DXP Enterprises Q4 2006 Earnings Call Transcript

Mar.16.07 | About: DXP Enterprises, (DXPE)
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DXP Enterprises, Inc. (NASDAQ:DXPE)

Q4 2006 Earnings Call

March 15, 2007 5:00 pm ET

Executives

Mac McConnell - Chief Financial Officer, Senior Vice President-Finance, Secretary

David R. Little - President, Chief Executive Officer

Analysts

Matt Duncan - Stephens Inc.

Andrea Sharkey - Sidoti & Company

Paul Resnik - Dutton Associates

Rick Nelson - J Giordano Securities

Presentation

Operator

Good afternoon. My name is Mary and I will be your conference operator today. At this time, I would like to welcome everyone to the DXP Enterprises 2006 year-end conference call. (Operator Instructions)

It is now my pleasure to turn the floor over to your host, Mac McConnell, Senior Vice President of Finance. Sir, you may begin your conference.

Mac McConnell

Thank you. Welcome to DXP’s fourth quarter and full year results 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 and full year 2006 results. David Little will share his thoughts regarding 2006 results and the future. Then we will be happy to answer questions.

Sales for the fourth quarter increased 45% to $79.3 million from the fourth quarter of 2005. Sales by the four businesses acquired in 2006 accounted for $9.2 million of the sales increase. Excluding sales for the four acquired businesses, sales for the 2006 fourth quarter increased 28.2% from the 2005 fourth quarter.

Gross profit for the quarter increased 49% from 2005. Gross profit as a percentage of sales increased to 28.3% from 27.5% in 2005’s fourth quarter, as a result of successful acquisitions completed in 2006 and increased sales of higher margin fabricated pump packages. We continue to look for opportunities to acquire high margin, high service businesses which we can grow as part of DXP.

SG&A increased only 44.4% compared to the 45% sales increase and the 49% gross profit increase.

Interest expense increased 124%, primarily as a result of increased debt incurred to fund acquisitions and internal growth. Long-term debt increased $7.5 million during the quarter, primarily as a result of funding three acquisitions in the fourth quarter of 2006.

EBITDA increased 84% and pretax income increased 69%, compared to the fourth quarter of 2005. Net income increased 68%. Net income increased less than the pretax income increase because of increased state income taxes.

Diluted earnings per share for the fourth quarter increased 69% to $0.61 from $0.36 for the 2005 fourth quarter.

For the full year 2006, sales increased 51% to $279.8 million. Sales by the four businesses acquired in 2006 accounted for $11.8 million of the 2006 sales increase. Excluding sales of the acquired businesses, sales increased 44.6%. This sales increase is primarily due to a broad-based increase in sales of pumps, bearings, safety products and mill supplies to companies engaged in oil field service, oil and gas production, mining, electricity generation and petrochemical processing.

Gross profit for the year increased 58.1% from 2005. Gross profit as a percentage of sales increased to 28.1% for 2006, from 26.8% for 2005, primarily as a result of increased margins on pump equipment sold by the businesses acquired in 2005 and 2006.

SG&A for 2006 increased only 43.7% compared to the 51% increase in sales and the 58% increase in gross profit.

Interest expense for 2006 increased 94%, primarily as a result of the combination of increased debt to fund acquisitions and internal growth and an approximate 177 basis point increase in market interest rates for 2006 compared to 2005.

Long-term debt increased $10.1 million during 2006 as a result of spending $12.1 million on acquisitions during the year. At December 31, 2006, $13.6 million was available to be borrowed under our line of credit.

EBITDA increased 118% and pretax income increased to 125% for 2006 compared to 2005. Net income increased 118%. Again, net income increased less than pretax income because of increased state income taxes.

Diluted earnings per share increased 121% to $2.08 from $0.94 for 2005. 2006 was a very successful year.

Now I would like to turn the call over to David Little.

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David R. Little

Thanks, Mac, and I would also like to thank everybody for participating in our first conference call. I would like to first reflect on some of the successes we had in 2006 and then talk about the initiatives we have for 2007.

We started 2006 with the reorganization of our top management team so that we could have more focus on the three segments of our business, DXE service centers, innovative pumping solutions, and B2B solutions.

I asked David Vinson, who was the Senior Vice President of Operations, to head up innovative pumping solutions, and Mike Wappler, who was Senior Vice President of Sales, to head up B2B solutions. I hired Greg Oliver, Senior Vice President of Operations of DXP Service Centers who came from Home Depot Supply, to team up with John Jefferies, our Senior Vice President of Sales and Marketing to help run the DXP Service Center objectives.

The focus by these individuals has made a big difference in the growth and profitability of these segments. We have become more focused.

B2B solutions added four new SmartSource sites with two different customers, added two new product categories with an existing customer, and signed several new agreements to implement SmartSource programs in 2007. The group hired a hunter salesmen to call on Fortune 1,000 accounts, ended the year with two-and-one-half implementation teams, so we now can implement two sites at a time, and we also celebrate our 10th anniversary with our first SmartSource client.

Innovative pumping solutions created a VP of Sales, added five salesmen to call on engineering contractor firms. Because we did this, we had to add additional fabrications space which double our capacity at our Houston facility. That created a healthy backlog for 2007 and because of manufacturing lead times, most of the orders we received today are actually for shipments in 2008.

DXP service centers are managed under five regions which all experienced organic growth from 12% to 45%. They opened up two new service centers, expanded product categories in 10 locations. I like to call this our progress towards creating DXP superstores.

We continue to look for ways to increase margins by increasing value-added services and providing great customer service.

These teams also did a great job of integration of four acquisitions in 2006, executing growth strategies for these new acquisitions. Everyone understands that we must grow the top line and the bottom line, including acquired companies.

On the corporate level, significant corporate improvement, including selecting and making progress on the implementation of our new price maker software, which will increase margins, I would also like to give a special thanks to our accounting and IT group for their efforts to get through SOX compliance. The reason this announcement and conference call is later than in prior years is because the three acquisitions that we concluded at the end of ’06, and the fact that we accomplished SOX compliance in a six-month period of time.

IT continues to increase productivity and has done a great job of integrating our acquisitions. Purchasing and inventory control have done a fantastic job of sourcing better and increased customer service through having the right inventory shipped on time and minimizing stock-outs.

We are a people business and human resources has done a great job of finding, keeping, training new and existing employees in a very tough labor market.

Well, enough about 2006. What are we going to do to be wildly successful in 2007?

First and foremost, I would like to say that our strategies are working. We have a three-prong growth strategy of organic growth, operational strategies and acquisitions.

On the organic growth strategy side, we talked about DXP service centers. They are adding product categories to existing locations. They are expanding their customer base by opening up new service centers. They are also implementing what I will call our DXP super center concept, which is to take the product categories that DXP has and combine them all into one super center so that we can be a one-stop shopping for our customers.

Innovative pumping solutions is excited about the fact that their increased fabrication facility is now in service. They have hired a new salesmen to cover engineering contractors on a worldwide basis and they have a very good backlog and a very good outlook for 2007 and 2008.

B2B solutions, they added staff to execute SmartSource implementations. They started the year of ’06 with one team. They ended the year with two. They look to add another team because of a pipeline they have in terms of implementations. It takes us about 90 days to implement a new SmartSource site.

They have also added a hunter salesperson, as I mentioned before, to call on the Fortune 1,000 accounts so that we can keep the funnel full.

We just concluded a 2007 go-forward meeting. Everybody presented an excellent forecast. Our markets look strong and we continue to have the ability to take market share away from our competitors.

On the operational strategy front, I think it is important to notice that SG&A as a percent of sales continue to make incremental declines. We have implemented our price maker software, which we hope to improve gross profit margins in ’07. We have seen some incremental improvements across some of our product lines and we continue to take it across the entire product line.

The IT staff continues to work on productivity, such as warehouse automation, search engines for product look-ups, et cetera.

I think it is important to note that we are, as a distribution company, we are in the people business. So I am very proud of our HR department and the fact that they have been able to hire very good people. I actually think that I would comment on the fact that our people are enjoying working here. Motivation is high and I contribute all of that to the fact that we feel like we are winning.

From a corporate alignment point of view, that continues to work -- I think it works strong because of segregating our customers into very different categories. You have the customer that wants high service and he is willing to pay for that service. If they want a cheaper price, we can drive them to a B2B solution, and of course innovative pumping solutions continues to do very well in margin improvement and we are very pleased with them.

The last prong of our strategy is acquisitions. It is our goal to become a national company. I believe that when we go to a new geographic area, that the best practice for us is to buy market share and to acquire an existing company. When we acquire that company, we not only gain new geographic reach but we also gain the ability to service new clients and to service them with all of the different product offerings that DXP has.

We truly believe that when we look at some of these acquisitions and we describe what DXP is all about, that they feel like we have a winning operating strategy, we have a great MIS staff and commitment, and it gives upside potential to their employees.

When we look at acquiring companies, we typically have in the past acquired smaller companies which we are able to buy at four to six times EBITDA. As we look at becoming a larger company and we look at larger acquisitions, some of this EBITDA would certainly be correct in it going up as a purchase price, based upon the size of the company. But all of our acquisitions are accretive and we are very excited with how they have integrated into our company, how we have been able to grow them, how we have been able to take value-added services to them to help them be more successful.

When we look at DXP, it is also about gaining market share, and how do we do that? There are several things that we feel like are key to our competitive strength. One is that we are unique in the fact that we are the only company I know of that can offer pumps, bearings, power transmission, hose, safety equipment, industrial supplies, on a first-tier basis, meaning that we buy directly from a manufacturer and not from a second source, on a single purchase order and ship on a consolidated shipment.

We also pride ourselves in not being a catalog house and the fact that we have extensive product knowledge and the expertise around everything that we sell. We can cross-sell to existing customers. We can build our DXP service centers, which have been quite a success story when we look at Oklahoma City. We can provide flexible supply chain solutions to customers that are more sophisticated. Our B2B solution group is truly an outstanding group of people that understands the ins and outs of supply chain from a distributor to our end-user customers.

And we have just an awesome MIS group. I cannot say enough really nice things about them.

Several years ago, we read a book called Good to Great, and it had a theory, and that theory was all about what is your economic driver? Our economic driver is our people, is our highest cost besides the cost of goods sold. It is our most important resource. We spend a lot of time training and hiring the right people and that part of our business is really, really fine-tuned.

We are passionate -- we are very passionate about being customer-driven. We are going to give the customer what he wants. We are going to charge a fair value for that and that makes us I think not a product-driven but a customer-driven company, which has taken us over the last 10 years to really drive home to our people.

What are we truly going to be good at? DXP super centers, we continue to strive to be world class at that. We strive to be world class at pump packaging solutions for the oil and gas industries, selling these packages all over the world, and B2B solutions, supply chain management.

We look forward to a very successful 2007. The markets, our forecast all point towards us having a really good year. We are excited about that and that pretty much concludes what we are here to tell you guys about today. So we are going to open it up for questions and we look forward to hearing from you.

Question-and-Answer Session

Operator

(Operator Instructions)

Our first question comes from Matt Duncan from Stephens Inc. Please go ahead.

Matt Duncan - Stephens Inc.

Good afternoon, David and Mac, and congrats on an excellent quarter. A couple of quick questions here. David, I know you guys did not give guidance in the press release and you did not give any here in your prepared comments, but you mentioned that on Tuesday you went through a plan and the forecast for ’07. Is there anything you can tell us about what your expectations are for this year, at least on the top line anyway, on revenue?

David R. Little

Well, our goal is, and I think we have made this public to everybody, our goal is to certainly grow the top line 20% and the bottom line 35%. We do that through the three-pronged growth initiatives that we have. Certainly we have been exceeding that. I would say, not to venture out too far, that we feel pretty strongly that we are going to exceed that.

Matt Duncan - Stephens Inc.

Okay, fair enough. On the innovative pumping solution side, you mentioned interestingly that it looks like you guys have got enough orders to pretty much take you through 2007. You mentioned that some of the orders you are taking today are probably not going to be fulfilled until 2008, that group is so busy and I did see that the first time I was down there to see you guys, but I am curious if you have any feel for how much you think you can grow those revenues this year. Are we looking at something on par with what you did there in 2006, or could it even accelerate a little bit?

David R. Little

I believe we have told people, Mac, that we grew that business about 80% last year? Again, I think that part of our business is 15%. Is that right?

Mac McConnell

15% to 20%.

David R. Little

Yes, so I think they feel pretty good about growing that segment of the business about 50%.

Matt Duncan - Stephens Inc.

Okay. I wanted to ask a little bit too about your acquisition strategy and what the pipeline looks like. I know obviously you guys plan on acquiring across the country to get larger. Can you just comment a little bit on what the pipeline is like right now? Are you seeing a lot of good opportunities? Just talk a little bit about that.

David R. Little

We see more opportunities than we can act upon, and that is two-fold. One is, as you all now, we have not tapped the equity markets for any additional capital, so we have funded all existing acquisitions internally and with our bank revolver.

Secondly, the execution of those acquisitions, we have a plan and we stick with that plan and the plan is all about not just acquiring somebody and leaving them alone. We have to grow their top line and we have to grow their bottom line, so we do not really prefer to do so many acquisitions that would just look kind of like a roll-up. So we are very selective. We like to pick high margin oriented companies, companies that can throw off some serious money on the bottom line. We may pay a little more good will for a type of company like that but that has worked really, really well for us.

Yet at the same time, we do have a goal of being a national company, so we would entertain a larger acquisition that would get us there fast. I think on several conferences people ask me what my personal goals are and I love this business and I am passionate about it and I really want to be a billion dollar company and to be a major force in this. It is going to take more than your average $20 million revenue company and only doing two or three of those, or only growing 10% to get to that billion dollar number. So we would look at that kind of opportunity also.

Matt Duncan - Stephens Inc.

Great, and last question here and I will jump back in the queue. Did you guys notice any difference in the growth rate in your non-energy customers business in the fourth quarter? I know some other industrial distributors have mentioned that business was a little bit slower in the fourth quarter than maybe it had been earlier in 2006. Did you see that or do you see your business staying pretty strong, even with the non-energy customers?

David R. Little

First of all, I think 12% organic growth is pretty strong and so I made a comment that we have five regions and the slowest region grew 12% and the highest growth region was about 48%. There are always markets that are going to be better than other markets, regions that are better than other regions.

We do feel very fortunate to not be in the home building and the automotive sector.

Matt Duncan - Stephens Inc.

Sure. I appreciate it. Thanks, guys, and congrats again on a great quarter.

Operator

Our next question comes from Andrea Sharkey from Sidoti and Company. Please go ahead.

Andrea Sharkey - Sidoti & Company

Good afternoon, everyone. Just follow-up on that last question, if you look at Q1, do you think that -- I mean, we are getting pretty close to the end of it. Is it shaping up to look similar to what you have had in this fourth quarter you just reported or are you seeing any significant differences one way or the other?

David R. Little

I think the only thing that -- everything looks up. Everything looks up so we would anticipate a quarter-to-quarter continuous growth rate and that is certainly our goal. The only thing that makes that not come true at this point, or what we can see is that sometimes we have capital projects, especially on the innovative pumping solutions side, where you might not have several couple-million dollar projects close, and then they close the next quarter. I am not anticipating that to happen in the first quarter. In fact, I think, Mac, we did close a pretty nice job in the first quarter but that would be the only thing that would cause our quarter-to-quarter activity to be a little -- what would the term be, unbalanced or --

Mac McConnell

Choppy.

David R. Little

Choppy. Choppy might be a good word. Is that fair?

Andrea Sharkey - Sidoti & Company

Yes, that’s fair. I definitely understand that. Actually, talking about the innovative pumping and saying that you are booking orders into ’08, is there any plan on your part to even expand your capacity further so that those projects that you are booking out into ’08 you could pull into ’07, or is that more just a function of that is when the customers want the delivery, is ’08?

David R. Little

Well, it is not customer-driven but you are close. It is manufacturing driven. A lot of our manufacturers in the pump side of the industry, we do not see this in other parts but on the pump side of the industry, their delivery of the pump, when we fabricate things we buy a pump, we buy a diesel engine, we do the fabrication of piping controls, but we buy those major components. It is those lead times frankly that are out causing us to be into ’08.

From our own point of view, we are running three shifts. A larger capacity and from time to time, that will cut back to two shifts, so we have a lot of flexibility to produce on our end. It is the manufacturers that hold us back.

Andrea Sharkey - Sidoti & Company

Okay, that makes sense. And then, talking about the moving towards the super stores, I know we have talked about having, as you mentioned, getting the right people to be able to cross-sell these products. Could you give us an update on how that process is going? Have you been able to successfully find the sales staff that you need to be able to introduce these new product lines to your existing service centers?

David R. Little

The comment is when we have a DXP service center that just sells comps and we are wanting to add bearings and power transmission, our strategy is to go out and find the very best bearings and power transmission salesmen and inside salesperson that is kind of like a small acquisition of those two people. We have the products and they are the ones that are kind of our seed to get started in that business. That is a very strong initiative by all our regional managers. They are supposed to help HR find those kinds of people because they are in the field, they hear from their customer who the very best people are.

Everybody has an initiative to truly have a super store, which would be all our products; bearings, power transmission, pumps, safety, industrial supplies, hose, and to have a true super store. Every region is supposed to have at least one of those this year.

That is not to be confused with the fact that there will be several others that will be like a bearing and power transmission store that does in fact become a safety store also but it does not have all our products, but now they are a bearing and safety store. So there is incremental market share gain by just doing one product category.

Andrea Sharkey - Sidoti & Company

Sure, okay, that’s great. Last kind of clean-up question, could you tell me what your cash flow from operations and your CapEx were for ’06 and what you think your CapEx might be for ’07?

David R. Little

I’m glad someone finally asked an accounting question.

Mac McConnell

Capital expenditures for 2006 were $2.4 million, and I guess I would assume that for 2007, we would spend that amount or more. And your other question was?

Andrea Sharkey - Sidoti & Company

Cash flow from operations for the year, ’06.

Mac McConnell

On the cash flow, $131,000.

Andrea Sharkey - Sidoti & Company

Thank you.

Operator

Our next question comes from Paul Resnik from Dutton Associates. Please go ahead.

Paul Resnik - Dutton Associates

Congratulations on the quarter. I finally after all this time to come up with a sales target that was so outrageously aggressive that you had a little trouble reaching it but you blew out my earnings estimate anyway.

A couple of questions. On RA Mueller, when did they -- was that acquisition in the fourth quarter of 2005?

Mac McConnell

Yes, it was.

Paul Resnik - Dutton Associates

So there was a couple million in revenues there that might have been helped in the comparison. On SmartSource, I am still trying to get a sense here. Certainly it provides a really stable growth opportunity. As you progress there, are the margins continuing to track the general corporate margins or are you seeing some opportunity to do better?

David R. Little

We feel like that they get to the same operating income level but they do it different. The customer typically we will drive down margins a bit and so our margins will be lower but the customer pays for our people. It is on site so it gives us management fees, and then plus the fact that we do not have bricks and mortar, our operating expense is much lower. So we are still trying to -- we still drive a minimum of a 10% operating margin, and so we are very pleased with that business.

Like you pointed out, when you land one of those contracts, they are doing business with a couple hundred vendors and then all of a sudden they buy everything from you, so each site is a $1.5 million to -- I don’t know what our biggest site is -- $5 million. It is a huge market share gain and a big win.

As I pointed out also, as we celebrate our tenth anniversary of a particular account, that these annuities last for a pretty long time.

Paul Resnik - Dutton Associates

Just one out-of-the-box question, innovative pumps is a great business and it is really a cross-site manufacturing business. Do you see any other product lines where that sort of model would make sense?

David R. Little

We are very, very pleased with power machinery that we purchased -- when did we purchase that, end of -- in ’06.

Mac McConnell

’05.

David R. Little

’05, at the end of ’05, and that business is actually again related to pumps but nonetheless, it is a little different in the sense that instead of being fabrication, it is a remanufacturing facility. We take used equipment and we refurbish it to new and we do it in 12 weeks when new equipment lead times are 52 weeks, and so if you can imagine these are sold on pipelines, a pipeline wanting to get its product flowing cannot wait for 52 weeks. We actually can sell the used equipment at the same price as new and then, of course, because we redid it and remanufactured it and we have really talented people that can do that, we actually tout the fact that the product is better than new.

Paul Resnik - Dutton Associates

And the SmartSource runs about 10% of the business?

Mac McConnell

That is correct.

Paul Resnik - Dutton Associates

Okay, I will give other people a chance. Thanks a lot.

Operator

(Operator Instructions)

Our next question comes from Rick Nelson from J Giordano Securities. Please go ahead.

Rick Nelson - J Giordano Securities

Good evening. Just one quick question, Mac. Everybody else has asked all the questions I was planning on asking. Just on the other income, $413,000, is that something that is on a more regular basis or is that just one of those quirky things?

Mac McConnell

It is a one-time gain. It came from the State of Texas decided they wanted one of our buildings for a widened highway.

Rick Nelson - J Giordano Securities

Okay. I take it though that the momentum, the strong momentum you had going into the fourth quarter, that is just carrying on into this year. Again, you blew my numbers out, and congratulations. Very nice. Thank you very much.

Operator

Gentlemen, there appear to be no more questions at this time. I would like to turn the floor over to Mac McConnell and David Little for any closing comments.

David R. Little

Well, this was our first conference so thank you. I hope we did okay. I would like to thank everybody for the questions that they had. We are very excited about our company. We feel like that our employees are putting in 110% and we are winning at the game of business and we look forward to talking to you all again. Thank you very much.

Operator

Thank you, everyone. This concludes today’s conference call. You may disconnect your lines at this time and please have a wonderful day.

TRANSCRIPT SPONSOR

Dutton Associates is one of the largest issuer-paid equity research firms in the United States, and our investment performance is ranked comparable to that of the top Wall Street firms. Our analysts, primarily CFAs with over 20 years of experience at the major securities firms, are among the most experienced on Wall Street. We offer high-quality, independent, fundamental research on small-cap public companies in a year-long program consisting of an initial report, three quarterly update reports, research notes between the quarters, and institutional conferences and roadshow opportunities.

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