Q2 2018 Earnings Call

At this time I'd like to welcome everyone to the DXP Enterprises 2018 second quarter Conference call.

All lines have been placed on mute to prevent any background noise. After our speakers remarks there'll be a question and answer session. If you'd like to ask a question. During this time simply press Star then the number one on your telephone keypad, if you'd like to withdraw your question press the pound key.

Thank you Mr. Kent <unk> Chief Financial Officer, you May begin your conference.

Hey, Tim.

This is Kent <unk> and welcome to Dxp's Q2, 2018 conference call to discuss our results for the second quarter ending June 32018.

Joining me today is our chairman and CEO , David Little before.

Before we get started I want to remind you that today's call is being webcast and recorded and includes forward looking statements actual results may differ materially from those contemplated by these forward looking statements a detailed discussion of the many factors that we believe may have a material effect on our business on an ongoing basis are contained in our SEC filings, but DXP.

So there is no obligation to update that information as a result of new information or future events. During this call. We may present, both GAAP and non-GAAP financial measures a reconciliation of GAAP to non-GAAP measures is included in our earnings press release, the press release and an accompanying investor presentation are now available on our website at IR.

DXP E Dot com.

I will now turn the call over to David to provide his thoughts and a summary of the second quarter.

Thanks, Kent and thanks to everyone on our 2018 second quarter conference call today.

And as always it is my privilege to share Dxp's results with you on behalf of over 2577, DXP people, who work hard everyday as one team driving stakeholder success and value creation through.

Through the first half of 2018 DXP is off to a great start and I'm extremely proud of the team's performance here today.

During our call I will start off with a summary of my thoughts and Kent will take you through the key financial details.

After our prepared comments, we will open it up for Q&A.

Reflecting on where we were at this point in 2017.

Had just started the turn the corner from the downturn, we have experienced in physical year, 2015, and 2016 and momentum we're starting to build.

Day after six quarters of sequential sales increases we have.

<unk> seen the benefit of our positive attitude customer service excellence and winning culture.

In terms of the present operating environment.

S M and PMI manufacturing indexes, which gives us an indication of how dxp's broad industrial markets will perform continues to show expanding business strength.

Demand remained strong and consistent.

The PMI index, which has moved from March reading of.

59, 3% to a reading of 62% for June the trend continues to be above the average of the last 12 months of 59, 1%.

This supports the strength we are experiencing in sequential sales growth within our service centers as we experienced growth in our broad industrial regions, including southeast northeast North Central and Alaska.

We remain excited to see this momentum momentum on the industrial side of DXP. Additionally.

Additionally, the metalworking business index, while off record highs continues to show strength with a reading of 57, 5%.

This is a deceleration from March which had a reading of 58, 9%, but we continue to see sequential growth above GDP within our metalworking products Division.

In terms of oil and gas quarterly average oil prices drilling ducks.

To increase quarterly average prices from Q2 are up 42% from Q2 of 2017 and 8% from the first quarter of 2018.

Across our business, we feel well positioned to benefit from this upward movement. Additionally, dxp's backlog continues to support these trends and reflects the growth we were experiencing within all three of our business segments.

In terms of possible issues are headwinds, we are carefully watching and reviewing tariff developments dxp's suppliers, though are mostly multinational and will mitigate any tariffs. The best they can so that all of their distributor partners will have reasonable price increases.

DXP buys very little product from China, and Dxp's private label pump manufacturing operations are 100% made in the USA, which further reduces our exposure to tariffs overall momentum continues in our business and we are focused on DXP smart.

Coverage for 2018.

We are focused on growing the topline and bottom line as well as being fast convenient and customer driven for all of our customers.

During the first half of 2018. This has meant a focus on driving margin improvement and selling value as we move through 2018 and beyond we will continue to drive improvement in our publicly stated goal of 10% plus EBITDA margins.

Turning to our results total DXP revenues of $311 2 million for the second quarter of 2018 was an eight 9% sequential increase and a 24, 1% increase year over year. This reflects stability and growth in our end markets as well.

As the addition of application specialties company.

For the second quarter ASI contributed $12 4 million in sales are sequentially increase of 16, 7% from Q1 for ASI, adding the acquisition of ASI total DXP sales increased.

Adjusting sorry, adjusting for the acquisition of ASI total DXP sales increased 19, 2% year over year and eight 5% sequentially.

In terms of sales increases by business segment, we continue to see in our.

To see strength in our capital projects.

Zero and OEM business innovative pumping solutions sales.

Sales increased 67% year over year to $74 3 million, while service center sales increased 17, 5% year over year to $193 6 million in supply chain services the growth.

Well, then we will pay.

And supply chain services the growth, but it is great to see.

Okay.

Marketing services most of the growth some amount anyway, we'll skip that part.

But it is great to see both sales growth and continued increases in our backlog, especially within the Ips business segment.

The innovative pumping solutions increase was primarily driven by pump works made in America products and modular packaged equipment for onshore markets sequentially Ips experienced a nine 8% increase from Q1 of 18 to Q2 of 2018 or $6 seven.

Million dollar sales uptake, we continue to remain encouraged by the improvements in the Ips backlog, which has continued to grow through the first half of physical 2018, the Ips quarterly average backlog increased 62, 8% from Q1 of 2017 to Q2.

Of 18, and 17, 1% from Q1 of <unk> to Q2 of 2018, the service Center sales.

Sales growth was primary driven by increases in our rotating equipment and bearing and power transmission product divisions within service centers, we saw particular strength in DXP Canadian service safety services.

West Southeast and seal regions.

Dxp's overall gross profit margins for the second quarter were 27, 4%, a 15 basis point decline versus Q2 of 2017, however, adjusting for the acquisition of ASI gross margins were 27, 8%.

31 basis point improvement over Q2 of 17, Dxp's gross margins expanded pretty significantly from Q1 and for the first time since Q3 of 2017, we were showing improvement in our year over year comparisons the improvement in gross.

<unk> during the second quarter was primarily driven by an increase in Ips segment and the Ips segment.

Yeah.

The safety service business in Canada also experienced significant gross profit margin improvement from Q1 to Q2, expanding 646 basis points.

As we have discussed this is the seasonally soft season, and we expect to see further progress in our efforts during the second half of 2019.

SG&A for the second quarter increased $6 4 million versus Q2 of 17 or 10, 9% as a percent of sales SG&A decline.

251 basis points going from 23, 4%.

In Q2.

Physical 17% to 29% in Q2 of 18.

As I mentioned at the start of our my comments he had.

DXP has approximately 2577 full time employees SG&A will increase as expected and reflect our investment in our people and organizations as we grow going forward.

<unk> overall operating income margins was six 5% or $20 1 million, which includes corporate expense and amortization. This reflects a 236 basis point improvement in margins over Q2 of 17 that being said, we still have a ways to go to full recovery. This.

Quarter, we benefited from the leverage we get from SG&A growth is less than the overall sales growth within the business and gross margin improvement.

Operating income margin was 12, 1% service Center operating income margin was 11, 3% and supply chain services operating income margin was nine 8%.

Ips operating income margins experienced the greatest increase growing from three 9% to 12, 4% service centers increased operating income margins by 15 basis points and supply chain services operating income margins increased by 85 basis points, primarily driven.

And by a decrease in SG&A percentage of sales.

Overall, DXP produced EBITDA of 28 million versus $16 9 million in 2017, a year over year increase of $11 million or 65%.

EBITDA as a percent of sales was 9% versus six 8% for Q2 of 2017.

Earnings per diluted share for the second quarter was 63 cents compared to <unk> 23 per share in the second quarter of 2017 a.

Our year over year increase of <unk> 40 per diluted share. This does not include some one time items that Kent will discuss in more detail, but after adjusting for these items DXP produced 61 cents per share.

In summary, DXP continues its steady March out of the oil and gas downturn in the industrial slide to deliver sequential sales EBITDA and earnings per share increases of 9%, 56% and 153% respectively.

<unk> is a great team focused on producing great results for our customers suppliers and shareholders alike. All three business segments performed well during the second quarter DXP and all of our stakeholders remain excited about our future and our smart recovery as we now focus on the second half of physical too.

2018, we will continue to deliver margin expansion, while ensuring operational efficiencies investing in people tools and automation where appropriate.

We will drive change and innovate for growth and lead smarter.

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

This trend continuing to expand.

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

Our financials in more detail.

Yes.

Thank you David.

And thank you to everyone for joining us for a review of our second quarter financial results Q2 was a strong quarter for DXP and completed the first half of fiscal 2018 on a positive note.

In Q2 2018 financial results reflect continued sales growth and marks our sixth consecutive quarter of sequential sales increases are accordingly, compounded growth rate of 7%.

Our second quarter performance includes onetime items, including a gain related to the sale of our corporate headquarters that closed on June 15th and costs associated with the repricing of our term loan B, which we closed on June 20.

Adjusting for these items Dxp's performance still remained in line with our key financial metrics and expectations and keeps us on the path to the smart recovery. We have been focused on is at DXP team.

Total sales for the second quarter increased 24, 1% year over year to $311 $2 million.

Adjusting for the $12 4 million in Q2 sales contribution from ASI organic sales increased 19, 2%.

Total sales growth for the second quarter was supported across all three business segments, reflecting the continued expansion we are seeing from existing and new customers.

Average daily sales for the second quarter were up 22, 2% over Q2, 2017 or $4 9 million per day in Q2, 2018 versus 4 million per day in Q2 2017.

Adjusting average daily sales for ASI.

For Q2 increased 17, 3% versus Q2 2017 average daily sales increased seven 1% sequentially from Q1 of this year.

The overall growth reflects what we're seeing in some of our key end market indicators through the first half of 2018, including the rig count U S oil and gas production drilling the metalworking business index, the PMI and the overall average increase in the price of oil in terms of business segments. All three experienced sales growth year over year with Ips Sean.

Latest improvement increasing 67% followed by our service centers, which experienced 17, 5% growth in supply chain services with four 6% growth.

Notable businesses within our Ips segment, which experienced year over year sales growth include our configured to order engineered to order re manufacturing businesses and our branded private label pump offering in particular, we have seen growth a rebound of projects focused on onshore applications.

Regions within our service Center segment, which experienced meaningful sales growth include the south central southwest Southeast and Texas Gulf Coast regions. Additionally, we saw meaningful increase within our metalworking product division, which is primarily in the northeast and north central with a growing presence in the Pacific Northwest.

Turning to our gross margins gross margins were 27, 8% adjusting for the acquisition of ASI.

These total gross margins for Q2 reflect the progress we are beginning to see in our engineered to order business and our Canadian safety services as.

As we continue to ramp up sales gross profits should align with revenue growth as we are able to drive operational effectiveness and absorbed under absorbed overhead with the production ramps.

Sequentially, our Ips segment gross margins experienced a 144 basis point improvement from Q1 Service Center gross margins increased 74 basis points adjusting for the acquisition of ASI supply chain services gross margins declined 60 basis points from Q1.

In terms of potential headwinds to gross margins as David mentioned in his earlier comments tariffs are being discussed with our customers and suppliers that said, we have not seen tariffs impact customer to customer demand.

We are beginning to see cost pass through from suppliers in the form of absolute price increases <unk> as surcharges. The price increases are fine as DXP simply passing those on to customers surcharges are a little more involved and signaled the volatility and the nature of the discussions around trade. However, DXP believes it is still way too early to predict any longer term implications.

<unk> that feels more than comfortable that it can move through the obstacles equal to or better than our peers.

In terms of operating income combined all three business segments improved by 176 basis points and year over year business segment operating income margins versus Q2 2017.

Total DXP operating income increased to 95, 6% versus Q2, 2000 $17 million to $21 million.

Ips had the greatest uptick improving operating income margins 811 basis points to $8 9 million operating income followed by service centers, which had a 15 basis point improvement to $21 9 million supply chain services increased 85 basis points year over year, driven by a decrease in segment SG&A.

Turning to EBITDA second quarter, 2018, EBITDA was $28 million up 65% from Q2 2017. This does include a $1 3 million gain associated with selling our corporate headquarters our EBITDA margin expanded 274 basis points from Q1 2018 year over year EBITDA margins increased 223 basis points primary.

Italy, reflecting the SG&A leverage we experienced as we grow sales sales growth of 24% with only 11% SG&A growth on a year over year basis. During Q2. This translated into a two seven times operating leverage as we move through the cycle. We should experience continued operating leverage as long as we continue to drive organic growth.

Steady improvement in gross margins.

In terms of our EPS. Our Q2 net income was $11 $6 million. This is up seven 4 million or 179, 6% versus Q2 2017.

Our earnings per diluted share for the second quarter was 63.

However, our diluted EPS includes a few notable onetime items, including the sale of our corporate headquarters that closed on June 15th which resulted in a onetime gain of $1 3 million or 6% <unk> <unk> per diluted share impact. Additionally, we incurred approximately 916000 transaction costs associated with the term loan B repricing on June 25th.

Which had a <unk> <unk> per diluted share impact adjusting for these items Dxp's Q2 diluted.

Diluted excuse me EPS was <unk> 61 per share versus <unk> 63.

Per share.

Turning to the balance sheet in terms of working capital we are comfortable with where the numbers came out during the growth and rebound stage. We are focused on providing the capital to support our business and particularly for our capital project related businesses within Ips working capital as a percentage of last 12 months' sales for the second quarter was 18, 7%. This is up.

Our historical average, but remains within our targeted range and reflects investments as I just mentioned.

The main driver of the increase in working capital as a percentage of sales less cost and estimated profits in excess of billings and accounts receivable during Q2.

Cost and estimated profits has increased $11 million from Q4 and receivables are up $17 1 million from Q1 in terms of cash we had $2 9 million of cash on the balance sheet at June 30.

In terms of Capex capex in the second quarter was $4 $7 million or one 5% on our second quarter sales compared to the same period in 2017, Capex dollars up $4 2 million. The interest the increase reflects investments made within our Ips business segment, including two additional CNC machines, the purchase of patterns for our manufacturing business.

So smaller items, including forklifts in cranes. Additionally, within our service Center segment, we have four facilities relocate to better serve local markets.

As we highlighted in Q1 DXP is also making investments in software to enhance our sales efforts and our corporate operations.

Turning to free cash flow in the near term capital intensity of our business remains elevated as we invest in growth, which can be seen in lower operating and free cash flow generation.

For Q2, and the six months ended June $36, 2 million and $6 9 million in operating cash flow respectively.

Our free cash flow for the second quarter was a negative $10 9 million adjusting for the $21 7 million reclassification of outstanding checks adjusted free cash flow would have been $10 8 million that said, we did make investments in that business and really supporting our growth as evidenced by the increase in Capex and operating working capital.

Return on invested capital ROIC increased to 140 basis points from Q1 to 18, 6% and continues to improve as we drive margins and operating leverage.

In terms of our capital structure as we have discussed we successfully repriced our term loan b, reducing our borrowing costs by 75 basis points to LIBOR, plus 475 versus LIBOR plus $5 50. This is expected to generate annual interest expense savings of approximately $1 9 million.

We have two main covenants, including the fixed charge coverage and our secured leverage ratio at June 30, our fixed charge coverage ratio was three three to one and our secured leverage ratio was three two to one total debt outstanding at June 30 was $254 million in conclusion, we are pleased with our ability to have six sequential quarters of sales increases.

EBITDA growth with room for improvement and meaningful diluted EPS growth now I will turn the call over for questions.

Yes.

At this time I would like to remind everyone in order to ask a question. Please press Star then the number one on your telephone keypad.

Pause for just a moment to compile the Q&A roster.

Again, if you'd like to ask a question. Please press Star then the number one on your telephone keypad.

Your first question comes from the line of Steve Barger with Keybanc capital markets. Your line is open.

Good afternoon, guys and congrats on the quarter. This is Ryan on for Steve.

Hey, Brian how is it all right. Thanks, good good just start off with the with the obvious one that comes first can you give the organic daily sales rate by month.

Regarding <unk>, what you saw in July .

Yes, no absolutely.

Average daily sales kind of going through the quarter are as follows for.

April was $4 6 million.

For May $4 8 million.

And then for June $5 2 million.

And for July based upon our sales flash.

$4 $7 million.

Okay and then.

Really strong performance in Ips this quarter. So I was just wondering was there any.

One time items impacting that whether it's just the.

Huge amount of project deliveries.

Kind of what's driving that performance.

We use percentage of completion, so we don't kind of smooth out any any one job affecting us that big of an amount in there really wasn't any our backlog continues to grow.

Our throughput through our shops continues to grow.

Sure.

And of course as their utilization rate goes up so does that grew overhead applied in things that will help us make more money on each job starts happening so.

We're just.

Recovering nicely.

Look forward to continued growth.

Yes, Brian the only thing I'd add.

The only thing I'd add to David's comments, there just to kind of put some numbers on that because I know we.

Typically talk about it as our Ips.

Quarterly average backlog year over year is up 62, 8% and sequentially up 17% so.

I think last quarter was.

We reported similar numbers and so it just continues to grow just to support what Nathan just said so.

Okay and then.

Gross margin has been a big focus for you guys.

It sounds like you potentially have more room for improvement just.

With regard to <unk> historically gross margins are down about 20 basis points from <unk>.

Do you think the tools that you have implemented and maybe some.

Benefits from mix do you think you could maybe.

Outperform that historical average and potentially see flat too.

Improving gross margin sequentially in <unk>.

We are.

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

We.

I would I would say that we're comfortable with the flat.

Would be comfortable with increases.

Also for the fact that we're kind of having.

A series of price increases from inflation and price increases from tariffs a little bit in <unk>.

Not been a problem they've all been real manageable, but there's kind of a timing of an event they kind of hit US immediately and then we pass them on.

We soon.

Maybe even months later so.

I think we have a little bit of a headwind with that it's ultimately a good thing.

Inventory goes up the value of it goes up in.

And increase sales go up.

From an inflation point of view so so it's really good for distribution Budd.

And getting margins up.

My goals to get them to 30%.

But it's going to take us a while to get there so not getting too aggressive for the third quarter.

Flat, Okay, maybe up a little bit.

Okay, and then just two more for me.

Just curious to hear what you're hearing from customers in the Permian in regard to takeaway capacity constraints.

Did they see that impacting completion activity at all in that basin.

So.

First of all thank you need to understand them.

I get that you may want to use this for other companies and things but.

The magnitude of our backlog for the Permian Basin is.

There is less than 4% of our total backlog. So it's not a particularly gigantic number for us we have seen that backlog.

Slip a little bit over the last.

Few months.

Total backlog has gone up but specific to what youre asking about.

Odessa and the Permian Basin.

Declining a little bit.

That said, it's still substantially over what it used to be a year ago.

And so we're not.

We're not thinking that people are moving out or all of the other basins and things like that.

We see a good deal of activity there.

We're happy to serve as now.

As you know we make we make large pumps that go on pipelines and gas pipelines in oil pipelines.

So to the extent.

That we fixed some of these problems.

We're quoting a lot of large Florida jobs. So ultimately all of that will help us but.

Do we have a temporary.

Decline.

I'm going to have to agree with that.

Okay, and then my last one EBITDA margins came in a little bit above 9% this quarter and Dave I'm, just thinking if demand trends hold.

You start to see some more pricing do you think that 10%.

Margin goals, you've been talking about is maybe achievable in the back half.

But we can achieve that before and so it's.

Liberally.

So capable.

We're.

You know it.

If we take.

Well first of all part of that 9% did have.

Gain on the sale of our corporate building, we're consolidating into another building, which is a good economic move for us and so we will have benefits going forward, but.

We did have a one three or four gain on that so when you back that out we're really like it.

And a half or so.

It is definitely our goal to get that up I think when we think about that though.

Kind of a combination of.

But revenue.

Growing in expenses not rolling as fast so we can get.

Is that a sales layer.

Was favorable and then the others as gross profit margins and as we go from being in a.

You know us.

A buyer's market to a little bit more of a sellers market. It takes a while to adjust our people's attitude is about that.

But we should see incremental.

Gross profit margin improvement.

But it's I forgot where we stable core is kind of like.

Alright.

2025, 20% to 25 basis points, a quarter kind of deals. So if we do that and in sales.

Flat to coming down a little bit based on revenues.

It will take multiple quarters to get there.

Thanks for the time, guys and again congrats on the quarter.

Okay.

And there are no further questions at this time.