Kent Yee - SVP & CFO David Little - Chairman, President & CEO.

Ryan Mills - KeyBanc.

Good afternoon. My name is Tim, and I will be your conference operator today. At this time, I would like to welcome everyone to the DXP Enterprises 2018 Second Quarter Conference Call. All lines have been placed on mute to prevent any background noise. After our speakers' remarks, there will be a question-and-answer session.

[Operator Instructions] Thank you. Mr. Kent Yee, Chief Financial Officer, you may begin your call..

Thank you, Tim. This is Kent Yee and welcome to DXP's Q1 2018 conference call to discuss the results of our second quarter ended June 30, 2018. Joining me today is our Chairman and CEO, David Little. Before we get started, I want to remind you that today's call is being webcast and recorded and includes forward-looking statements.

Actual results may differ materially from those contemplated by these forward-looking statements.

A detailed discussion of the many factors that we believe may have a material effect on our business on an ongoing basis are contained in our SEC filings, but DXP assumes no obligation to update that information as a result of new information or future events. During this call, we may present both GAAP and non-GAAP financial measures.

A reconciliation of GAAP to non-GAAP measures is included in our earnings press release. The press release and an accompanying investor presentation are available now on our website at ir.dxpe.com. I will now turn the call over to David to provide his thoughts and a summary of the second quarter..

Thanks, Kent, and thanks to everyone on our 2018 second quarter conference call today. As always, it is privilege to share DXP's results with you on behalf of over 2,577 DX people who work hard every day as one team driving stakeholder success and value creation.

Through the first half of 2018, DXP is off to a great start and I'm extremely proud of the team's performance year-to-date. During our call, I will start off with the summary of my thoughts and Kent will take you through the key financial details. After our prepared comments, we will open it up for Q&A.

Reflecting on where we were at this point in 2017, we have just started to turn the corner from the downturn we experienced in fiscal year 2015 and 2016 and momentum we're starting to build. Today after six quarters of sequential sales increases, we have seen the benefit of our positive attitude, customer service excellence and winning culture.

In terms of the present operating environment, the ISM and PMI manufacturing indexes which gives us an indication of how DXP's broad industrial markets will perform continuously show expanding business strength. Demand remains strong and consistent. The PMI index, which has moved from March reading of 5% -- 59.3% to a rating of 16.2% for June.

The trend continues to be above the average of the last 12 months of 59.1%. This supports the strength we are experiencing and sequential sales growth within our service centers as we experience growth in our broad industrial regions including Southeast, Northeast, North Central and Alaska.

We remain excited to see this momentum on the industrial side of DXP. Additionally, the Metalworking Business Index while all record high continues to show spring with the reading of 57.5%. This is a deceleration from March, which had a reading of 58.9%, but we continue to see sequential growth above GDP within our metal working products division.

In terms of oil and gas, quarterly average oil prices, drilling, DUCs continued to increase. Quarterly average prices from Q2 are up 42% from Q2 of '17 and 8% from the first quarter of 2018. Across our business, we feel well positioned to benefit from this upward moment.

Additionally, DXP’s backlog continues to support these trends and reflects the growth we were experiencing within all three of our business segments. In terms of possible issues or headwinds, we are carefully watching and reviewing tariff developments.

DXP suppliers though are mostly multinational and will mitigate any tariffs best they can so that all of their distributor partners will have reasonable price increases. DHP buys very little product from China and DXP’s private label pump manufacturing operations are 100% made in the USA, which further reduces our exposure to tariffs.

Overall, momentum continues in our business and we are focused on DXP's smart recovery for 2018. We’re focused on growing the top line and bottom line as well as being fast, convenient and customer driven for all of our customers. During the first half of 2018, this has been a focus on driving margin improvement and selling value.

As we move through 2018 and beyond, we will continue to drive improvement and our publicly stated goal of 10% plus EBITDA margins. Turning to our results, total DXP revenues of 311.2 million for the second quarter of 2018 was an 8.9% sequential increase and a 24.1% increase year-over-year.

This reflects the building and growth in our end market as well as the addition of applications specialties company. For the second quarter, ASI contributed 12.4 million in sales are sequentially increased of 16.7% from Q1 for ASI. Adding the acquisition of ASI, total DXP sales increased adjusting -- sorry, adjusting for the acquisition of ASI.

Total DXP sales increased 19.2% year-over-year and 8.5% sequentially. In terms of sales increases by business segment, we continue to see strength in our capital projects, MRO and OEM business. Innovative Pumping Solutions sales increased 67% year-over-year to 74.3 million while Service Center sales increased 17.5% year-over-year to 193.6 million.

In Supply Chain Services, the growth -- but it is great to see -- Supply Chain Services must have grown some amounts. Anyways, we'll skip that part. But it is great to see both sales growth and continued increases in our backlog especially within the IPS business segment.

The Innovative Pumping Solutions increased was primarily driven by pump works made in America products and modular packaged equipment for onshore markets. Sequentially, IPS experienced a 9.8% increase from Q1 of '18 to Q2 of '18 or $6.7 million sales uptick.

We continue to remain encouraged by the improvements in the IPS backlog, which has continued to grow through the first half fiscal 2019. The IPS quarterly average backlog increased 62.8% from Q1 of '17 to Q2 of '18 and 17.1% from Q1 of '18 to Q2 of '18.

The Service Centers sales growth was primarily driven by increases in our rotating equipment and bearing and power transmission product divisions. Within Service Centers, we saw particular strength in DXP's Canadian Safety Services, Southwest and Southeast and Central regions.

DXP's overall gross profit margins for the second quarter were 27.4% a 15 basis points decline versus Q2 of '17. However adjusting for the acquisition of ASI, gross margins were 27.8% or a 31 basis points improvement over Q2 of '17. DXP's gross margins expanded pretty significantly from Q1 and for the first time since Q3 of 2017.

We are showing improvement in our year-over-year comparisons. The improvement in gross margins during the second quarter was primarily driven by an increase in IPS segment. DXP Safety Service business in Canada also experienced significant gross profit margin improvement from Q1 to Q2 expanding 646 basis points.

As we have discussed, this is the seasonally soft season and we expect to see further progress in our efforts during the second half of 2018. SG&A for the second quarter increased $6.4 million versus Q2 of '17 or 10.9% as a percent of sales SG&A decline 251 basis points going from 23.4% in Q2 fiscal '17 to 20.9% in Q2 of '18.

As I mentioned at the start of my comments, DXP has approximately 2,577 full-time employees, SG&A will increase as expected and reflect our investment in our people and organizations as we grow going forward. DXP's overall operating income margin was 6.5% or $20.1 million which includes corporate expense and amortization.

This reflects the 236 basis points improvement in margins over Q2 of '17. That being said, we still have ways to go to full recovery. This quarter we benefited from the leverage we get from SG&A, growth is less than the overall sales growth within the business and gross margin improvement.

IPS operating income margin was 12.1% .Service Center operating income margin was 11.3% and Supply Chain Services operating income margin was 9.8%. IPS operating income margins experienced the greatest increase growing from 3.9% to 12.1%.

Service Centers increased operating income margins by 15 basis points and Supply Chain Services operating income margins increased by 85 basis points primarily driven by decrease in SG&A percentage of sales. Overall DXP produced EBITDA of $28 million versus $16.9 billion in 2017, a year-over-year increase of $11 million or 65%.

EBITDA as a percent of sales was 9% versus 6.8% for Q2 2017. Earnings per diluted share for the second quarter were $0.63 compared to $0.23 per share in the second quarter of 2017, a year-over-year increase of $0.40 per diluted share.

This does not include some one-time items that Kent will discuss in more detail, but after adjusting for these items DXP produced $0.61 per share. In summary, DXP continues its steady march out of the oil and gas downturn and the industrial slide to deliver sequential sales, EBITDA and earnings per share increases of 9%, 56% and a 153% respectively.

DXP has a great team focused on producing great results for our customers, suppliers and shareholders alike. All three business segments perform well during the second quarter. DXP and all of our stakeholders remaining excited about our future and a smart recovery as we now focus on the second half of fiscal 2018.

We will continue to deliver margin expansion while ensuring operational efficiencies, investing in people, tools and automation where appropriate. We will drive change and innovate for growth and lead smarter.

Going forward, we also expect both organic and acquisition opportunities, our second quarter results moves us closer to DXP's past economic performance and after quarters of sequential increases our customers and all our end markets have returned to growth and we look forward to this trend continuing to expand.

I would like to thank our entire team for their hard work, commitment, dedication to our growth strategies and performance goals, and most importantly, our customers that value our ability to be fast, convenient and customer driven. With that, I will now turn this back over to Kent for review of our financials in more detail..

Thank you, David, and thank you to everyone for joining us for our review of our second quarter financial results. Q2 was a strong quarter for DXP and complete the first half of portfolio 2018 on a positive note.

The Q2 2018 financial results reflects continued sales growth and marks our sixth consecutive quarter sequential sales increases or quarterly compounded growth rate of 7%.

The second quarter performance includes one-time items including a gain related to the sale of our corporate headquarters that closed on June 15th and cost associated with the re-pricing of our Term Loan B, which we closed on June 25th.

Adjusting for these items, DXP's performance still remained in line with our key financial metrics and expectations and keeps us on the path to the smart recovery we have been focused on as a DXP team. Total sales for the second quarter increased 24.1% year-over-year to 311.2 million.

Adjusting for the 12.4 million Q2 sales contribution from ASI, organic sales increased 19.2%. Total sales growth for the second quarter was supported across all three business segments. Reflecting the continued expansion we’re seeing from existing and new customers.

Average daily sales for the second quarter were up 22.2% over Q2 2017 over 4.5 million per day Q2 2018 versus 4 million per day in Q2 2017. Adjusting average daily sales for ASI, ADS for Q2 increased 17.3% versus Q2 2017. Average daily sales increased 7.1% sequentially from Q1 of this year.

The overall growth reflects what we are seeing in some of our key end market indicators to the first half of 2018 including the rig count, U.S. oil and gas production, drilling, the Metalworking Business Index, the PMI and the overall average increase in the price of oil.

In terms of business segment, all three experienced sales growth year-over-year with IPS showing the greatest improvement increasing 67% followed by our Service Centers which experience 17.5% growth and Supply Chain Services with 4.6% growth.

Notable businesses within our IPS segment, which experienced year-over-year sales growth include; our configured-to-order, engineered-to-order, remanufacturing businesses and our brand and private label pump offering. In particular, we have seen growth or rebound of projects focused on onshore applications.

Regions within our Service Center segment which experienced meaningful sales growth include the South Central, Southwest, Southeast and Texas Gulf Coast regions. Additionally, we saw meaningful increase within our metalworking product division which is primarily in the Northeast and North Central with a growing presence in the Pacific Northwest.

Turning to our gross margins, gross margins were 27.8%, adjusting for the acquisition of ASI. DXP’s total gross margins for Q2 reflect the progress we’re beginning to see in our engineered-to-order business and our Canadian Safety Services.

As we continue to ramp up sales, gross profit should align with revenue growth as we are able to drive operational effectiveness and absorb -- under-absorb overhead with the production ramps. Sequentially, our IPS segment gross margins experienced a 144 basis point improvement from Q1.

Service Center gross margins increased 74 basis points adjusting for the acquisition of ASI. Supply Chain Services gross margins declined 60 basis points from Q1. In terms of potential headwinds to gross margins as David mentioned in his earlier comments, tariffs are being discussed with our customers and suppliers.

That said, we have not seen tariffs impact customer demand. We’re beginning to see costs pass-through from suppliers in the form of absolute price increases and-or as surcharges. The price increases are fine as DXP simply passes those on to customers.

Surcharges are a little more involved and signal the volatility in the nature of the discussions around trade. However, DXP believes it is still way too early to predict any longer term implications that feels more than comfortable that it can move to the obstacles equal to or better than our peers.

In terms of operating income combined all three business segments improved by 176 basis points in year-over-year business segment operating income margins versus Q2 2017. Total DXP operating income increased 95.6% versus Q2 2017 to 20.1 million.

IPS had the greatest uptake improving operating income margins 811 basis points to 8.9 million operating income followed by Service Centers, which had a 15 basis point improvement to 21.9 million. Supply Chain Services increased 85 basis points year-over-year driven by a decrease in segment SG&A.

Turning to EBITDA, second quarter 2018 EBITDA was $28 million up 65% from Q2 of 2017. This does include a $1.3 million gain associated with selling and corporate headquarters. Our EBITDA margin expanded 274 basis points from Q1, 2018.

Year-over-year EBITDA margins increased to 223 basis points primarily reflecting the SG&A leverage we experienced as we grow sales, sales growth of 24.4% with only 11% SG&A growth on a year-over-year basis. During Q2, this translating into 2.7 times operating leverage.

As we move through the cycle, we should experience continued operating leverage as long as we continue to drive organic growth and steady improvement in gross margins. In terms of our EPS, our Q2 net income was $11.6 million. This is up $7.4 million or 179.6% versus Q2 of 2017. Our earnings per diluted share for the second quarter was $0.63.

However our diluted EPS includes a few notable one-time items including the sale of our corporate headquarters that closed on June 15, which resulted in a one-time gain of $1.3 million or $0.06 per diluted share impact.

Additionally, we incurred approximately $916,000 of transaction cost associated with the Term Loan B re-pricing on June 25, which had a $0.04 per diluted share of impact. Adjusting for these items, DXP's Q2 diluted EPS was $0.61 per share versus $0.63 per share.

Turning to the balance sheet, in terms of working capital, we are comfortable with where the numbers came out. During the growth of rebound stage, we are focused on providing the capital to support our business in particularly for our capital deposit related businesses within IPS.

Working capital as a percentage of last 12 months sales for the second quarter was 18.7%. This is above our historical average, but remains within our targeted range and reflects investments as I just mentioned.

The main driver of the increase in working capital on a percentage of sales was cost and estimated profits and excessive billings and accounts receivable during Q2. Cost and estimated profits has increased $11 million from Q4 and receivables are up $17.1 million from Q1. In terms of cash, we had $2.9 million from the balance sheet at June 30.

In terms of CapEx, CapEx in the second quarter was $4.7 million or 1.5% of second quarter sales. Compared to the same period in 2017, CapEx dollars are up $4.2 million.

The increase reflects investments made within our IPS business segment including two additional CNC machines, the purchase of patterns for our manufacturing business and some smaller items including forklifts and cranes. Additionally, within our servicing segment, we have 4 facilities relocate to better serve local markets.

As we highlighted in Q1, DXP is also making investments in software to enhance our sales efforts in our corporate operations. Turning to free cash flow in the near term capital intensity of our business remains elevated as we invest in growth, which can be seen in lower operating and free cash flow generation.

For Q2 and the six months ended June 30th, we used $6.2 million and $6.9 million in operating cash flow respectively. Our free cash flow for the second quarter was a negative $10.9 million adjusting for the $21.7 million reclassification of outstanding checks, adjusted free cash flow would have been $10.8 million.

That said, we did make investments in our business and we supporting our growth as evidenced by the increase in CapEx and operating working capital. Return on invested capital or ROIC increased 140 basis points from Q1 to 18.6% and continues to improve as we drive margins in operating leverage.

In terms of our capital structure, as we have discussed, we successfully re-priced our Term Loan B reducing our borrowing cost by 75 basis points to LIBOR plus 475 versus LIBOR plus 550. This is expected to generate annual interest expense savings of approximately $1.9 million.

We have two main covenants including the fixed charge coverage and a secured leverage ratio. On June 30th, our fixed charge coverage ratio was 3.321 and our secured leverage ratio was 3.221. Total debt outstanding at June 30th was $250.4 million.

In conclusion, we are pleased with our ability to have six sequential quarter sales increases, EBITDA growth with room for improvement and meaningful diluted EPS growth. Now, I will turn the call for questions..

[Operator Instructions] Your first question comes from line of Steve Barger with KeyBanc Capital Markets. Your line is open..

This is Ryan on for Steve. Just start off with the obvious one that comes first.

Can you give the organic daily sales rate by month, and in regard to 3Q, what you saw in July?.

Yes, absolutely, average daily sales kind of going to the quarter kind of are as follows; for April is $4.6 million, for May $4.8 million, and then for June $5.2 million, and for July based upon a sales flash $4.7 million..

Okay and then really strong performance in IPS this quarter.

So I was just wondering, was there any one-time items impacting that whether just a huge amount of project deliveries or what kind of driving that performance?.

We use percentage completion, so we don't kind of smooth out any one job affecting us that big of amount, and there really wasn't any.

Our backlog continues to grow our throughput through our shops continues to grow and of course as our utilization rate goes up, so this back overhead applied and things that helped us to make more money on each job starts happening. So, we're just recovering nicely and look forward to continuing growth..

Yes, Ryan, just one think I'd to add -- the only thing I'd add to David's comments there just to kind of put some numbers on that because I know we typically talk about it. It is our IPS quarterly average backlog year-over-year is up 62.8% and sequentially up 17%. So I think last quarter was -- we reported similar numbers.

And so it just continues to grow, just to support what David just said, so..

Okay. And then gross margins has been big focus for you guys and it sounds like you potentially have more room for improvement, just and in regard to 3Q, historically gross margins are down about 20 basis points from 2Q.

Do you think the tools that you have implemented and maybe some benefits from mix, you think you could maybe outperform that, that historical average and potentially see flat to improving gross margin sequentially in 3Q?.

We do have a focus on that and thanks for noticing.

We -- I would say that we're comfortable with the flat -- we would be comfortable with increases, if it wasn't for the fact that, we're kind of having a series of price increases from inflation and price increases from tariffs a little bit and it’s not been a problem, they’ve all been real manageable.

But there’s kind of a timing of an event, they kind of hit us immediately and then we pass them on weeks and even months later. So, I think we have a little bit of headwind with that. It’s ultimately a good thing. Our inventory goes up. The value of it goes up and an increase, sales go up from an inflation point of view.

So, it’s really good for distribution, but -- and getting margins up, my goal is to give them to 30%, but it’s going to take us a while and get there. So not getting too aggressive for the third quarter, LACT's okay maybe up a little bit..

Okay and then just two more for me.

Just curious to hear, what you’re hearing from customers in the Permian and regarding takeaway capacity constraints? Did they see that impact and completion activity at all in that basin?.

So first of all I think you need to understand them -- I get that you may want to use this for other companies and things. But the magnitude our backlog for the Permian Basin is less than 4% of our total backlog. So, it’s not a particularly gigantic number for us. We have seen that backlog slip a little bit over the last few months.

Our total backlog is going up, but specific to what you’re asking about, I guess, in the Permian Basin, it’s declining a little bit. That said, it’s still substantially over what it used to be a year ago. And so, we’re not thinking the people are moving out or going to other basins and things like that.

We do see a good deal of activity there and we’re happy to serve it now. We add as you know, we make large pumps that go on pipelines and gas pipelines and oil pipelines. So, to the extent that we fix some of these problems we’re quoting a lot of large, large jobs. So ultimately all of that will help us.

But do we have a temporary decline? I’m going to have to agree with that a little bit..

And then my last one, EBITDA margins came and a little bit above 9% this quarter. And Dave I’m just thinking if demand trends hold you start to see some more pricing.

Do you think that 10% margin goal, you’ve been talking about is maybe achievable in the back half?.

Well, we’ve achieved it before. And so, it’s definitely achievable. We’re -- if we take -- first of all part of that 9% did have a gain on the sale of a corporate building. We’re consolidating into another building, which is a good economic move for us. And so, it’ll have benefits going forward.

But we did have a 1.3 or 4 gain on that, so when you back that out, we really like it 8.5 or so and is definitely our goals to get that up. I think when we think about that though, it's kind of a combination of revenue growing and expenses not going as fast. So, we get percent of sales there that this is favorable.

And then the others just gross profit margins. And as we grow from being in a buyers' market to a little bit more of a sellers' market, it takes a while to adjust our people attitude about that.

But we should see incremental gross profit margin improvement, but it's, not forgot when we say the force kind of like 20 to 25 basis points a quarter kind a deal. So if we do that and then sales are flat to come down a little bit based on revenues then it will take multiple quarters to get there..

And there are no further questions at this time. This concludes DXP Enterprise 2018 second quarter conference call. You may now disconnect..