DXP Enterprises' CEO Discusses Q2 2012 Results - Earnings Call Transcript

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 |  About: DXP Enterprises, Inc. (DXPE)
by: SA Transcripts

DXP Enterprises, Inc. (NASDAQ:DXPE)

Q2 2012 Earnings Call

August 1, 2012 5:00 PM ET

Executives

Mac McConnell – SVP, Finance and CFO

David Little – Chairman, President and CEO

Analysts

Matt Duncan – Stephens

Holden Lewis – BB&T Capital Markets

Operator

Good afternoon, ladies and gentlemen. Thank you for standing-by. Welcome to the DXP Enterprises Incorporated 2012 Second Quarter Conference Call. During today’s presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be opened for questions. (Operator Instructions)

I would now like to turn the conference over to Mac McConnell, Senior Vice President of Finance and CFO. Please go ahead.

Mac McConnell

Thank you. This is Mac McConnell, CFO of DXP. Good evening and thank you for joining us. Welcome to DXP’s second quarter conference call. David Little, our CEO, will also speak to you and answer your questions.

Before I begin, I want to remind you that today’s discussion will include forward-looking statements. We want to caution you that such statements are predictions and actual events or results can differ materially. A detailed discussion of the many factors that we believe may have a material effect on our business on an ongoing basis is contained in our SEC filings that DXP assumes no obligation to update that information.

I will begin with a summary of DXP’s second quarter 2012 results. David Little will share his thoughts regarding the quarter’s results then we will be happy to answer your question.

Sales for the second quarter increased 32.5% to $261.9 million from the second quarter of 2011. After excluding second quarter 2012 sales of $39 million for businesses acquired in 2011 and 2012, sales for the second quarter increased 12.8% on a same-store sales basis.

Sales for Supply Chain Services increased 17.2% to $42.6 million, compared to $36.4 million for the 2011 second quarter. Excluding second quarter 2012 SCS segment sales of $4.4 million for acquired businesses SCS segment sales for the second quarter 2012 increased to 5% from 2011 on a same-store sales basis. Sales of Innovative Pumping Solutions products increased 61.3% to $35.2 million compared to $21.8 million for the 2011 second quarter.

Sales by our Service Centers segment increased $44.6 million to $184.1 million compared to $139.5 million of sales for the second quarter of 2011. After excluding 2012 Service Centers segment sales of $34.5 million for businesses acquired in 2011 and 2012, Service Centers segment sales for the second quarter of 2012 increased 7.2% from the second quarter of 2011 on a same-store sales basis.

When compared to the first quarter of 2012, sales for the second quarter of 2012 increased 3.8% after excluding $6.9 million of sales for businesses acquired in 2012 on a same-store sales basis. Sales for the second quarter increased 1.1% from the first quarter. This increase occurred despite the 3.1% decrease in the number of business days in the second quarter compared to the first quarter.

Second quarter 2012 sales for Supply Chain Services increased 12.8% compared to the first quarter of 2012. Second quarter 2012 sales of Innovative Pumping Solutions products decreased 10.8% compared to the first quarter of 2012. Second quarter 2012 sales by our Service Centers segment increased 5.2% compared to the first quarter of 2012.

After excluding $6.9 million of Service Centers sales for businesses acquired in 2012 on a same-store basis, Service Centers segment sales for the second quarter increased 1.2% from the first quarter of 2012.

Gross profit for the second quarter of 2012 increased 33.8% from the second quarter of 2011 compared to the 32.5% increase in sales. Gross profit as a percentage of sales increased to 29.3% in the second quarter of 2012 compared to 29% for the second quarter of 2011. This increase is primarily the result of increased profit margins for the SPS and IPS segment.

Gross profit as a percentage of sales for the second quarter of 2012 increased to 29.3% from 28.3% for the first quarter of 2012 primarily as a result of improved margins in all three segments.

SG&A for the second quarter of 2012 increased $12.1 million or 27.8% from the second quarter of 2011, compared to the 32.5% sales increase. This increase is partially the result of the $8.7 million of SG&A expenses associated with the acquisitions completed in 2011 and 2012 on a same-store sales basis. As a percentage of sales, SG&A decreased to 21.3% from 22.1% for the second quarter of 2011. This decrease is primarily a result of economies of scale.

SG&A for the second quarter of 2012 increased $4.2 million or 8.2% from the first quarter of 2012. This increase is primarily the result of $2.9 million of SG&A expenses associated with the acquisitions completed in 2012 on a same-store sales basis. As a percentage of sales, SG&A increased to 21.3% from 20.4% for the first quarter of 2012, primarily as a result of increased health insurance claims, incentive compensation, travel, charitable donation and professional fees. We incurred approximately $800,000 of legal fees for acquisitions during the second quarter of 2012.

During the third quarter, we will expense approximately $1.5 million of transaction cost associated with the acquisition of HSE. Interest expense for the second quarter of 2012 decreased 25.5% from the second quarter of 2011. This decline is the result of decreased rates on our credit facility. On July 23, 2011, we amended our credit facility. This amendment significantly decreased the interest rate and commitment fees applicable at various leverage ratios from levels in effect before July 23, 2011.

Interest expense for the second quarter of 2012 decreased 8.1% from the first quarter of 2012, due to lower interest rates in the second quarter, which really resulted from the low leverage ratio at December 31, 2011 that took effect on our interest rate as of March 10, 2012.

At June 30, 2012 our total long-term debt was $181.3 million, and our bank leverage ratio was 1.91 to 1 at June 30, 2012. On a pro forma basis, including the acquisition of HSE, our bank leverage ratio would be approximately 2.3 to 1 as of June 30, 2012.

On July 11, 2012 DXP closed on a $325 million credit facility. The pricing grid for the new facility is almost the same as the old facility. The primary differences are the rates for the $100 million term loan component or 25 basis points higher than for the non-term loan borrowings, and then unused line fees will be five basis points higher than the old agreement. Because the leverage ratio is higher after the completion of the HSE acquisition, interest rates are expected to be 50 to 75 basis points higher than those in effect at June 30.

At June 30, our borrowings under the credit facility were at a rate of approximately 1.5%. The amortization of debt issuance costs will be approximately $70,000 a quarter higher under the new credit facility.

In the third quarter, we’ll write off $655,000 of debt issuance cost related to the old credit facility. Our availability under the new credit facility is approximately $70 million to $75 million. The new credit facility also includes $100 million of accordion feature, which allows us to increase the line without the approval of the entire bank group.

Cash on our balance sheet at June 30, 2012 was $6.6 million. Accounts receivable and inventory balances were $157.8 million and $99.4 million respectively at June 30, 2012.

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

David Little

Thanks, Mac, and thank you to all our participants on our conference call today. While given the headwinds of Europe, our own dysfunctional government, the presidential election, high unemployment and world economic slowdown, DXP’s performance continues to be outstanding. Our DXP people’s execution of our strong strategic growth strategy is taking market share and improving our bottom-line performance. We have now produced 10 straight quarters of sequential quarter-over-quarter growth in both the top line and bottom-line.

Our organic sales grew 12.8% and total sales grew 32.5%, our sequential quarter-over-quarter organic sales growth of over 1% reaching $261.9 million. We continue to grow our EBITDA margins up from 8.1% in 2011 to 9.1% in the first quarter and 9.4% in our second quarter. Our goal of 10% EBITDA margins by 2013 certainly looks achievable.

Our Q2 2012 pro forma return on invested capital was 31% after tax. This was one of the highest returns of working capital plus successes in our industry. Being customer-driven experts in MROP solutions continues to be a win-win both for DXP and our customers.

I would like to give a special thanks to our DXP family including the new members of our family for their efforts and belief and being customer-driven experts across a large breadth of products and services. All of our product divisions, rotating equipment, bearings and power transmission, safety services and products, metal working, industrial supplies, are growing and doing a fantastic job of supporting our super center program and our 12 regions – helping our 12 regions to capture new market share.

Our acquisition program is alive and well. In the second quarter of 2012 we completed three acquisitions for a total transaction consideration of $36.9 million or six times acquisition EBITDA of $6.2 million. Note, total transaction consideration includes working capital adjustments plus expenses, CapEx reimbursement expense. Transactions completed included Aledco and Force Engineered Products, Industrial Paramedic Services, and Austin & Denholm.

Subsequent to Q2, we announced the completion of HSE Integrated acquisition on July 11, 2012 which will begin financial reporting in Q3. We are excited to have these three acquisitions as part of our DXP family. Aledco and Force Engineered Products adds to our Rotating Equipment division and our new Northeast region which now includes Rotating Equipment, Bearing and Power Transmission and Metal Working and positions us to serve the promising Marcellus Shale play.

The additions of the Industrial Paramedic Services and Austin & Denholm provide entry into Canada and it favors DXP’s presence across North America. Western Canada or Alberta is a major oil and gas market and will allow DXP to leverage its expertise within this market and better serve DXP’s customers who desire a products and service provider for the entire North American footprint.

For Q2, these acquisitions contributed $5.2 million in sales, $611,000 in operating income or an 11.8% margin respectively. All acquisitions in Q2 contributed $39 million of sales and $3.7 million in operating income or a 9.5% respectively. This includes Kenneth Crosby, CW Rod, Mid-Continent, Aledco and Force and Pump & Power, Industrial Paramedic Services, and Austin & Denholm.

Year-to-date acquisitions have contributed $70.8 million in sales and $6.9 million in operating income for a margin of 9.8% respectively. When we look at Aledco and Force Engineered Products highlights, first of all they’re a leading distributor of industrial, sanitary and all built pumps and process equipments in Pennsylvania, New York.

LTM sales and adjusted EBITDA at acquisitions of $21.5 million and $4.1 million respectively. Three locations in Canada, Calgary, Nisku, and Dawson Creek established initial presence in Canada and major markets driving safety services standards and best practices across the work environment. We focus on specialty industrial medic and clinic service and we have a strong presence in the oil sands.

Austin & Denholm highlights, a leading distributor of industrial pumps and process equipment in Western Canada. LTM sales and adjusted EBITDA at acquisition of $7.4 million and $748,000 respectively. Two locations in Alberta, Calgary and Edmonton. Established a rotating equipment division in Western Canada. They offer product distribution and small pumps and rotating equipment overhaul repairs.

Since Q4 of 2011, we have completed eight transactions. DXP’s acquisitions are focused on adding scale and geographic reach to our product divisions as well as establishing DXP’s presence across North America. Three acquisitions or 37.5% of the deals or $19.6 million of trailing 12-month acquisition sales at the time of acquisition have been within the rotating equipment division.

Another three transactions for $137 million in DTM acquisition sales at the time of acquisition were – have been within Sales Services division. Two transactions or $109.9 million of trailing acquisition sales of some of the acquisitions have been within (inaudible) our working products. Five transactions, 62.5% or $132.1 million of sales have been within the United States and three transactions, three others, 37.5%, $134.1 million of trailing acquisition sales have been in Canada.

Overall, we are pleased with the acquisitions we have completed since Q4 2011. We remain excited about our pipeline. We continue to see opportunities in the United States and Canada. Over the short to medium term we will continue to see a minimum of 10% of our growth coming from acquisitions across North America. We continue to like the opportunities we are able to uncover; purchase multiples have remained in our historical range and financing costs were at all times low, an ideal environment for acquisition activities.

I’d like to point out why we were excited about safety services and then a little bit about our last acquisition of HSE. First-server market advantage. Safety puts us at well – at the drilling site and leads to pull through of other products and services after a well is completed; the leverage knowledge of new industrial projects and oil and gas that bridge across DXP’s platform.

The opportunity potential to pull-through core DXP product sales after the initial on-site safety services. The ability to compete on master contract basis to service a product positions DXP for continued increase in demand for sole source, one-stop product and services provided with a national and international reach. Complementary end-markets coverage in financial is compelling. Core safety products in markets fit well into DXP’s core markets oil and gas, exploration, production, chemical, petrochemical, refinery, power and mining. Industrial growth in excess of GDP with greater than 10% EBITDA margins. I like that one especially.

HSE, DXP announced the purchase of HSE on May 1, 2012. We signed the plan of arrangement agreement on April 30, 2012 and the deal was closed on July 11, 2012. HSE is and maybe is and maybe Canada’s largest provider of health safety environmental services throughout the industry. Strong focus on oil and gas markets approximately 85%. Operates in two business segments, industrial 55%, oil field 45%.

Sales and EBITDA for the year ending 2011 were at CAD98.2 million, CAD13.1 million of EBITDA. For the 12 months ending 12/30/2012, sales and EBITDA were $05 million and $19 million respectively. Purchase price of CAD1.8 per share or $85 million in US or a 4.5 times trailing EBITDA. Accretive to earnings; somewhere between $0.10 and $0.17; this does not factor in synergisms approximately of $630,000 in public company cost savings.

Great strategic bid. Complementary to existing DXP’s Service Centers business and Safety Services division, a combination of our safety service division and HSE creates the number two player in the safe and healthy services given us fast reach and scale. Immediately established with DXP and leading markets of Western Canada driving major safety best practices.

Strength in Service Centers business and Safety Service division; strengthens in DXP’s service center business from Canada had strong customers to safety service division including companies like Husky Oil Operations, Canadian Natural Resources and Suncor Energy. Certainly financially compelling; it’s accretive, and it has strong cash flow. Provides DXP with a platform in Canada; HSE has 20 locations across Western and Eastern Canada. Strategic presence in the major oil plays. Establishes a presence in Canada’s safety market expertise and complete suite of safety services operating and health, savings, and environment. Opportunities to compete on master service agreements across North America. DXP provides a national operating base to better serve customers and operating leverage to increase growth acceleration.

Combined, further diversification of geographic mix, green’s number two player, meaningful margin enhancements for DXP going forward; one of the things we are excited about too is HSE provides a CFO, Canadian CFO and her team as a face of operations for the other acquisitions we’ll deal in that marketplace.

An when we look at our segments, first DXP, the Service Centers segment, we are extremely grateful to our employees, customers, and suppliers for making Q2 a successful quarter for Service Centers segment. Sales increased 5.2% from Q1 to Q2 of 2012 and 32% compared to Q2 2012 versus Q2 of 2011.

Operating income increased 21.2% to Q1 of 2012 and 30% compared to Q2 2011. Several end-market – customer markets remains stable or slightly improving such as oil and gas chemical, mining, food and beverage to entire manufacturing, there is some softness in some markets but our goal is to continue to grow by taking market share from mom-and-pop operations by capturing more on our customers’ MRO step.

Our continued success in key end customer markets is contributing to the expansion of our Service Centers networks. Our Q1 investment in Mid-Continent supply, pumping power and Aledco has broadened our technical product and service portfolio, thereby strengthening our market position and providing our industrial customers with increased value. Each acquisition and 2% of our investment reinforces our commitment to being the one-stop source for expert solution. Each acquisition has allowed us to reinforce our leading position in the industry by widening the breadth of technical products services we are able to bring to our customers. Collectively, our investments allow us to take full advantage of the leverage we have created in our industry.

Our super center strategy continues to create value for our industrial customers seeking to consolidate their vendor base without sacrificing local inventory and expertise. We will continue to prioritize our Service Centers by investing in key product lines of service expansion throughout our Service Center network. In Q2, North Texas management team successfully elevated our Conroe service center to super center status broadening our opportunity.

We would like to recognize our employees, customers, and suppliers in the Conroe market for their dedication helping us create our super center. We presently have 30 SuperCenters in 12 process candidates. As we move into the third quarter we will offer a strong network of 30 SuperCenters and a growing pipeline of in-process candidates. We are confident in our regional management team’s ability to deliver an additional two new SuperCenters in Q.

Innovative Pumping Solutions. Sales for Q2 of 2012 versus Q2 of 2011 were up 61% compared to Q1 2012 – were up 61% when compared to Q1 2012 sales were down 11%. The first quarter – the second quarter decline has contributed to two large orders in the first quarter. Operating income was up 125% in Q2 of 2012 to Q2 of 2011. Gross profit increased 1.71% to 34.2% in Q2 of 2012, from 31% in Q1 2012. Most of this increase was because of two – the same two major orders on Eagle sales that were taken at lower margins.

The IPS segment is continuing to be faced with manufacturers’ contingent lead time on major equipment component. We also see end-users taking steps to delay delivery and production of modular packages. What appears to be the driving force here is one, end-users’ total project is suffering from the delivery issue on other aspects of the project. Therefore, they don’t need our equipment as fast. And in some cases, there is evident attempt to slowdown our completion of modular package by the end-user. And for this reason, we see the rest of year at Q2 levels.

Land-based activity, the extended lead times, unstable economy, uncertain political climate of the upcoming elections are contributing to a noticeable slowdown in quoting activity as it relates to modular pumping packages in the oil and gas and mining sector for capital ex projects on the land-based activity. We are monitoring this closely and on a positive note, we hear that 2013 will be a great year for the oil and gas industry. In the Rocky Mountains in North Dakota regions we are seeing a shift from produced injection packaged opportunities to production equipment such as black unit opportunities. The current black unit package is being marketed by DXP and on those building location has gained acceptance in the market and we’ll provide additional modular packaging opportunities for these business units. This type of modular packaging may result in slightly lower margins based on the competitive nature and markets of this product.

The Gulf Coast. We are seeing some signs of activity in this sector. The opportunities or projects that were in play prior to the BP oil spill was placed on hold due to the regulatory agencies placed a moratorium on the activity. The moratorium has been lifted. BP and Chevron are moving forward with projects. We feel confident based on the products that DXP has to offer in our relationship with BP and Chevron and other players will result in opportunities in this sector. The project in this sector have a longer range scope than the land-based projects and the extended manufactured lead times are less of an issue.

Midstream. We see the quoting activity in this sector very good and consistent with Q1 of 2012 and Q4 of 2011. In this sector delivery is performing and many opportunities can be realized when DXP and our manufacturers can provide accessible deliveries. Working with our major manufacturers to commit and hold credible deliveries will be a key component of new equipment requirements. We feel our remanufactured products and HP-Plus products will continue to provide opportunities based on our ability to provide quality products and favorable deliveries as we control the entire process of providing health products and packages in this category.

Q3 outlook. Based on the current backlog and sales activity, Innovative Pumping Solutions segment scheduled deliveries for Q3 should approximate Q2 levels. At present, 529, PMI and Golden are working two shifts in the production of our modular package. We see this continuing into Q3.

Supply Chain Services. The Supply Chain Services segment continues to see increase in both top and bottom line. Sales increased 12.79% from Q1 of 2012 and 17.2% from Q2 of 2011. Operating income increased 38.5% from Q1 of 2012 and 82.7% compared to Q2 of 2011. Overall, the Supply Chain Services segment continues strong consistent revenue growth.

We have also seen the business development team active with new projects as DXP’s unique value proposition of a large breadth of products and technical expertise is gaining reputation in the marketplace. In Q2, the operational excellence team continues to improve efficiencies by standardizing on additional reporting across supply chain locations. This allows our site managers to dedicate more time and focus on freight and accounts receivable, freight cost reductions for the customer and DXP has been a major saving initiative in 2012 along with the staying on top of our receivables reducing day sales.

The Supply Chain Services implementation team is busy with the implementation of two food processing companies with an onsite store and an electronic component manufacturing facility that was signed in Q1. Q2 saw the addition of new customer in the pharmaceutical market. This customer will have four onsite locations going live over the next several quarters. SCS also expanded the long-term customer relationship with the general manufacturing to the Massachusetts plant.

DXP’s proprietary software solution Chase, which is DXP’s computerized maintenance management software, was a key element in the awards of one of the abovementioned contract. The site is going live with complete store room integration and onsite store and checks. Q2 also saw the expansion of our SCS Dallas warehouse in order to handle a large product scope. This at the request of our large beverage account extended our 3PL relationship and enhanced our long-term relation and opportunity. SCS continues to grow personnel and accommodate site management and implementation of these locations. Two of these are industrial distribution brands goods. As we continue, we are investing in people to grow our future.

The most recent acquisition in Canada has also sparked interest for SCS by existing and new customers looking for smarter, cost-saving solutions in today’s ever increasing competitive marketplace. As a company we’re in the process of understanding the supply chain in Canada for DXP’s first tier vendors so that we can offer our customers DXP’s unique solution.

Q3 and Q4 should see continued positive growth. We’re seeing more activity and request for cost-saving solutions than we have for the last couple of years. Also many opportunities are arising because of service and performance issue with our competitors.

In my conclusion, we feel that there is a softness in some markets caused by uncertainties. As the uncertainties becomes stable and I am not sure it matters to the direction; just that it becomes clear and stable, we will see our economy grow. Noting we will see – nothing we see is falling off a cliff. We believe these strong players with the right growth strategy such as DXP will grow at the expense of our smaller competitors.

As stated before, acquisitions have purpose, to expanded geographic reach and we leverage DXP product and services divisions to take market share. SuperCenters have a purpose, expand DXP’s product services divisions on a local basis and gain market share. Integrated supply has purpose; it leverages our breadth of products and expertise to take market share on a customer-by-customer basis. Modular pumping system have purpose, they capture capital equipment that gives us after-market service and repairs. Bricks-and-mortar have purpose, it gives us local presence and being a part of the community with same-day delivery. Three segments and five divisions have purpose, to give us unique ways of meeting the needs of our customers in a way that makes them more profitable.

Geographic expansion has purpose, to better serve our national customers and create economic scale. Breadth of technical products and services have purpose, to build a company of experts that is different from competitions commodity products that bring the solutions and be the solutions for our customers, maintenance repairs, and operating needs for technical products and services.

DXP continues to outperform our competition. We look forward to a great second half of the year and beyond. We are now open for questions.

Question-and-Answer Session

Operator

Thank you, sir. We will now begin the question-and-answer session. (Operator Instructions) our first question is from the line of Matt Duncan with Stephens. Please go ahead.

Matt Duncan – Stephens

Afternoon guys.

David Little

Hi, Matt.

Matt Duncan – Stephens

The first question I’ve got, David, I appreciate all the details that you gave us there. That’s very helpful sort of thinking through the back half of the year. To put it all into perspective do you still feel like in the current environment DXP can grow 10% organic plus that 10% plus from acquisitions that you guys have talked about or is the 10% growth bogey going to be a little tougher in the current environment, just – how do you think about overall organic growth with what’s your seeing right now in the business?

David Little

Well, we started the – July seems to be a really good month for us and I think you said it right, I think it’s tougher but I think it’s achievable.

Matt Duncan – Stephens

So that still is your goal is to grow at 10% organic and then add the acquisitions on top of them?

David Little

Absolutely.

Matt Duncan – Stephens

Okay, looking at the business and sort of some pieces here, you said July had started off strong. What sort of sales trends did you see through the quarter, Mac?

Mac McConnell

Days sales, I guess, in the first quarter, per business day we average $3,942,000 a day. April was $3,983,000. May was $4,104,000. And June was $4,573,000.

Matt Duncan – Stephens

And in July it sounds like you – it’s probably following a normal pattern or the month may be down from the June month is always – you have a hot month at the end of a quarter, but year-over-year growth in July sounds they got started off pretty good though?

Mac McConnell

Yes, yes.

Matt Duncan – Stephens

All right. David, at IPS, is backlog no longer growing there given that you’re starting to see some customers, I guess, who are acting like maybe they’re going to wait a little bit while trying to push out deliveries a little bit. Well, what’s going on with your backlog and quoting activity in that business?

David Little

Well, people, okay, two different questions. But we’re maintaining our backlog I would say it’s not particularly growing, but it’s not declining either. And then as far as quoting activity a lot of the quotes are people aren’t – their quoting things, there’s projects out there, but they look like they’re being delayed. And the only read we can get on that is what I’ve said and that is that the marketplace, there’s a lot of uncertainties out there, a lot of headwinds, people don’t know the direction of where we’re headed and so they look like to me they’re – they have lot of projects they’re just putting them off for a while.

Matt Duncan – Stephens

Okay, are you seeing sort of that across the energy business in general or is that really just more tied to the capital spend stuff?

David Little

It’s tied to capital spend.

Matt Duncan – Stephens

So how is the rest of your energy customer base doing? Are you still seeing pretty good demand trends from those customers?

David Little

Oh, yes. I mean, we’re – yes, I don’t want to give the impression that we feel like things are declining. We actually feel really good about our business and in most of our – in most people’s, I think, out of 12 regions, only three of them reported flat down a little bit. Everybody else reported up. It’s just that we had to recognize what we’re reading in the paper and what’s happening in the marketplace. And so and what PMI is doing and what ISM is doing, et cetera. So we’re watching those things. They don’t appear to be affecting us that bad, but they could and I’m just a really strong believer. There’s nothing out there that’s going to cause to fall off some cliff, but it’s just not going to happen. There’s – but I think there is uncertainty in the market so people are kind of being a little more conservative.

Matt Duncan – Stephens

Okay, David on HSE, the revenue and EBITDA level that that business had for the 12 months ending May is quite a bit above the 12 months ending December. Can you talk a bit about what drove that and sort of how that business is doing right now, I guess, the breakout in Canada typically is down in the second quarter, you’ve got the spring breakup period. But how is that HSE business doing now that if you’ve taken it over?

David Little

It’s doing really well. It’s doing better than we expected. The first part of the year they did have a fire, a big blow out on a drilling rig. So they had some additional business there. What we don’t know is how much did that pulled away from other normal business that we have. Alberta doesn’t have an unemployment problem. They have an employment problem. And so the amount of people that we have is – we’re trying to fly people in, et cetera, so business is really, really good there and I don’t – I know we have the fall out and so the drilling rig count in Canada goes down, but I believe on a year-over-year basis it’s actually up.

Matt Duncan – Stephens

Okay and then last thing I’ve got and I’ll hop back in queue. The gross margin that you had this quarter was very strong, it was up 100 basis points from the first quarter. It sounds like some of that is tied to the stuff you saw at IPS that you talked about. Is there anything else going on? I know you are a little bit disappointed in that 1Q gross margin. So is the go forward gross margin somewhere between those two quarters and how should we think about that in our models?

David Little

Well, yes, we did have two large orders taken at lower margins that had some effect. Now, that’s – we’re only talking about $8 million worth of business. So that’s going to be pretty watered down by the time you look at it across $261 million. So I don’t think that accounts for all of it. Likewise, I don’t account – I know we have talked about P2 and I hate to – I hate to even have to be discussing it now because we have talked about it so much in the past but P2s – our pricing deal looks at velocity pricing and charges more for slower moving items, et cetera.

We have implemented that in a couple of regions and I will say, and I didn’t want to, but I will is we’re having some nice success with that product. Again, because it’s only two regions out of 12, I don’t think we can attribute it to that. And so at the same time I know SCS has increased their margins, of course, IPS did mostly because of those two large jobs and the service centers, they have increased their margins. So we always have a pressure on our guys to increase their margins and it’s – in every quarterly meeting we discuss it. So I’m just going to give them a pat on the back and say they’re doing a nice job.

Matt Duncan – Stephens

Okay, thanks.

Operator

Thank you (Operator Instructions) Our next question is from the line of Holden Lewis with BB&T Capital Markets. Please go ahead.

Holden Lewis – BB&T Capital Markets

Thanks, good afternoon. The EBITDA, you commented in your prepared remarks that based on the improvement you see on the EBITDA margin so far, you feel like 10% is pretty well in sight for 2013, but really talking about Q1 is at 9.1%, Q2 is at 9.4% – you’re talking about maybe you’re 70 basis point you’re so shy of that 10% level. You sound pretty confident in it. I assume you’re talking organically maybe you’re just blending in the acquisition as we get there but can you talk to me is this organic about what the bridge is from maybe 9.2%, 9.3% right now to 10%.

David Little

So, I mean, in a matter of two months we’ve seen the two regions on P2 see margin enhancement of 1% to 2%.

Holden Lewis – BB&T Capital Markets

Down.

David Little

That kind of answer your question I think.

Holden Lewis – BB&T Capital Markets

Okay you’re sort of envisioning that. So, if it’s in two of the 12 regions now how quickly would you anticipate rolling it out to the other 10?

David Little

It’s the – people have sharpened it a bit to be mixed. So, I mean, we’re talking about over the next six months or so.

Holden Lewis – BB&T Capital Markets

Okay, so you think that over the next six months you think you roll it out to the next 10 so you’ve got a few; the first two were sort of beta, they’re working well and it’s software after all; rolling it out to the rest is relatively easier. Is there heavy training involved how do we sort of look at that?

David Little

Well, there is training but there is more convincing. We still allow the people to adjust the price and now we track. So like in one region we have a 40% acceptance of the price meaning that they use the price suggested or even a higher price 40% at a time. The other region is at 25%. Now the 25% region has had about a 70 basis point improvement where as the 40% guys had 1.5% improvement. So the better acceptance we have – so it’s a matter of rolling it out, gaining people’s confidence. We’ve made adjustments to like I think people felt like we were – we went a little too far the first 12 rounds so they adjusted that. I mean, we’re trying to gain these people’s confidence and it’s been a – it’s going to require now – and by the way we think we ultimately drive 80% compliance.

Holden Lewis – BB&T Capital Markets

Okay. And how long as it taken you, on either site one or site two to get to where you are today? I mean, how long does it taken you from the time that you put it in place to the time that you get to these types of numbers?

David Little

They implemented it two months ago. So we’ve had two full months, not counting July. We are not counting July; we are actually backed May and June.

Holden Lewis – BB&T Capital Markets

That’s pretty quick.

David Little

Well that’s, yes, exactly. No, I mean, it took us – well, that’s the part I didn’t want to talk about, but, I mean, it took us a year to basically to massage the data, get all the data, get it programmed in, do all the things I’ve been talking about this for a while.

Holden Lewis – BB&T Capital Markets

Right.

David Little

So I’d say in May 1 was the go-live date for those two locations. Now, by the way, the go-live date and you saw – so you said, well, it was going to take a year to do the next one. No. We’ve already populated the suggested price into all the regions, but they’re not being trained to use it and they’re not being expected to use it at this point. So then, everything will go quicker now is my point.

Holden Lewis – BB&T Capital Markets

Okay, so that alone it sounds like it can drive those gross – continue to drive those gross margins up at a decent clip. That’s how you’re kind of initially getting there. Okay.

David Little

Absolutely.

Holden Lewis – BB&T Capital Markets

I’m sorry.

David Little

Absolutely.

Holden Lewis – BB&T Capital Markets

Okay, and then I just want to make sure I truly got the tone corrected of your business. So IPS I think we got it, you’re clearly seeing some slowing, people have – so staying a bit more cautious, it seems like that’s just sort of the nature of the capital spending type world. So IPS, you’re kind of looking at revenues kind of sticking kind of where they are maybe margins being at or slightly below current levels. I think I got that.

SCS, I just want to make sure I got that it sounds like you’re – because you’re implementing existing and new packages, it sounds like you’re pretty confident that your revenues will continue climbing there. Is that the right message.

David Little

Yes.

Holden Lewis – BB&T Capital Markets

Or economically are you seeing maybe some of this exiting work coming off a little bit or slowing?

David Little

No, that’s the right message. We’re – that segment is growing, something drastic that happened which we just did not see. I mean, I think we may have a little slowness here or there. And so, there will be some amount of business that – some amount of existing business that we think will stay levered, but let’s say it goes down a little bit. But I do believe we’re putting more into the top of the funnel and we should see it grow.

Holden Lewis – BB&T Capital Markets

Okay, now the margin in SCS, for a long time it kind of ran between 5% and 6%, now in the last three quarters, we found it gone to 6.2% to 7.5%, 9.2%, I mean, you’ve seen big improvements in that business and quite frankly I think you’re achieving margins that has been rarely seen in integrated supplies. Again, what’s kind of the story there? What specifically is driving those margins that this is sustainable?

David Little

Well, as an example, we – there was a rather large contract out there for Xerox. And at the end of the day we just simply passed. I think in the past we were chasing the elephants and now we’re chasing the smaller plants that frankly value our level of more technical products. And so, therefore, we’re able to charge a little more than just the really, really big guy that beats you up on price and so that’s been our strategy. That was DXP strategy way back 15 years ago. Precision had a much more chase the elephant strategy and so while they were running it, they stayed with that strategy and now that we have John Jeffery who comes from DXP back in the fall, we are just being more selective on the kind of accounts that value – the value proposition that we bring in and then we see real large acceptance of that. So when people value rotating equipment, when they value things that have a higher level of expertise to it, we win every time.

Holden Lewis – BB&T Capital Markets

Okay and so, I mean, does it has the margin been achieved because, you have gotten rid of the lower margin business? Or is that done as the margin has been achieved because you have been formatting and getting a larger share of new jobs that you bid at higher margins?

Mac McConnell

Well, first of all, as you know in all distribution there is leverage. So if sales are going up bottom line goes up greater. So we have the same amount of management over an increasing top line. So we’re getting margin enhancement there. I would say we have not lost any business in a long time. So we have the existing accounts. Now we may have done a better job of getting price increases through and, et cetera. But, it’s partly the leverage of increasing sales, same personnel, and then also John’s like he said, he is been focused on freight and he’s been focused on some productivity things and frankly they’ve just done a really nice job of growing the business and growing the bottom line.

Holden Lewis – BB&T Capital Markets

Got it. Great. Thanks. I’ll jump back in.

Mac McConnell

Okay

Operator

(Operator Instructions) our next question is a follow up from the line of Matt Duncan. Please go ahead.

Matt Duncan – Stephens

Hey, guys, just want to get back in and, David, maybe talk a bit more about end markets. We talked some about energy earlier, what are you seeing from other end markets and you mentioned some softness, where are you seeing the softness and what stands out as still being the strong?

David Little

Well, oil and gas is still strong as you know we’re kind of after the product and services except for safety services is all – after the drilling completion. So drilling has -the drilling rig count has declined not significantly by the way I might add but it’s declining and we see that most being the non-horizontal stuff, the none new technology stuff and the stuff related to gas which is sort of having an effect because gas is starting to go up some.

We might blame that on the weather. So we don’t see any – we see the oil and gas market as being very, very strong and then we see midstream being even stronger because we’ve poked all these holes in the ground for the last couple of years. And now they’re starting to address how they move the product from the field to refineries, to chemical plants to export places; so how do we move product around, and so mid streams growing and they’re putting in a lot of new pipelines.

And then still, our chemical markets are doing really, really well with gas prices still being relatively cheap. We’re seeing some rubber products that are very active. We see – we do see a little bit of maintaining the status quo, which is okay around mining. Some commodities have gone down so nobody has any $100 million expansion projects. We see general manufacturing as it relates to the oil and gas industry as it’s CW Rod, and their cutting tool business they’ve had a blow-out year.

They’ve been a great acquisition and the Metal Working Group is doing just fantastic. So manufacturing around products that support the oil and gas industry are doing really, really well. We see there’s some drought conditions in the middle of the states. So ag has been slow. And that’s been a good market because corn prices and stuff like that are up but, but the farmers have suffered through the drought.

Matt Duncan – Stephens

Okay, that helps. That color is helpful. Turning to the balance sheet for a minute, Mac, the leverage you said is pro forma, I guess, around 2.3 times. Remind us what’s your comfort level is with that leverage ratio, and I get the impression from what you said David that your M&A strategy at this point is probably focused on smaller bolt-on type acquisitions as opposed to the bigger ones. Is that fair?

David Little

Well, you asked several questions and I’ll answer them all. First of all our bank – our banks lets us go to 3.5. It used to be 4 but it’s a syndicated loan, they’ve let us go to 3.5. I’m comfortable at 3 and below. So, again, I think we weathered – I’ll just reiterate the fact that in 2009 we weathered a 31% I call that a cliff by the way our sales were down 31%. We were able to generate free cash flow and pay down debt and deal with that. So we feel like our business accommodates a good amount of leverage. And so then when we look at acquisitions, we do have a lot of bolt-on type stuff that’s available to us again where we keep it within our parameters of six times EBITDA or less. Businesses that are growing businesses that help our regions be at least super regions if not SuperCenters and so the activity is, there is activity there.

Matt Duncan – Stephens

Okay and a last thing for me on, Mac, on quarterly interest expense going forward, if I heard everything you said correctly in your prepared comments, it sounds like your current debt level is around $250 million, that your current rate is probably 2% to 2.25% on that debt. So that gets you to kind of $1.4 million of an underlying interest expense per quarter and then you said you’ve got $650,000 or so of a one-time cost flowing through that line into 3Q. Are there any sort of unused commitment fees that are flowing through there as well? Just what is that quarterly interest expense line going to look like at this debt level going forward?

Mac McConnell

I mean, the increase in our amortization, we’re writing off the old debt issuance costs and now we have $3 million of new debt issuance cost that we’re going to be amortizing and the increase in that is $70,000 a quarter. Sorry, I guess, amortization is about, $187,000 a quarter.

Matt Duncan – Stephens

Okay. So you add that.

Mac McConnell

And there is an unused...

Matt Duncan – Stephens

And you’ve got $1.6 million per quarter at that $250 million debt level is that right?

Mac McConnell

I’m sorry say that again.

Matt Duncan – Stephens

So if you add in the debt amortization cost, and like I said, am I right as to the rate – I think you said it – you were at 1.5% for the June quarter but you had an increase with the new facility of 50 to 75 bps. So it’s probably 2%, 2.25% would be the interest rate now, is that right?

Mac McConnell

Yes, there’s a $100 million term loan. So it’s a 2.25% and then the rest of the debt at a 100 and then – I’m sorry a 200 basis points. We have a little bit of other debt that are in a variety of interest rates, but it’s a small amount of debt. Then we’d have $187,000, $190,000 a quarter of amortization cost. And then these unused line fee I think is 25 – or it’s 20 basis point, so that’s 20 basis points on the $75 million that’s not used.

Matt Duncan – Stephens

Okay. All right, so putting all that together then, I’m getting about $1.6 million a quarter of interest expense and then for the 3Q specifically we’ve got to add in that $655,000 as a one-time write off of that amortization correct?

Mac McConnell

Yes.

Matt Duncan – Stephens

All right, I just want to make sure I had that line item. Thanks, guys.

Mac McConnell

I mean, there is always a little bit borrowed at prime, which is much higher, 3.5%. So there’s a few other little extra expense that hit.

Matt Duncan – Stephens

Okay, all right. That’s helpful, Mac. Thank you.

Mac McConnell

Sure.

Operator

Thank you. Our next question is a follow-up from the line of Holden Lewis. Please go ahead.

Holden Lewis – BB&T Capital Markets

Great, thank you. I just want to confirm, where does the $1.5 million – I guess, the $0.8 million that you incurred for acquisitions in Q2 and I think you said $1.5 million for HSE in Q3 is going to flow through. You always are doing acquisitions. So I assume there’s always a charge of some sort or a cost of some sort, but can you give us some perspective of how unique the $0.8 million, the $1.5 million is. Is that kind of a normal level or is that way above the norm? What’s kind of the normal level of M&A stuff in your world?

Mac McConnell

Well, these are all way above what we’ve been running. Buying CW Rod in Houston, Texas and KC in New York, we were using one attorney and things were simpler. We’ve bought two – in the second quarter we bought two companies that were in Canada. We that Canadian counsel, we had US counsel. HSE has investment banking fees in that $1.5 million. So the amount that we’ve spent in the first quarter and the fourth quarter and we didn’t – the only acquisitions we had in 2011 were in the fourth quarter and so these numbers are much higher. They were $100,000 a quarter or something for, which we’ve seen a big ramp up as we’ve – in this second quarter and third quarter.

Holden Lewis – BB&T Capital Markets

So, presumably as you go back to obviously you’re still comfortable doing deals but probably not big ones, probably more of the smaller bolt-on ones. You would expect that after Q3 these costs would sort of slip back into that nominal range rather than where they are today.

Mac McConnell

Yes, definitely.

Holden Lewis – BB&T Capital Markets

Okay. And then in the quarter, your intangible amortization actually ticked up, given that that’s related to acquisitions, correct me if I’m wrong, but if I’m right, can you give me a sense of what does HSE going to do with that line item in the P&L?

Mac McConnell

Right, thinking we came up with, I’ve got that. I’ve $3 million a year on amortization for HSE was just kind of our estimate.

Holden Lewis – BB&T Capital Markets

Okay. So that’s...

Mac McConnell

That’s off the top of my head.

Holden Lewis – BB&T Capital Markets

Okay. So it’s about $700,000 per quarter, is that 2.6 from Q2 of intangibles and probably become something like 3.4, that’s the way to look at it?

Mac McConnell

But what was your question?

Holden Lewis – BB&T Capital Markets

The intangible amortization was 2.6 in Q2, we would expect that to step up with HSE and it sounds like a 3.4 level is about going?

Mac McConnell

And also, I mean, we did known – we did three acquisitions in the second quarter; they weren’t there for the entire quarters. So the – if we didn’t even buy HSE, the third quarter amortization would be a little bit higher than the second quarter.

Holden Lewis – BB&T Capital Markets

Got it. Okay.

Mac McConnell

And you have intangible, and our – the times when we’ve talked about accretion and all we’ve used – we were using an estimate of $3.3 million for annual amortization of intangibles for HSE. But we haven’t done the appraisals yet so we don’t know what the real number is.

Holden Lewis – BB&T Capital Markets

Sure. Okay. Excellent, thank you.

David Little

Thank you.

Operator

And ladies and gentlemen, this does conclude our conference today. We’d like to thank you for your participation and you may now disconnect.

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