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DXP Enterprises, Inc.(NASDAQ:DXPE)

Investor Conference Call

December 10, 2013 8:00 AM ET

Executives

Kent Yee – SVP, Corporate Development

David R. Little – Chairman, President and CEO

Mac McConnell – SVP - Finance, CFO and Secretary

Analysts

Matt Duncan – Stephens Inc.

Joe Mondillo – Sidoti & Company

Daniel Cole – Manulife Asset Management

Holden Lewis – BB&T Capital Markets

Operator

Good day, ladies and gentlemen. Thank you for standing by. Welcome to the DXP Enterprises, Inc. Investor Conference Call. During today’s presentation all parties are in a listen-only mode. Following the presentation the conference will be open for questions. (Operator Instructions) I would now like to turn the conference over to Kent Yee, Senior Vice President of Corporate Development. Please go ahead, sir.

Kent Yee

Thank you. Good morning everyone. Thank you for joining us regarding our public announcement regarding the purchase of B27. The purpose of this call is to review the transaction, the strategic rationale, and then provide an opportunity for our analyst to answer any questions.

David Little, Chairman and CEO will provide his comments regarding the purchase of B27 and the strategic implications but before that I will provide comments regarding the transaction and a brief overview of B27.

After the market closed yesterday, we announced the purchase of B27. We signed a definitive agreement on December 9, 2013. The transaction is subject to Hart-Scott-Rodino and other customary closing conditions and is expected to close in the first quarter of 2014. The transaction was structured as a purchase of stock for approximately 285 million or 8.1x 2013 expected EBITDA of 35 million. The purchase price of 8.1x is higher than our customary 3x to 5x due to the size, margins, growth rate and return profile of B27. The transaction is expected to be accretive to earnings in 2014, and a note that this does not factor any revenue synergies.

A brief overview of B27. B27 is a leading global supplier of pump and integrated flow control solutions with the focus on the oil and gas, power generation, air quality and other industrial markets. Similar to DXP, B27 has five major offerings. Integrated flow solutions which is similar to DXP's innovative pumping solutions offers modular pump integrated packages. It also offers pump distribution which is similar to our service center, or our branch based distribution business.

Additionally B27 offers remanufactured pumps, branded pump manufacturing and service repair and parts. This provides a summary overview of B27 and now I’ll turn the call over to David Little to provide a brief strategic rationale of the transaction and overview of B27.

David R. Little

Thanks Kent. I would like to review our growth strategy for DXP first. When we look at organic growth, our top priorities are to build super centers, sales force expansion, new markets and geography, and product line expansion. B27 certainly gives us the new markets. They have a sales office in Dubai and a facility - something in Nigeria, and they've been selling in the international markets in a much bigger way than DXP has in the past. They also give us some product line expansions, not so much in terms of products that we already distribute for, but for products that they actually manufacture.

Some of the manufactured products are positioned in our industry by the manufacturer selling direct and so we haven’t been able to sell those types of products because we don’t actually manufacture them. This is much like our HP-plus line where [inaudible] and the Woods Group, et cetera wouldn’t give us access to a horizontal product that we needed to take care of our customer, so we went about manufacturing it ourselves and B27 is really just taking this to a new level along some API products.

Yet at the same time, this manufacturing process is really an extension of what DXP already does in remanufacturing API products from a used core body, we haven’t made the casings and et cetera though we have made all the internal parts and create a remanufactured API product that we sell to our customers that need a shorter delivery time. Both B27 and DXP both do these processes. An extension of that is then merely to make a new core body and have the machinery necessary to do such and they've done that very, very successfully and we are proud to get into that part of the business. It helps us control our own destiny in a greater way.

And then certainly another growth strategy is acquisitions, certainly B27 is a large acquisition for us, and it’s not something that we're totally unused to, we’ve done a large acquisition before, this one is even easier in the sense that I've known their top management team for probably over 15 years to 20 years and they are really a great management team along with building a really fine company and so we are - again we’re really pleased with this acquisition not only because of the scale that it gives us but because of the expertise and the people that they have.

When you look at scale, this puts DXP as a rotating pump company or rotating equipment company up in the $700 million range, which is certainly far larger than any other distributor that I know of, and certainly also larger than those of other manufacturers they represent. I also think the acquisition continues to make possible our theme of being customer driven experts in MROP solutions, being a one-stop source for the customer for technical rotating equipment and their service needs. And we think this creates long-term shareholder value.

When we break down B27, there is very similar parts. They are in the parts business; we are in the part business. They're in the pump business; we are in the pump business. They do service and repair; we do service and repair. Their IFS or integrated flow solutions is very similar to our IPS with the exception that the modular systems that they’re really noticed for are air quality systems, and so that really broadens our product offerings in a way that servicing the same customer base, servicing them on a international basis, but it’s just a slightly different need. And so we look forward to the expansion of our Innovative Pumping Solutions offering.

When we look at being a distributor, they are a distributor. We look at the remanufacturing piece, we are going to be a dominant player in that industry. We are basically the only two companies that do this in a significant way. When we look at extending that remanufacturing into manufacturing we feel really, really good about what that offers us and our abilities to service the customers the way we want to service them.

So it’s - in our opinion it’s really a great fit. We appreciate the fact that you can tell from the numbers that they are a value company, they don't sell on price, they sell on providing a great service, and they believe and get paid for it.

I think when we think about the deal we certainly want to make this point, we don’t think of this is as a way of cutting costs in any particular way; we look at the synergisms coming from the marketing channel and our service and our salesmen and the relationships we have. So we see B27 [inaudible] products like Goulds, Viking in the territories that we represent and given them a little more to sell to the customers and the relationships they have and then vice-versa DXP being able to sell the API product, DXP being able the sell their Innovative Flow Solutions, integrated flow solutions modular systems and so we see the real synergisms of this deal coming from a revenue enhancement.

When we bought [inaudible] that long ago seems like we bought PMI which is a remanufacturing company and when we bought it they were doing $3 million in sales and now they do $15 million to $20 million through our marketing channel. So we’re really pleased with the fact that this isn't a cost-cutting move; this is a revenue and market share move to really gain market share. Again, I can’t say enough about their management team have years and years of experience, international experience and domestic experience and certainly they’re rotating equipment experts.

I think I covered most of the points. We’re very excited about this. This is a people business, and they’ve got great people. It’s really a great fit, and yet at the same time it does what we want to do in terms of growing organically and through acquisitions, it expands our market reach, and we look forward to this being very, very successful, I think both teams are extremely excited about the deal. And I think besides how we paid for it, any [inaudible] thing [ph] like that from a financial point of view, we will just open that up for questions and we are ready for questions.

Question-and-Answer Session

Operator

Ladies and gentlemen we’ll now begin the question-and-answer session (Operator Instructions) Our first question comes from the line of Matt Duncan with Stephens. Please go ahead.

Matt Duncan – Stephens Inc.

Good morning, guys. Congrats on a great acquisition.

David R. Little

Thank you, Matt.

Matt Duncan – Stephens Inc.

First question I've got is on EPS accretion. I guess I saw on the slides you guys expect this to be $0.50 to $0.55 accretive to 2014, is that correct?

David R. Little

Yeah, yes, yes.

Matt Duncan – Stephens Inc.

David, is that based on a January 1 closing? Just want to make sure that I understand the whole timeframe. You guys expect this to close January 1.

Kent Yee

You know it is - Matt, this is Kent, it is subject to Hart-Scott, and so from what we’re hearing today the timing it should hopefully coincide with the first of the year. But we are not assured of that 100% and so but that’s what we’re hoping for.

Matt Duncan – Stephens Inc.

Okay, Kent, can you maybe go through some of the math on where you’re getting the accretion range from? It looks like they’re expecting around $35 million in EBITDA this year. I'm assuming you guys expect that to grow. Can you just walk me kind of real quickly where the range comes from?

Mac McConnell

Matt this is Mac McConnell.

Matt Duncan – Stephens Inc.

Hi Mac.

Mac McConnell

Our math just started with the $35 million EBITDA number backed out approximately $1.3 million in transaction expenses. Deducted – then the interest expense, and one of the key factors in the interest is - our leverage ratio will increase from this transaction, so that raises our interest rate and it raises the interest rate of all of our debt and…

Matt Duncan – Stephens Inc.

Mac, [inaudible] that resulted in it looks like interest expense because of the deal is around $11.5 million factoring in the borrowing, $11 million or so, maybe $11.5 million, borrowing under your new debt agreement plus the increase in rate on your existing debt. Is that in the ballpark?

Mac McConnell

I guess that, I came up with $10 million or $11 million of increase in interest expense.

Matt Duncan – Stephens Inc.

Okay. Okay. And then how much of the purchase price is going to intangibles here? Because I know that's a big swing factor.

Mac McConnell

We’re still estimating, we have talked to that firm that is now working on calculating the estimate of intangibles and the amortization and they have given us, they’ve already done some preliminary work but they haven’t finished, and they’ve given us the range of $60 million of intangibles to $70 million of intangibles with a [10 year of] [ph] life.

Matt Duncan – Stephens Inc.

Okay. That's all very helpful. I appreciate that. I want to talk David maybe a little more about the strategic rationale here. It sounds like you are picking up some pump manufacturing capabilities which I find interesting. How do you see that helping you guys; how quickly can that be a big contributor to DXP?

David R. Little

Well it’s a big contributor immediately. They’ve been doing this for a while, this is not new to them and so and then we ask them what their capacity is and so I think without investing a whole lot of money, I think they feel pretty strong about being able to double their capacity, so that was the first question out of DXP people’s question box was how much capacity can you withstand coming from DXP, without lead times being extended. They believe in where their strategy is – an API product by definition is a standard product.

So the question and the differentiator that they used to their benefit is time, and so from the time they get an order until they can get it shipped and working in the field is typically going to be shorter than what the OEMs have produced in the past. And that time is consistent also as to why we are successful with our remanufactured pumps and so we know that that can be meaningful, it’s not always meaningful, if somebody has got a project, it is a two year project and they have got plenty of lead time et cetera and they want a Flowserve or Goulds or [Stahl] [ph] or something, then they are probably not going to look to us because of our limited brand in their eyes. But if they are looking for something quick then we can respond quick.

Matt Duncan – Stephens Inc.

David, looking at the growth trajectory of this business, it looks like it was up substantially last year, it is up substantially again this year – what is the outlook here? What's the backlog growth been like for these guys? And it sounds like your accretion analysis is based off of basically this year’s EBITDA repeating. So it sounds like this business is growing, and maybe that's been on the conservative side. So what's the growth trajectory look like from here for these guys do you think?

David R. Little

Well I think we would be disappointed if we didn’t have minimum of 10% organic growth and I say that because that is what I told them. So and we will have [base] [ph] schemes around that. So - and how much more can DXP add to that, well, we think it’s a lot but well I don’t think we are - we’re not used to giving forward looking forecast. So I’ll just leave it at that.

Matt Duncan – Stephens Inc.

Maybe David, does their backlog growth sync up with your expectation of that 10% growth or more? Are they seeing good backlog growth like you have in this pump package business?

David R. Little

Yes.

Matt Duncan – Stephens Inc.

Okay. All right, that's it for me. I will hop back in queue. Thanks, guys and congratulations.

David R. Little

Yeah, Matt, just I’m going to go ahead and answer that question as you get off. One of the things that I will point out is that they are seeing a lot of mid market oil and gas business and they’re continuing to see that growth and that growth is showing up in their API product that they’re making and it’s showing up in their IFS packaging business that they’re making.

So both of those areas are growing substantially and then we have some – they have some strategies to grow internationally, and so those could pan out to be pretty large projects also, so I have all the confidence in the world that they will in fact grow their business.

Matt Duncan –Stephens Inc.

Okay, thanks. I will hop back in queue.

Operator

Our next question comes from the line of Joe Mondillo with Sidoti & Company. Please go ahead.

Joe Mondillo – Sidoti & Company

Hi good morning guys.

David R. Little

Hi Joe.

Joe Mondillo – Sidoti & Company

Just wondering first off, what's the D&A of the business?

Mac McConnell

Around $3 million.

Joe Mondillo – Sidoti & Company

Okay. And then so I just want to be a little more clear in terms of the actual business and how it compares to the existing DXP. It sounds like they’re very similar type businesses, but can you give us an idea of how much of B27 is sort of related to the service center business and how much is more related to IPS? How are those going to be sort of reported in the two segments?

David R. Little

Right. That’s a really good question Joe and the part that, I guess I would answer this a little different answer then Kent [Unclear] answer it, in my opinion. Most of the API type business will be package related, it will be large jobs with [Inaudible] et cetera, so technically that moves to the IPS piece of the business.

All of the IFS piece of their business will be in the IPS type business, and then the distribution, parts, service work et cetera will all fall in the service center sector. And so if we look at the numbers that way, of course I think we are…

Kent Yee

Yeah, for 2012 Joe if you look at it that way it’s 86% of their business is IPS related, 14% would then be - for 2012 would then be service center business for 2012.

Joe Mondillo – Sidoti & Company

Okay, and just to be clear, API and IFS stands for what?

David R. Little

Well, API best…

Joe Mondillo – Sidoti & Company

Or what is it?

David R. Little

Their brand is best pump…

…[inaudible] and the API is just an American Petroleum Institute.

Joe Mondillo – Sidoti & Company

Okay.

David R. Little

And so that’s just the term used in the industry.

Joe Mondillo – Sidoti & Company

Okay.

David R. Little

A particular type of pump, and IFS stands for Integrated Flow Solutions, which is just a made up name, just like our Innovative Pumping Solution, that just their name versus our name and but they call it Integrated Flow Solutions, what that is is modular - a modular system put together.

Joe Mondillo – Sidoti & Company

Okay, great. And then so in terms of the drivers of this business, can you just give us a little more color on what's the main I guess end markets that's driving overall B27?

David R. Little

Certainly, their markets - they are in the oil and gas industry, they are in the power industry, they are in air quality which is really sort of the oil and gas market really and the part of the market in the oil and gas that’s really booming, it continues to be sort of the mid-stream, it’s the infrastructure of moving the product, we’ve punched a whole lot of holes in the ground, so we are looking at how do we move that product efficiently versus trucking it all around, but they play in upstream, midstream, downstream, being refineries and petrochemical et cetera, power generation and air products.

Joe Mondillo – Sidoti & Company

Okay. So you didn't really compete with these guys, but this is sort of complementary to your product portfolio. Is that correct?

David R. Little

No, we do compete with them, but I think we probably apply the 80:20 rule and 80% of the time we are not, and 20% of the time we are.

Joe Mondillo – Sidoti & Company

Okay. And has this been sort of on your radar for a while? I mean I know they are based in Houston, so I'm sure you're very familiar with the Company. And how long has this been sort of in the works?

David R. Little

That’s an interesting question. We looked at this company about 15 years ago, they were being – they were owned by the Best family and we ended up not doing anything with them at that particular time. Then later they came up for sale and they were purchased by Champagne and that was - they were just, at that point, they were willing to pay more for the company than I was and I wish I has bought them because I know they bought them for about $40 million back then.

So, yes, the answer to your question is yes, I have known about them for a long, long time. They are really good people. I have lunch with them every once a year kind of deal just to stay in touch and when they have been a competitor, they’ve been a very good one and what I mean by that is they are not price cutters, and so we are just really happy with the opportunity to do the deal this time. The management team really wanted to team up with DXP, they saw the synergisms and the things and the style that we used to run our companies and so they were pretty influential in trying to make sure we got this deal.

Joe Mondillo – Sidoti & Company

So it sounds like it’s a really good fit and there's a lot of overlap. What's sort of the footprint of B27's facilities and operations? There's no – is there a possibly down the line any synergies related to consolidating facilities or such?

Kent Yee

They are located primarily in Houston, Texas; Louisiana kind of Shreveport to Geismar area, they have a sales office in Dubai, and they have a location in Oklahoma, there is not necessarily a lot of overlap geographically in terms of those physical locations, with our locations, and their facilities are really different than what we do; once again they are IPS related, so they are not kind of our if you will branch-based distribution.

Joe Mondillo – Sidoti & Company

Okay.

David R. Little

The facilities they have at Houston and up in Tyler are our much needed capacity expansions and so we will not be combining [inaudible].

Joe Mondillo – Sidoti & Company

Okay. And then just lastly, any risks that you possibly see in terms of the actual closing of this acquisition? In terms of antitrust or anything like that?

Kent Yee

No, we don’t see any risk at all.

Joe Mondillo – Sidoti & Company

Okay.

Mac McConnell

[We are doing the government’s work] [ph] there aren’t any reason why there should be.

Joe Mondillo – Sidoti & Company

Right, okay. Good enough. Thanks a lot guys.

Mac McConnell

Thank you.

Operator

Our next question comes from the line of Daniel Cole with Manulife Asset Management. Please go ahead.

Daniel Cole – Manulife Asset Management

Hey, David, Mac how are you guys?

Mac McConnell

Good.

David R. Little

Good.

Daniel Cole – Manulife Asset Management

Good. You mentioned that their IFS is modular and service-oriented the same way as your IPS operations are, and then you just talked little bit about the facilities. But given that they have it sounds like similar processes and values, the question is were you going to integrate them into your IPS operations or do they have different processes and values and you’re going to keep them as a separate stand-alone operation?

David R. Little

Yes, I’ll answer that. When we look at IPS today, we have a very strong presence in facilities and capabilities at Houston. When - and then from there we go to Denver and then we have facility in NatPro in Calgary, we have a little lesser but a nice facility down in New Orleans and then we have another facility in Snyder, so Texas.

And when you look at IFS, they have a really huge centralized facility at Tyler, that has all the capabilities from sand blasting, to painting, to engineering, to drawings et cetera, and they are also, they are making - their expertise where ours is typically fire water pumps and chemical injection and some of the products along those lines, theirs is more like, they can do those products, they absolutely have the ability to do those products. But I think that if IFS was to get one of those types of products they probably have it made in Houston and if we were to get more of, some of their air quality type products et cetera, we would have that done in Tyler so.

So if you look at that, but it doesn’t make sense because you got all these, you got these engineers, you got CAD/CAM drawings, 3D type drawings, you got capabilities, you’ve got land, you got space, capacity, you’ve got workforces actually probably, Tyler has probably a really good labor force, IFS is probably one of the larger employers in Tyler whereas we are certainly not bad in Houston, Texas. So there is just any - they hadn’t any reason to integrate.

Daniel Cole – Manulife Asset Management

Got it, great, fantastic, thank you.

Operator

Our next question comes from the line of Holden Lewis with BB&T Capital Markets. Please go ahead.

Holden Lewis – BB&T Capital Markets

Great. Thank you. Good morning, guys. Good afternoon, I guess.

David R. Little

Tell us what country you are in?

Holden Lewis – BB&T Capital Markets

Well, talk to us about the cross-selling opportunities. Obvious it sounds like they bring geography in terms of International as well [inaudible] and different types of products. How do you plan on sort of incenting or encouraging the cross-selling to occur? I mean obviously sales people get comfortable in their habits, that sort of thing, and oftentimes it takes some sort of incentivization to really get them to take something brand-new and sort of put it into the market. But can you just talk about what you might do to try to foster the cross-selling that seems to be part of the appeal of the deal?

David R. Little

Yes, you may not like this answer, but it’s a philosophy that’s really served me well over the years, and so I just believe in paying double, and what I mean by that is that I don’t want there to be a lack of teamwork, and anytime you take and try to split commissions or split profits or anything like that, you create division and you create people trying to do things on their own et cetera.

So what’s really worked for me in the past, and I will use here in this particular example, is to give everybody credit and so that there is not a reason for people not to work with each other. There will be times when we are going to be competing on the same job and so that’s a little different, we’ll just compete and David Little will win and one of the salesman will lose, and so I’m okay with that.

But at times also there will be times when we need B27 to help us close the loop and help sell something that we have a salesman also working on and I just believe in teamwork and paying both people for the results. Our selling expense is never, if it’s 3% of sales then and I pay 6% of sales but that’s still not anywhere that keeps us from being profitable.

Holden Lewis – BB&T Capital Markets

Okay. And just I might have missed it I am on a traveling cell, but did you state that you expected the fiscal or the calendar 2014 accretion to be $0.50 to $0.55?

Kent Yee

Yes, that’s correct.

Holden Lewis – BB&T Capital Markets

Again and that assumes that it is acquired on January 1?

Kent Yee

Yes, that assumes a full year.

Holden Lewis – BB&T Capital Markets

Okay. And does it assume the sort of 10% revenue growth, or is that just based on assuming it stays at $235 million in EBITDA?

Mac McConnell

That was the 35 million of EBITDA.

Holden Lewis – BB&T Capital Markets

Okay, so it’s $0.50 to $0.55 for 2014, assuming that financially it does not grow at all?

Mac McConnell

Right, yes.

Holden Lewis – BB&T Capital Markets

Okay, great. Thank you.

David R. Little

Thank you, Holden.

Operator

(Operator Instructions) Our next question comes from the line of Matt Duncan with Stephens. Please go ahead.

Matt Duncan – Stephens Inc.

Hello, guys, just a couple of quick follow-ups. Looking at the slides you guys have on your website, it looks like the gross margins have been trending down a little bit. Is that just a function of mix that's causing that slight gross margin compression, and where do you expect their margins to go from here?

Kent Yee

Yeah, Matt, that’s correct, it is a function of mix, David mentioned earlier in the call that they’ve had extreme growth in their IFS as well as their branded pump manufacturing business and there is some legacy jobs if you will when they really started to grow that business that kind of have if you will watered their gross margins.

David R. Little

I think…

Matt Duncan – Stephens Inc.

But Kent it sounds like you would…

David R. Little

Let me add to this, I don’t think we expect any more erosion of margins, I hate to be too optimistic if things are going to go up but realize that over the past few years they’ve been a new kid on the block with their API product lines, so they’ve had to, they’ve had to [buy] [ph] some orders.

Matt Duncan – Stephens Inc.

Okay. That's helpful, David. And then last thing for me, just looking at your balance sheet, if I'm doing my math correctly, you’re now roughly 3.4x levered. If I just add this debt to your end of third quarter debt level, and then give you the $35 million of EBITDA, And I think that's probably towards the high end of what’s you are comfortable with, David. So what are your thoughts around the balance sheet from here and your ability to keep doing acquisitions? Do you intend to stay active there?

David R. Little

Well, I’m not quite sure I agree with you earlier statement, we’re nowhere near 3.4 million leveraged to date before this acquisition, that does not…

Matt Duncan – Stephens Inc.

Well, I'm talking after the deal, David. I am just saying…

David R. Little

Okay, I think you said pre-deal, but you [inaudible] okay, I got it. That’s right. It may be around, it will be over three, we have our deal with the bank allows us to go to 4 probably, if that’s correct.

Kent Yee

Yes, that’s correct, initially out of the gate.

David R. Little

So I think we have other deals that are teed up and this is, this isn’t – part of our growth strategy is to continue to do acquisitions, in fact 10%, and 10% organic as we’ve stated, 20% [those are the] [ph] size of the company every four years. So we are not backing off of that. On the other hand I think we are going to be creating $150 million of cash flows that will allow us to pay down debt and do additional deals so we don’t really have any real specific plans as we speak. We are comfortable we think the – we think 2014 is going to be a good year. I’m not sure it’s going to be a fantastic year yet, but it certainly is going to be a good year. And so I think we are [inaudible].

Kent Yee

Yeah, Matt one thing I wanted to, Matt one thing I wanted to point out is our credit agreement actually out of the gate we’ve got traditional covenants if you will, it’s part of the package but it’s three and three quarters which we’re allowed to go up to and then you have some natural step downs as part of that credit agreement over time.

But Dave is correct, we feel comfortable I guess with the amount of free cash flow that we’ve spent off and frankly speaking we have not done an acquisition now over the past six months. We have de-levered some probably from what you are looking at in our current public filings, but so just to give you that additional color.

Matt Duncan – Stephens Inc.

Okay.

David R. Little

I think what we have close to a $100 million [inaudible]…

Kent Yee

Yeah.

David R. Little

After this deal, yes.

Kent Yee

Yeah.

Matt Duncan – Stephens Inc.

Okay. That's all very helpful, guys. Thank you.

Operator

Ladies and gentlemen, this does conclude the DXP Enterprise, Inc. Investor Conference Call. We’d like to thank you for your participation. You may now disconnect.

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