost reductions with declining in revenues.
That said, DXP generated $20.9 million in free cash flow in the fourth quarter, $84 million in fiscal 2015 and during the fourth quarter DXP also paid down debt by $27 million and for the full year reduced debt by $65.6 million. Now I’d like to talk about our segments.
Allow me to now focus on summarizing activities within our three business segments, Service Centers, Supply Chain Services, and Innovative Pumping Solutions. The Service Centers segment sales decreased 16.3% for the fiscal year 2014 and ‘15 with an operating margin of 9.4%.
Several factors contributed to the financial challenges we faced this year; declining economy, negligible price inflation, overall margin pressure from upstream oil and gas, softening industrial sector and weak demand for mining and agricultural customers and the Canadian exchange rate.
The cumulative effect of these headwinds impeded efforts to grow our top line and bottom lines. We anticipate these challenges to carry forward into 2016 and we are prepared to make the necessary adjustments to take market share and maintain profitability.
Difficult economic conditions aside, we have remained positive and used the down cycle to work on organic sales programs, productivity projects and consolidations that will make us faster and easier to do business with.
Examples include the kick-off of a national rotating sales organization, the resurgence of our Vendor Managed Inventory programs, the establishment of metalworking private label programs, just to name a few.
Additionally we completed the acquisition of Tool Supply Inc., and Cortech Engineering and we're excited to have both of these great companies as part of our DXP family. Tool Supply adds service center customers in the transportation, aircraft, general machining, wood processing, aerospace and OEM market.
Cortech adds municipal oil and gas, chemical and other complementary industries and end markets. Each acquisition furthers the efforts we have been undertaking over the past two years to add geography and business that has good end markets outside of oil and gas.
In the fourth quarter, our South Atlantic management team successfully elevated our Orlando Florida service center to a supercenter status broadening our opportunity. We would like to recognize our employees, customers and suppliers in the Orlando market for their dedication and helping us create our last supercenter.
We presently have 43 supercenters. Moving into the first quarter of 2016, we anticipate a continued deceleration in those markets that we have already experienced soft demand.
These environments provide us with unique opportunity to provide technical and business solutions to customers who are looking to improve productivity and lower overall operating cost. We look forward to capturing new market share from customers looking for an MROP distributor that can provide meaningful solutions to their toughest problems.
Finally, our concentration on DXP employee development and training will continue to stay front of our mind. We have created a substantial blend of commercial and technical training that will allow us to execute on our commitment to be the best solution for industrial customers.
We look forward to helping our customers successfully manage through these tepid and uncertain economic times. DXP Supply Chain Services. DXP Supply Chain Services saw a slight increase year-over-year and was able to contribute to grow their bottom line.
This is mainly due to margin enhancements, they are increasing our products scope with more value added solutions for our customers and a continued push for operational excellence, providing technology to drive cost out of the supply chain. In Q4, SCS continued to see the effects of weak oil and gas, energy, heavy manufacturing, trucking and mining.
We predict to see the industrial market continue in the recession over the next two quarters as well as no oil and gas recovery this year. Q4 is the slow time for SCS because of the reduced number of days billed during the winter as well as holidays.
We experienced as predicted a Q4 slowdown as many of our customers take the time to shutter their operations for weeks at a time over the holidays in order to control costs.
The SCS team feels confident that with the addition of new sites into Q4 and into Q1 of 2016 that we should remain relatively flat in the first two quarters despite the impact of a slowdown in the industrial market and oil and gas.
SCS sustained its organic growth strategy around gaining market share in slow times by implementing six new sites and several long-term renewals. We did experience a loss of a couple of sites or so greatly affected by the slowdown in oil and gas that it was no longer cost effective for DXP's Supply Chain Services to operate an on-site location.
The remaining business on those sites reverted back to our service centers where it made better soon. We are continually winning new sites, diversifying our account base so that we can ride out the efforts in tides of the market fluctuation. DXP IPS segment. Upstream oil and gas mining sector.
Land base, quote activity and order hit rate in this sector were lower than expected levels through the fourth quarter. This is the result of lower oil prices than a sluggish economy. We expect this profile to continue through the first quarter. Customer feedback on current oil prices at current levels are below their expectations.
Orders are slower than we expected. Again, lower oil prices are the contributing factor. Predicting any increased purchasing activity is difficult under the current market conditions and uncertainty of our customers.
The inventory for drilled un-fraced wells in the major US shale plays continues to be a positive indicator of future production that is currently available to be brought online in the future.
The expenditures that are being funded are strategic, offer the best return on invested capital and can be brought to market with short lead times with the lowest equipment cost. Our customers continue to focus on these business aspects. Our customers and repair opportunities are not a level where we would expect.
However, with mild weather conditions in the major oil and gas plays, plays a contributor to lower equipment failure as well as reduced production rates. Mining. CapEx products in the copper mining segment continued to be depressed due to low cost of commodity based on customer feedback we have gathered. Midstream/upstream.
As stated in past quarters, this sector continues to produce the majority of quotes and order activity. The Eagle Ford, Permian shale plays continued to provide the opportunities for this activity. The Marcellus, Bakken, [indiscernible] continue to provide opportunities, however, not at the rate of the Eagle Ford, Permian and Bakken shale plays.
The order profile for the majority of the products being quoted and sold in the shale plays continues to be associated with our multiple LACT unit design. We continue to see increase in produced water opportunities for our horizontal surface pump line as well as our tank product offering.
The equipment at the terminal loading and offloading facilities utilizing centrifugal packages and fabricated at 529, Houston, Golden and Colorado locations. The LACT unit markets in the Eagle Ford stack, Permian plays remains low margin business.
We continue to be very aggressive in this space to maintain our presence with a focus to place equipment in the field to have aftermarket MRO opportunities on the equipment. With our high-energy multi-stage remanufacturing equipment and rewrite business remains consistent.
This equipment is being utilized in the midstream sector, gathering systems, booster station applications and the crude oil and LNG applications requirements. CapEx related expenditures in this category have been affected as well as current oil prices. The service and repair side of this business continues to be positive.
We continue to provide delivery propositions for our horizontal surface pumps, centrifugal pump equipments and our remanufacturing high energy equipments with lead times that allows us to outperform our competitors when delivery is a major factor. Currently delivery and price are critical to the getting the orders.
The API-610 product, the market opportunities for this product, both domestic and international are providing consistent quote activity and order rates. These products are primarily used in midstream and upstream markets.
The delivery proposition, quality and price point we provide is very attractive to the customer with requirements for new equipment in this product line. We have had success in securing several API-610 opportunities for pipeline expansion products in Canada and the United States.
We're very optimistic that our US midstream, upstream opportunities will remain consistent through Q1. Gulf of Mexico, this sector continues to remain soft and in the markets - municipal, municipal Eastern Canada markets are expected to continue to improve to current levels for Q1 which are much better.
New government is committed to making investments in industrial municipal infrastructure. This is in the early stages and we have had success in landing some nice orders in this segment. Oil and gas continues to have a significant impact on the sector in Western Canada as it relate to capital project as well as aftermarket MRO opportunity.
We expect to experience margin pressure on CapEx projects that get approved for purchasing. Petrochemical, this segment has expanded CapEx budgets for 2016 by 30% to 50% over 2015 levels. Current budget quote activity is promising.
IFS, Innovative Flow Solutions, we are optimistic about the upcoming opportunities of our modular rotating equipment packages.
We continue having success with our modular package design to the filter, the liquids and gas products produced at the wellhead and gathering stations, increased regulations by pipeline transmission companies who are filtering certain components from liquids and gas part of the product being put in the pipeline.
We also provide fuel gas filtration systems that’s designed to clean the wellhead natural gas so it can be utilized to power the natural gas engines that run onside the equipment. These product opportunities are expected to continue in 2016. Mideast and Dubai, we remain focused on the region in all opportunities. Our quote activity is promising.
We are optimistic of the increase in opportunities in this region. We are optimistic Q1’s performance will be in line with Q4. We will continue to see our opportunities to improve projects to be competitive, delivering driven and price sensitive.
We will continue our strategic rationalization of the market that customer complete scope of the project equipment, the competitors we are quoting, what is the realistic full expectation of the customer, what is the most important to the customer and what value is the customer willing to place on each aspect.
Understanding all the aforementioned components will allow us to make the proper strategic business decisions to take market share and margins that support our business model. Our oil and gas markets very soft due to the current oil and gas price. It has remained softer than expected and longer than initially expected.
As expected, we are in a very price sensitive and delivery sensitive market that has also an excess production capacity, availability. At this time, we will continue to be diligent to the placement of equipment in the field so that we can enjoy the MRO opportunities that come from servicing that equipment.
In conclusion, DXP would appreciate the oil and gas market bottoming and the rest of the industrial market to improve.
We are positioning DXP for this eventual market turn and will drive market share gains by being the only industrial distributor with industry-leading and in-house rotating equipment brands plus the only industry integrator that owns the majority of the value stream on the modular pumping and flow system packages.
Industrial pumps and API manufacturing that is 100% made in the United States, ANSI pumps with a standard carbide steel construction.
DXP is the best industrial distributor that understands being customer driven and the customer wants - and what the customer wants, ease of doing business with fast deliveries, quality and superior products, a comprehensive aftermarket program to support the equipment we distribute. They want fewer and more relevant suppliers.
DXP aims to give the customer exactly what they want, customer-driven experience. With that, we will now take questions..
[Operator Instructions] And we will take our first question from Matt Duncan with Stephens Inc..
Good morning, guys..
Good morning, Matt..
So I want to start by talking about the balance sheet and I think it’s probably front-of-mind for a lot of people. So it looks like Mac as you refer to in our prepared comments, you guys are starting to talk to the banks about what you can do about the covenant.
My recollection is that your leverage ratio covenants 4.25 if we annualize the EBITDA that you had in the fourth quarter, you are obviously going to be well in excess of that and I think the likelihood is pretty high.
Given what you reported in the fourth quarter and the trajectory, your energy markets that you may have trouble by the end of the first quarter.
So where are you in those conversations with the bank? What’s your goal for when you might get that resolved? And do you have any indication at this point sort of what that resolution might be?.
I mean, I guess to some degree to summarize, we provide with model that the bank has requested. We gave to them two days ago, so the process is in the early stages of working through this amendment..
And do you have an indication that they are going to be willing to work with you? I mean, obviously in the past, many times you guys have been in this situation. The banks have been very willing to work with you and you guys haven’t sounded overly difficult to get these covenants when you needed them.
Where do you think we are today or given that the leverage ratio is creeping up and looks like it could hit five or higher this year, and maybe going to any tougher to get terms with the bank? Are you pretty confident this will be resolved fairly easily?.
I agree with you. Our bank group has been very supportive in the past, they were supportive back in 2009 and ‘10 and they have worked with us during 2015. I will also admit what we are - as you explain, that we are asking for this time is a little tougher for the banks than what we have asked for before.
DXP is also - you’ve seen, we’ve been paying down a lot of debt, so that helps. We have a number of initiatives underway of fairly significant cost cutting. Going forward we are reselling some like corporate office building presumably when that’s sold, it’s a gain which creates EBITDA and reduces debt.
There are other initiatives going along as part of this process..
Do you have any view, Mac, on what free cash flow might be for this year based on your current forecast for the year, what kind of free cash flow can you generate this year?.
I think we are anticipating, I think it goes through the whole income statement first. I think we are anticipating sales to be down, but less than last year. And I think we are anticipating some pretty significant gains in our operating efficiencies. And so I think EBITDA will be down but not significant.
And so I think you start with that concept and then now the question becomes if you take EBITDA, I do believe that we spent a lot of money also on CapEx. Our sales are getting in. The pump ANSI business and things like that and all that is not totally behind us. We're always doing patterns and things like that, but the majority of that is behind us.
So CapEx will come down. And so then the last piece of that equation, I am giving you fuzzy comments, but I think you could deduct from there. The last is, I am trying to say, we go EBITDA, we got capital expenditures, always working capital.
So the last piece is working capital, I think we can assume that working capital will go down corresponding to revenues, and so we see that going down less, so therefore we see percentage of cash flow and excess of EBITDA minus CapEx being slightly less.
But it will go down correspondingly, it always does, distribution model, we sell less, we have less receivables, with cash we pay down debt, inventories go down, because we have less requirements of inventory and so we do generate cash through working capital.
But it’s a function of declining sales and we would like to hope that at some point of time in the future, that our working capital requirements are not that great that should the business turnaround and sales go up then we won’t also put ourselves in a bond where we don’t have money at that particular point.
And our models reflect that because we have a very high return on invested capital, so we don’t use a lot of working capital to generate growth in sales because of Supply Chain Services, because of IPS that just don’t require huge inventory levels to support sales..
So David, a couple of things that you said there that I think you’re exiting. So on the EBITDA side, it sounds like you don’t think it’s going to be down all that much year-over-year, so you did about $83 million in EBITDA in 2015.
Based on recent sales trajectory, you’re going to have a lot of pressure from declining revenues, so what are you doing on the cost side that’s going to help you keep EBITDA somewhat close to what you had last year.
How much can you take out of quarterly SG&A expense, for example to help drive a little better bottom line and sales go down and what are your targets there?.
So I think we can’t really start with the 80 some odd million, because that’s a yearly number, so we kind of start building a model off of the fourth quarter and we think the fourth quarter had a lot of noise, but lot of stuff in it that like getting into the top business and et cetera.
So we think the EBITDA number for the fourth quarter is not a normal level of EBITDA should be higher than that. And then - so then from there, we build off of what we think that number was and we build off of there, so we are not going to $80 million or even $75 million, we are going to be south of that..
So David, let me look at this way, if you take out the stuff in the fourth quarter, if it’s not normal and then kind of annualize that number, can you stick pretty close to that? I mean, if I am hearing you correctly something around $60 million seems like a double EBITDA number for 2016? If sales are down, call it in the low-to-mid teens, is that a reasonable guesstimate at this point?.
I think that’s a good guess..
Okay. All right. And then the last piece just along this line of questioning, you got a $50 million ATM or you can sell some equity, if need be to raise cash, I would think that’s not something you want to do with this current stock price.
Is that off the table, is a way to get some cash to pay down debt or are you thinking about maybe using that?.
No, it’s off the table..
Okay.
And then last thing, and I’ll hop back in queue, just on PumpWorks, if you could tell us how the launch of the PumpWorks line is going? What kind of revenues do you think it can generate this year based on what you’re seeing so far? And maybe if you can just talk about sort of how your - what you’re hearing back from your customers about that pump as it enters the market?.
Yes, I mean, I like to talk about that. I guess, we kind of got into this business, but we had hoped it would have been a little later, but anyway it was earlier. So sort of around the end of October, I would say, and so the foundry and the ANSI factory have produced about - and related equipment has produced about $8 million.
And if you relate that to what we were kind of down to do them with previous supplier, that probably equate to about $9 million. So we think we have been wobbling successful. We think that we have customers that truly view the pump as a superior pump, as superior delivery proposition and let’s talk about that a little bit.
There is multiple sizes and multiple kinds of ANSI pumps and so you don’t ever have these - they are not just sitting on a shelf always, so there is always something that kind of needs to be made as multiple different metallurgies, multiple different sizes et cetera.
So even though we do want to have inventory, and it’s kind of funny, we have actually had orders faster than we can get our inventories build up. In fact, our sales people do - are complaining off of not having enough inventory in the field, but we are trying to take care of our customers.
So a lot of the orders are getting pushed in front of stockholders. So that’s kind of causes not to be operating quite as smoothly as we would like. But that’s a good problem, not a bad problem.
And so we - and we have been amazingly surprised that it’s not just oil and gas customers that are - they just want things in a hurry, and they are not always concerned with brand, but we are having pretty nice success with chemical plants, petrochemical plants and refineries. And so we are aesthetic quite frankly..
Good. I think it’s going well. Thanks for the update there. I appreciate it. I’ll hop back in queue guys..
Our next question comes from Ryan Merkel with William Blair..
Hey, good morning everyone.
So first question, my understanding was your business lagged to the rig count and given the rig count is down 60% or so this year, wouldn’t next year sales be down almost as much as this year?.
Well, I’m thinking to make that assumption, but I don’t think that that gives us any credit for capturing market share from our weaker competitors and gives the credit for some of our growth initiatives, which are our PumpWorks and our after-market service and turnarounds in the downstream market, which is doing good, attention to capital projects that are downstream that are - or downstreams doing better.
But I think our upstream - and then our upstream business is a function of - more of a function of production, not just drilling. So when we say - and hand drilling has gotten so much more efficient, so I guess we have to look at really the production rate being down versus the drilling rate being down..
Historically, we have always said that the rig - our business, oil and gas part of the business, they tend to lag the rig count by six months to a year and what’s I believe has changed is the wells are being drilled faster, they are being hooked up faster, the shale plays are much more of an assembly line operation that in many instances the wells are being drilled in less than half the amount of time.
And in a lot of cases, they are being hooked up to production within days of the well being completed..
And one point, I really want make here too is that, we are not just an oil and gas company. 40% of our business is other industrial markets, and what’s been an oxymoron here thing is that when the upstream, when the oil prices as raw materials are cheap, the rest of the world is supposed to do a lot better.
And refineries are doing better and down chemical plants and petrochemical plants are doing better. And then other industries are supposed to do better with that, well, somewhat maybe because of the strength of the dollar or whatever, we have not seen these other industries do better.
In fact, they are doing better than oil and gas, but I think it’s fair to say that over the last six months or so we have kind of been in an industrial recession that most everybody in this space has had organic declines, and maybe they are only 3% or 4% versus 16% in oil and gas. But still nonetheless.
So 40% of our business is not oil and gas, and that’s supposed to give us a more balanced portfolio of sales going forward. But we’ve been unfortunate that over the last period here that we’ve kind of had both markets that is down, and that’s unusual..
Okay. Understood. Well, second question. Some of those other industrials that you’re probably referring to, early this year, Jan, Feb, sales - organic sales year-over-year are getting less bad..
Exactly..
Is that something that you’re seeing in your 40% of business that’s too industrial?.
When we look across our regions, last year, we only had one region that was plus 1% in sales; one. And this year, we saw more of our historical regions that are not oil and gas are projecting things to be a little better..
Okay.
So outside oil and gas, you’re starting to sense that things could be bottoming and possibly could get a little bit better in 2016?.
Yes, I do..
Okay. My last question, and I will get back in the queue. In terms of Midstream CapEx for 2016, do you have a view there as part of that guidance on EBITDA going back to Matt’s question, because that would be helpful because I think some of the rhetoric right now is that Midstream CapEx will be down 20% plus. Just curious if that [indiscernible]..
Yes, that’s correct. What’s helping us is that, we are a small fish. Flowserve has 70% of API 610 market. So combination of the fact that we have some really great relationships and some really great delivery propositions. Then it’s allowing us to be a little more successful getting the fewer jobs that are out there.
There are still jobs out there that you likely said, CapEx went down 20%, well, there is still 80% of those jobs that are still out there. So we are working diligently, we have close relationships with accounts and et cetera. So yes, it’s getting softer.
I would agree with a 100%, but we don’t think that we are going to see our best part of the business fall of 50%, we just don’t see it. Will it be down 10%? Yes, might be so.
And then to replace some of that 10%, we are getting way more aggressive in the downstream sector with the refineries and chemical plants and stuff and terminals and et cetera that also use API 610 pump. And then lastly, Saudi Arabia is still spending money like crazy. So we are - we have Saudi relationships and we are older there.
So we see that business actually being better and we feel our veteran refineries and downstream being better and then what’s offsetting that is, you’re correct that the Midstream market is getting softer..
Okay. Thank you. And we will take a question from Ryan Cieslak with Keybanc Capital Markets. Please go ahead..
Hey, good morning guys. David, I want to maybe look at the revenue and the sales question again a little bit way.
The question is sort of you look at maybe the first two months of the year so far, January to February, hard to be thinking how do revenues or sales look relative to the run rate you saw in the fourth quarter? Is there any indication that things maybe are close to the bottom or what are you seeing just from the initial trend so far year-to-date on a topline?.
Specific to IPS..
I was thinking more broadly speaking. But if you want to take it that route, that’s fine..
Well, I would do either one. Whatever you like, I am okay..
Let’s do both, I love that..
Okay. On a broad sense we think that the bad is gone out to do the good and so we think we are going to have further sales decline. We think it’s going to be less than the 16, something we had last year. And of course, all that could change.
I mean, we are - we see to be finding some firming up of oil prices, maybe I don’t know we’re going head up [Technical Difficulty] a while back. So maybe that’s all it’s having in right now, I don’t know. But we do see, some of the effects of cheap oil prices having a more positive effect on the other parts of the industrial sector.
So we see that being positive. But oil prices and rig counts and production are all down and so we are not going to be able to offset that. That said, we think it’s a slighter decline and that - I mean, we can cross our fingers, but we can’t count on it, so we are not planning for this, but we could all be having a different team six months from now.
But that said, we are trying to do things that allow us to take market share and to grow somebody else’s expense and one of those things is that, we use to have a big portion of our pump lines, we had restricted customers, restricted territories.
Now, we have replacements for that, which we think is a better faster pump, and the [indiscernible] we don’t have any customer restrictions, we don’t have any markets that are - that we can’t go to, we don’t have any geographies we can’t go to.
So consequently, we are paying our salesmen a little different to spend a portion of their time growing new accounts and whereas before, they were kind of restricted with our customer base and so therefore they have now started becoming, what we call, farmers.
And as farmers, we sold more product to existing customers, we call it cross-selling and we did that to capture more of each customer’s wallet and that worked for us until those customers, they are just buying last, so they’re buying last, so we don’t have - so really that we still do that, but it’s not helping that much.
What helped better is that we - instead of having just one customer that bought a lot from us, we had two customers that bought a lot from us. So that’s where we’re headed and we don’t have any handcuffs on us anymore.
We also are targeting the downstream market, which isn’t starting to do better, so that’s part of the industrial recession, coming out of that in my opinion, is to look at that and how we capture more of that, how do we look at LNG and we look at some of these other things. So we’re trying to move our salesforce.
We are not firing our salesforce, we are trying to take our salesforce and go out and capture new business and so realize that every one of our farmers, I will call the farmers now, they all started out as hunters, then they tended to develop an account base and then they kind of just started cultivating. So we are having a transition as a company.
We have ecommerce things going on to make it ease of doing business, where we have more opportunities to do national advertising that makes sense now, whereas before, it didn't. So, but unfortunately, we’re not - we’re having to be pretty thrifty with our money too.
So we’re trying to have a nice balance of operational efficiencies and supporting salesmen and new accounts in a way that is kind of artful to do and I've got really, really great regional management that really know how to run $100 million businesses and they’re doing really a great, great job.
But that said, we have to continually look at our expense load and look at cash flow and make sure we’re going to live up to whatever the world gives us, because at the end of the day, we can have great sales strategies, but still it just only produces so much, so the number we manage of are the sales and I think we’re doing a pretty good job of managing margins, except for the IPS segment, which is having, it has a little more fixed costs in it, so therefore it has some throughput margin pressures.
It has some - we’re trying to get an $8 million job and so when times are real good, we might get those jobs at 30% gross margins and now we only get 18, but we still want them at 18. So there is pressures there. I think the fourth quarter IPS results are not indicative of what they can do.
There was just a lot of stuff in there that just kind of all boiled up in there that particular quarter, but the 52 million that they did is, it was really not that bad. What was bad was that we’re used to making 16% EBITDA margins. So, and they didn't, they made something considerably less than that. So we will fix that.
They won’t do 16, but they should be able to do 8 or 9 or 10. So we’ll fix that, we’ll fix that. Now, the sales might go to 45 too, but still we’ll get 8, 9 or 10 out of 45, so whatever. So anyway, that’s kind of both answer..
That's good color. And I appreciate it.
So I mean, David, if I hear you right, this is a year where post the supplier transition, your guys clearly feel like you have some additional flexibility to go out there and really accelerate the share gains, is that a fair statement?.
I think it's fair that we can do that and I think it's fair that we still have a lot of flexibility in our cost structure..
Okay. And then I know it's getting a little bit long here on the call, but just the other question I had, when you look at and you made some color around the IPS margins going forward, and Mac, you called out the 1.7 million of unabsorbed cost.
How do we think about the trajectory of margins, maybe near-term into the first quarter or even the second quarter with what those unabsorbed cost, is that something that gradually goes away or gets absorbed, some color around that might be helpful?.
The ancillary portion, which is what I called out, explained, the forecast is that as we continue to ramp up production, essentially catch-up with demand, that those unabsorbed overhead will go away.
And in general the castings portion is, the forecast is by the end of the first quarter, they’re going to be breaking even and by the end of the second quarter, the PumpWorks business should be breaking even. We’re treating these as cost centers. The sales are out, are done and the service centers are in other places.
But the manufacturing facility is a cost center, and right now, the volume didn't absorb all the overhead because they’re still in the start-up process.
So those are pluses that overhead will go away now and some of the other fabrication locations, because sales are down, there is bound to be some unabsorbed overhead and some of that overhead can be done away with, some of it’s the ramp on the building and it's going to stay there. But as business gets better, we will absorb that overhead..
Joe Mondillo with Sidoti & Company, your line is open..
So I just wanted to dive a little bit more into what you're doing with the cost side of the business, the corporate expenses were pretty much flat for 2015, and I know there are some one-time items that you sort of said won’t re-occur, but how are you positioning or managing the cost structure of the business specifically, and do you have contingencies in place, if oil falls down to $20, for instance, how are you thinking about 2016, if things turn the wrong way?.
I think beside the fact that IPS has a capacity of fabrication and we can't, we’re going to maximize profitability when we’re maximizing that capacity and so now, we probably are - well, we’re over - we have overcapacity that there is some fixed cost there.
So I think again, the EBITDA margins are going to go from 16 to something, but the point I’m trying to make is that there is still a lot of variables expense. So we’re going to be doing what's necessary to try to drive those people to have operating margins of 10%, and that's SES or service centers and IPS.
So I think, IPS has the hardest job ahead of them, and I think, but I just - it’s just done. Unfortunately, we are a people business and besides cost of goods sold, well even in cost of goods sold, we have people that make up a good portion of that. So you just have to make tough decisions..
So I understand the service center, it's obviously, a lot of the cost is labor there, but on the IPS side, like you said, there is a lot of fixed cost, that was a big percent and the upturn of the cycle, and now, we’re in a severe downturn and there is a lot of supply of oil out there, who knows oil could remain at 30 for several years, at what point in time, do you say, okay, this has already been two years, what if we don't see a recovery in 2016, at what point in time are you thinking about taking a harder look at the capacity?.
Yeah. Joe, that's a great question and by the way, let me tell you how easy it is. We don't own buildings, we don't own shops. So we can get rid of them. Unfortunately or fortunately, I guess fortunately, we give up a little bit, but what we give up is that we have a shop in Canada, people in Canada like to do business with people in Canada.
We have a shop in Denver, because Denver people up in that market like to do business with those people up there and we have a shop in - multiple shops in Houston. So we look at consolidating some of those things, that’s a little easier to do quite frankly, being given up some geography.
But all of this capital equipment will travel, it's not necessary. Inspectors have to get on an airplane and come to town to expect stuff, but all fabrication will travel and we should stuff overseas all the time.
And yet at the same time, we have partners in Saudi Arabia, where we use them as our fabrication arm and we use our intellectual properties to sell the job and to engineer the job and they’re just pure fabrication shops. So we have levers, I want to make sure that we understand that we have levers of things we can do to take cost out..
Okay, but we are not at the point yet, it doesn't seem like you’re too overly concerned where you are starting to look at contingency plans of doing that?.
We’re at the point of where we’re going to tighten our belt a little bit, but not to the point of where we start positioning ourselves where we don't have a full recovery, when it all comes back..
Okay. And then just lastly, in terms of the working capital, I know you addressed this, but is there any additional opportunities of bringing down working capital other than just your revenue is down, so your receivables and inventory would come down with that.
Is there any other opportunities with the working capital or is it pretty much straight forward?.
I mean, we can always do a better job managing inventories and collecting receivables, but I’m not aware of anything dramatic. History tells me that inventory - the inventory decline doesn't happen as fast as the receivables decline. And so the inventory decline should somewhat continue..
But let's be realistic, I think we look at our inventory, it turns seven or eight items, we’re not a Fastenal or MRC where their inventory turns two or three times, our inventory turns seven or eight times, so I can almost disagree with Mac in his statement.
I think we do a pretty good job of collecting receivables and a darn good job of managing our inventory. So, but we have computer systems that take our inventory and when times are good, they have a 60, 90 day safety stocking and when times are bad, the banks are declining, well, we don't have any safety stock.
So we can adjust our inventory levels pretty quickly to the extent that people are still buying something, not something just goes off the radar screen and they start buying it, nobody is buying it and we end up having inventory reserves and we throw it away, but I feel pretty strong about our ability to generate.
We’re generating cash flow in excess of EBITDA, so that's pretty awesome..
Right. Okay.
I was just trying to get an idea of - because, you are right, your working capital was a huge source of cash in 2015, so just trying to get an idea of what you're seeing for opportunities there? I just have one last question though, regarding about a year ago, you gave a pretty good picture of how much oil and gas, and you broke it out between upstream and midstream and such as a percent of the company.
2015 was a huge downturn, though, so just wondering if you have any idea if you’ve updated that, where your oil and gas in terms of upstream, midstream as a percent of the total sales pretty much heading into 2016, because obviously it's going to be a lot smaller than what you listed a year ago..
Yes. I'm thinking that our upstream exposure was 20%..
Yeah. But we saw a decline in 2015, so your industrial piece declined slower than the upstream.
So I'm sure upstream is less than 20% now, do you know what your overall oil and gas exposure is going into 2016?.
I have not seen that number in a while, I can get that for you, but you’re right, I believe, I remember it being 20% and then so it should be down some, but if it's down more than to 18%, I’d be surprised. It’s still a pretty sizeable number..
Okay. I'll just follow up with you guys. All right, thank you..
And we’ll take a follow-up question from Matt Duncan with Stephens Inc..
Hey, guys. Just two quick ones. First, on gross margin, Mac, it sounds like you had the under absorption of overhead that hurt that line and you expect that to sort of ride itself by the end of the second quarter.
So should we see gross margins go back towards where they were in the 3Q, kind of by the middle of this year and it also sounds like maybe IPS, there are some things you can do a little bit better there.
So, the 70 basis point drop we saw 3Q to 4Q, can you recoup most of that by the middle of this year?.
I think we haven't really talked about the first quarter.
We saw January down from the fourth quarter and that triggered, we had hoped that that wouldn't happen, but it did, and so that triggered a big movement on our part to get back heavily involved in expenses and so we’re doing that, we’re making very significant strides, but a lot of that isn’t going to show up in the first quarter, it's going to show up in the second quarter.
So I would say that we would, we would kind of take some of the unusual things out, so I think somewhere between the third quarter and the fourth quarter is probably the EBITDA number we’ll have, but again that's based on March being a typical March that’s much better than January..
Okay. So the gross margin gets a little bit better than in the first quarter.
Should gross margin should step up again in the second quarter, back close to where we were in the third quarter of last year, probably about the third quarter of this year, is that a fair step function of what that’s going to look like?.
I think we’re thinking that margins are going to be under pressure and that, but we have things that we’re making higher margins on and some things we’re making less margins on, so I think if we were modelling margins, we would think of them in terms of I believe they were, what were they for the year, 28.3 or something like that..
28.2 for the year and 27.6 in the fourth quarter..
[indiscernible].
Okay, that's fair enough. That makes sense.
And then you kind of got to my other question, which is just the revenue trend that you’ve seen through the fourth quarter into January, it sounds like January kind of stepped down, but if you follow the normal quarter, March ought to be a much better month than January, I would assume relative to the average in the fourth quarter?.
Right..
Matt, you usually ask this question about days sales during the quarter, you haven't asked, so I’ll give it to you. The days sales in the fourth quarter averaged $4,495,000 and the way that worked is October was $4,365,000 a day, November increased a little to $4,471,000 a day and December was $4,653,000 a day.
None of that would make any sense when oil prices were declining during the quarter. So it just shows how our trend typically works, the business gets better as we go through the quarter.
Sales in January where days sales were approximately $4,088,000 a day in January and that works out to be right, a 9% decline from the average for the fourth quarter of 2015..
Right, but then you get the build in February and March in all likelihood like you saw from October, November to December, because that's the sort of the way your typical quarter looked?.
February actually is running about close to 2% below the days sales for the same number of days in January. So they hadn't necessarily seemed to pick up, but that's not unusual, I mean, it’s usually [Technical Difficulty].
That's hard to look at because we still - 20% of our business gets done on the last two days..
That's right. So you just don’t really know..
I’m not too concerned about that yet..
All right, guys. Fair enough, thanks..
And there are no further questions in the queue at this time. I'd like to turn the conference back over to our presenters for any additional or closing comments..
Thank you all very much..
And that does conclude today's conference. Thank you all for your participation..