Good day and welcome to DXP Enterprises Incorporated Fourth Quarter and Year-end Conference Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Mac McConnell, Senior Vice President of Finance. Please go ahead sir.

Thank you. This is Mac McConnell, CFO of DXP. Good evening and thank you for joining us. Welcome to DXP’s fourth quarter 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 2015 results, David Little will share his thoughts regarding the quarter results, then we will be happy to answer questions. Sales for the fourth quarter of 2015 decreased 27.2% to $278.7 million from $382.5 million for the fourth quarter of 2014. After excluding fourth quarter 2015 sales of $5.7 million for businesses acquired, sales for the fourth quarter decreased $109.5 million or 28.6% on a same-store sales basis. This decrease was primarily the result of declines to sales to customers engaged in the upstream oil and gas industry, our manufacturing equipment for the upstream oil and gas industry. The strength of the US dollar contributed to sales decline. Sales for our Canadian operations were $29.5 million for the fourth quarter of 2015. The change in the exchange rate reduced sales by approximately $4.6 million. Sales by our Service Center segment in the fourth quarter of 2015 decreased $65.1 million or 25.8% to $187.4 million compared to $252.5 million of sales for the fourth quarter of 2014. After excluding 2015 Service Center segment sales of $5.7 million from acquired businesses, Service Center segment sales…

Thanks Mac and thanks everyone on the conference call today. I would like to personally thank all of our DX people for their efforts this year. DXP collectively confronted a challenging economic environment of an upstream oil and gas depression which started 20 plus months ago and a surprising industrial recession. Note that in my opinion these conditions do not normally go together. When oil and gas prices are down, other parts of the industrial market are supposed to benefit, My point is that there are signs that the industrial recession is turning more positive in United States and Canada. Upstream oil and gas is still in a decline especially on the CapEx side. However maintenance, repair and operating expenditures are more consistent. We have and are taking transformative actions to position DXP for the future. That said, we remain focused on executing our sales strategies, improving cost efficiencies, managing working capital effectively, strong cash flow generation as we navigate the prolonged down cycle and upstream oil and gas. On a more specific front we have and continue to consolidate administration, facilities and management to drive efficiencies and reduce costs. Our sales growth objectives include capturing additional fabrication work on capital projects where in the past, some of our sales professionals only sold to pump. We are starting downstream safety turnarounds, our sales professionals are expected to spend time hunting new customers because there are no customers or territorial restrictions with our PumpWorks brand, which is a superior pump with a faster delivery than our competitors. Targeting customers that want cost savings in their MRO supply chain, DXP’s Supply Chain Services group has the answer. Of course we continue to sell - cross sell multiple product divisions to capture more of each customer span, plus we have new sales efforts…

[Operator Instructions] And we will take our first question from Matt Duncan with Stephens Inc.

Good morning, guys.

Good morning, Matt.

So I want to start by talking about the balance sheet and I think it’s probably front-of-mind for a lot of people. So it looks like Mac as you refer to in our prepared comments, you guys are starting to talk to the banks about what you can do about the covenant. My recollection is that your leverage ratio covenants 4.25 if we annualize the EBITDA that you had in the fourth quarter, you are obviously going to be well in excess of that and I think the likelihood is pretty high. Given what you reported in the fourth quarter and the trajectory, your energy markets that you may have trouble by the end of the first quarter. So where are you in those conversations with the bank? What’s your goal for when you might get that resolved? And do you have any indication at this point sort of what that resolution might be?

I mean, I guess to some degree to summarize, we provide with model that the bank has requested. We gave to them two days ago, so the process is in the early stages of working through this amendment.

And do you have an indication that they are going to be willing to work with you? I mean, obviously in the past, many times you guys have been in this situation. The banks have been very willing to work with you and you guys haven’t sounded overly difficult to get these covenants when you needed them. Where do you think we are today or given that the leverage ratio is creeping up and looks like it could hit five or higher this year, and maybe going to any tougher to get terms with the bank? Are you pretty confident this will be resolved fairly easily?

I agree with you. Our bank group has been very supportive in the past, they were supportive back in 2009 and ‘10 and they have worked with us during 2015. I will also admit what we are - as you explain, that we are asking for this time is a little tougher for the banks than what we have asked for before. DXP is also - you’ve seen, we’ve been paying down a lot of debt, so that helps. We have a number of initiatives underway of fairly significant cost cutting. Going forward we are reselling some like corporate office building presumably when that’s sold, it’s a gain which creates EBITDA and reduces debt. There are other initiatives going along as part of this process.

Do you have any view, Mac, on what free cash flow might be for this year based on your current forecast for the year, what kind of free cash flow can you generate this year?

I think we are anticipating, I think it goes through the whole income statement first. I think we are anticipating sales to be down, but less than last year. And I think we are anticipating some pretty significant gains in our operating efficiencies. And so I think EBITDA will be down but not significant. And so I think you start with that concept and then now the question becomes if you take EBITDA, I do believe that we spent a lot of money also on CapEx. Our sales are getting in. The pump ANSI business and things like that and all that is not totally behind us. We're always doing patterns and things like that, but the majority of that is behind us. So CapEx will come down. And so then the last piece of that equation, I am giving you fuzzy comments, but I think you could deduct from there. The last is, I am trying to say, we go EBITDA, we got capital expenditures, always working capital. So the last piece is working capital, I think we can assume that working capital will go down corresponding to revenues, and so we see that going down less, so therefore we see percentage of cash flow and excess of EBITDA minus CapEx being slightly less. But it will go down correspondingly, it always does, distribution model, we sell less, we have less receivables, with cash we pay down debt, inventories go down, because we have less requirements of inventory and so we do generate cash through working capital. But it’s a function of declining sales and we would like to hope that at some point of time in the future, that our working capital requirements are not that great that should the business turnaround and sales go up then we won’t also put ourselves in a bond where we don’t have money at that particular point. And our models reflect that because we have a very high return on invested capital, so we don’t use a lot of working capital to generate growth in sales because of Supply Chain Services, because of IPS that just don’t require huge inventory levels to support sales.

So David, a couple of things that you said there that I think you’re exiting. So on the EBITDA side, it sounds like you don’t think it’s going to be down all that much year-over-year, so you did about $83 million in EBITDA in 2015. Based on recent sales trajectory, you’re going to have a lot of pressure from declining revenues, so what are you doing on the cost side that’s going to help you keep EBITDA somewhat close to what you had last year. How much can you take out of quarterly SG&A expense, for example to help drive a little better bottom line and sales go down and what are your targets there?

So I think we can’t really start with the 80 some odd million, because that’s a yearly number, so we kind of start building a model off of the fourth quarter and we think the fourth quarter had a lot of noise, but lot of stuff in it that like getting into the top business and et cetera. So we think the EBITDA number for the fourth quarter is not a normal level of EBITDA should be higher than that. And then - so then from there, we build off of what we think that number was and we build off of there, so we are not going to $80 million or even $75 million, we are going to be south of that.

So David, let me look at this way, if you take out the stuff in the fourth quarter, if it’s not normal and then kind of annualize that number, can you stick pretty close to that? I mean, if I am hearing you correctly something around $60 million seems like a double EBITDA number for 2016? If sales are down, call it in the low-to-mid teens, is that a reasonable guesstimate at this point?

I think that’s a good guess.

Okay. All right. And then the last piece just along this line of questioning, you got a $50 million ATM or you can sell some equity, if need be to raise cash, I would think that’s not something you want to do with this current stock price. Is that off the table, is a way to get some cash to pay down debt or are you thinking about maybe using that?

No, it’s off the table.

Okay. And then last thing, and I’ll hop back in queue, just on PumpWorks, if you could tell us how the launch of the PumpWorks line is going? What kind of revenues do you think it can generate this year based on what you’re seeing so far? And maybe if you can just talk about sort of how your - what you’re hearing back from your customers about that pump as it enters the market?

Yes, I mean, I like to talk about that. I guess, we kind of got into this business, but we had hoped it would have been a little later, but anyway it was earlier. So sort of around the end of October, I would say, and so the foundry and the ANSI factory have produced about - and related equipment has produced about $8 million. And if you relate that to what we were kind of down to do them with previous supplier, that probably equate to about $9 million. So we think we have been wobbling successful. We think that we have customers that truly view the pump as a superior pump, as superior delivery proposition and let’s talk about that a little bit. There is multiple sizes and multiple kinds of ANSI pumps and so you don’t ever have these - they are not just sitting on a shelf always, so there is always something that kind of needs to be made as multiple different metallurgies, multiple different sizes et cetera. So even though we do want to have inventory, and it’s kind of funny, we have actually had orders faster than we can get our inventories build up. In fact, our sales people do - are complaining off of not having enough inventory in the field, but we are trying to take care of our customers. So a lot of the orders are getting pushed in front of stockholders. So that’s kind of causes not to be operating quite as smoothly as we would like. But that’s a good problem, not a bad problem. And so we - and we have been amazingly surprised that it’s not just oil and gas customers that are - they just want things in a hurry, and they are not always concerned with brand, but we are having pretty nice success with chemical plants, petrochemical plants and refineries. And so we are aesthetic quite frankly.

Good. I think it’s going well. Thanks for the update there. I appreciate it. I’ll hop back in queue guys.

Our next question comes from Ryan Merkel with William Blair.

Hey, good morning everyone. So first question, my understanding was your business lagged to the rig count and given the rig count is down 60% or so this year, wouldn’t next year sales be down almost as much as this year?

Well, I’m thinking to make that assumption, but I don’t think that that gives us any credit for capturing market share from our weaker competitors and gives the credit for some of our growth initiatives, which are our PumpWorks and our after-market service and turnarounds in the downstream market, which is doing good, attention to capital projects that are downstream that are - or downstreams doing better. But I think our upstream - and then our upstream business is a function of - more of a function of production, not just drilling. So when we say - and hand drilling has gotten so much more efficient, so I guess we have to look at really the production rate being down versus the drilling rate being down.

Historically, we have always said that the rig - our business, oil and gas part of the business, they tend to lag the rig count by six months to a year and what’s I believe has changed is the wells are being drilled faster, they are being hooked up faster, the shale plays are much more of an assembly line operation that in many instances the wells are being drilled in less than half the amount of time. And in a lot of cases, they are being hooked up to production within days of the well being completed.

And one point, I really want make here too is that, we are not just an oil and gas company. 40% of our business is other industrial markets, and what’s been an oxymoron here thing is that when the upstream, when the oil prices as raw materials are cheap, the rest of the world is supposed to do a lot better. And refineries are doing better and down chemical plants and petrochemical plants are doing better. And then other industries are supposed to do better with that, well, somewhat maybe because of the strength of the dollar or whatever, we have not seen these other industries do better. In fact, they are doing better than oil and gas, but I think it’s fair to say that over the last six months or so we have kind of been in an industrial recession that most everybody in this space has had organic declines, and maybe they are only 3% or 4% versus 16% in oil and gas. But still nonetheless. So 40% of our business is not oil and gas, and that’s supposed to give us a more balanced portfolio of sales going forward. But we’ve been unfortunate that over the last period here that we’ve kind of had both markets that is down, and that’s unusual.

Okay. Understood. Well, second question. Some of those other industrials that you’re probably referring to, early this year, Jan, Feb, sales - organic sales year-over-year are getting less bad.

Exactly.

Is that something that you’re seeing in your 40% of business that’s too industrial?

When we look across our regions, last year, we only had one region that was plus 1% in sales; one. And this year, we saw more of our historical regions that are not oil and gas are projecting things to be a little better.

Okay. So outside oil and gas, you’re starting to sense that things could be bottoming and possibly could get a little bit better in 2016?

Yes, I do.

Okay. My last question, and I will get back in the queue. In terms of Midstream CapEx for 2016, do you have a view there as part of that guidance on EBITDA going back to Matt’s question, because that would be helpful because I think some of the rhetoric right now is that Midstream CapEx will be down 20% plus. Just curious if that [indiscernible].

Yes, that’s correct. What’s helping us is that, we are a small fish. Flowserve has 70% of API 610 market. So combination of the fact that we have some really great relationships and some really great delivery propositions. Then it’s allowing us to be a little more successful getting the fewer jobs that are out there. There are still jobs out there that you likely said, CapEx went down 20%, well, there is still 80% of those jobs that are still out there. So we are working diligently, we have close relationships with accounts and et cetera. So yes, it’s getting softer. I would agree with a 100%, but we don’t think that we are going to see our best part of the business fall of 50%, we just don’t see it. Will it be down 10%? Yes, might be so. And then to replace some of that 10%, we are getting way more aggressive in the downstream sector with the refineries and chemical plants and stuff and terminals and et cetera that also use API 610 pump. And then lastly, Saudi Arabia is still spending money like crazy. So we are - we have Saudi relationships and we are older there. So we see that business actually being better and we feel our veteran refineries and downstream being better and then what’s offsetting that is, you’re correct that the Midstream market is getting softer.

Okay. Thank you. And we will take a question from Ryan Cieslak with Keybanc Capital Markets. Please go ahead.

Hey, good morning guys. David, I want to maybe look at the revenue and the sales question again a little bit way. The question is sort of you look at maybe the first two months of the year so far, January to February, hard to be thinking how do revenues or sales look relative to the run rate you saw in the fourth quarter? Is there any indication that things maybe are close to the bottom or what are you seeing just from the initial trend so far year-to-date on a topline?

Specific to IPS.

I was thinking more broadly speaking. But if you want to take it that route, that’s fine.

Well, I would do either one. Whatever you like, I am okay.

Let’s do both, I love that.

Okay. On a broad sense we think that the bad is gone out to do the good and so we think we are going to have further sales decline. We think it’s going to be less than the 16, something we had last year. And of course, all that could change. I mean, we are - we see to be finding some firming up of oil prices, maybe I don’t know we’re going head up [Technical Difficulty] a while back. So maybe that’s all it’s having in right now, I don’t know. But we do see, some of the effects of cheap oil prices having a more positive effect on the other parts of the industrial sector. So we see that being positive. But oil prices and rig counts and production are all down and so we are not going to be able to offset that. That said, we think it’s a slighter decline and that - I mean, we can cross our fingers, but we can’t count on it, so we are not planning for this, but we could all be having a different team six months from now. But that said, we are trying to do things that allow us to take market share and to grow somebody else’s expense and one of those things is that, we use to have a big portion of our pump lines, we had restricted customers, restricted territories. Now, we have replacements for that, which we think is a better faster pump, and the [indiscernible] we don’t have any customer restrictions, we don’t have any markets that are - that we can’t go to, we don’t have any geographies we can’t go to. So consequently, we are paying our salesmen a little different to spend a portion of their time growing new…

That's good color. And I appreciate it. So I mean, David, if I hear you right, this is a year where post the supplier transition, your guys clearly feel like you have some additional flexibility to go out there and really accelerate the share gains, is that a fair statement?

I think it's fair that we can do that and I think it's fair that we still have a lot of flexibility in our cost structure.

Okay. And then I know it's getting a little bit long here on the call, but just the other question I had, when you look at and you made some color around the IPS margins going forward, and Mac, you called out the 1.7 million of unabsorbed cost. How do we think about the trajectory of margins, maybe near-term into the first quarter or even the second quarter with what those unabsorbed cost, is that something that gradually goes away or gets absorbed, some color around that might be helpful?

The ancillary portion, which is what I called out, explained, the forecast is that as we continue to ramp up production, essentially catch-up with demand, that those unabsorbed overhead will go away. And in general the castings portion is, the forecast is by the end of the first quarter, they’re going to be breaking even and by the end of the second quarter, the PumpWorks business should be breaking even. We’re treating these as cost centers. The sales are out, are done and the service centers are in other places. But the manufacturing facility is a cost center, and right now, the volume didn't absorb all the overhead because they’re still in the start-up process. So those are pluses that overhead will go away now and some of the other fabrication locations, because sales are down, there is bound to be some unabsorbed overhead and some of that overhead can be done away with, some of it’s the ramp on the building and it's going to stay there. But as business gets better, we will absorb that overhead.

Joe Mondillo with Sidoti & Company, your line is open.

So I just wanted to dive a little bit more into what you're doing with the cost side of the business, the corporate expenses were pretty much flat for 2015, and I know there are some one-time items that you sort of said won’t re-occur, but how are you positioning or managing the cost structure of the business specifically, and do you have contingencies in place, if oil falls down to $20, for instance, how are you thinking about 2016, if things turn the wrong way?

I think beside the fact that IPS has a capacity of fabrication and we can't, we’re going to maximize profitability when we’re maximizing that capacity and so now, we probably are - well, we’re over - we have overcapacity that there is some fixed cost there. So I think again, the EBITDA margins are going to go from 16 to something, but the point I’m trying to make is that there is still a lot of variables expense. So we’re going to be doing what's necessary to try to drive those people to have operating margins of 10%, and that's SES or service centers and IPS. So I think, IPS has the hardest job ahead of them, and I think, but I just - it’s just done. Unfortunately, we are a people business and besides cost of goods sold, well even in cost of goods sold, we have people that make up a good portion of that. So you just have to make tough decisions.

So I understand the service center, it's obviously, a lot of the cost is labor there, but on the IPS side, like you said, there is a lot of fixed cost, that was a big percent and the upturn of the cycle, and now, we’re in a severe downturn and there is a lot of supply of oil out there, who knows oil could remain at 30 for several years, at what point in time, do you say, okay, this has already been two years, what if we don't see a recovery in 2016, at what point in time are you thinking about taking a harder look at the capacity?

Yeah. Joe, that's a great question and by the way, let me tell you how easy it is. We don't own buildings, we don't own shops. So we can get rid of them. Unfortunately or fortunately, I guess fortunately, we give up a little bit, but what we give up is that we have a shop in Canada, people in Canada like to do business with people in Canada. We have a shop in Denver, because Denver people up in that market like to do business with those people up there and we have a shop in - multiple shops in Houston. So we look at consolidating some of those things, that’s a little easier to do quite frankly, being given up some geography. But all of this capital equipment will travel, it's not necessary. Inspectors have to get on an airplane and come to town to expect stuff, but all fabrication will travel and we should stuff overseas all the time. And yet at the same time, we have partners in Saudi Arabia, where we use them as our fabrication arm and we use our intellectual properties to sell the job and to engineer the job and they’re just pure fabrication shops. So we have levers, I want to make sure that we understand that we have levers of things we can do to take cost out.

Okay, but we are not at the point yet, it doesn't seem like you’re too overly concerned where you are starting to look at contingency plans of doing that?

We’re at the point of where we’re going to tighten our belt a little bit, but not to the point of where we start positioning ourselves where we don't have a full recovery, when it all comes back.

Okay. And then just lastly, in terms of the working capital, I know you addressed this, but is there any additional opportunities of bringing down working capital other than just your revenue is down, so your receivables and inventory would come down with that. Is there any other opportunities with the working capital or is it pretty much straight forward?

I mean, we can always do a better job managing inventories and collecting receivables, but I’m not aware of anything dramatic. History tells me that inventory - the inventory decline doesn't happen as fast as the receivables decline. And so the inventory decline should somewhat continue.

But let's be realistic, I think we look at our inventory, it turns seven or eight items, we’re not a Fastenal or MRC where their inventory turns two or three times, our inventory turns seven or eight times, so I can almost disagree with Mac in his statement. I think we do a pretty good job of collecting receivables and a darn good job of managing our inventory. So, but we have computer systems that take our inventory and when times are good, they have a 60, 90 day safety stocking and when times are bad, the banks are declining, well, we don't have any safety stock. So we can adjust our inventory levels pretty quickly to the extent that people are still buying something, not something just goes off the radar screen and they start buying it, nobody is buying it and we end up having inventory reserves and we throw it away, but I feel pretty strong about our ability to generate. We’re generating cash flow in excess of EBITDA, so that's pretty awesome.

Right. Okay. I was just trying to get an idea of - because, you are right, your working capital was a huge source of cash in 2015, so just trying to get an idea of what you're seeing for opportunities there? I just have one last question though, regarding about a year ago, you gave a pretty good picture of how much oil and gas, and you broke it out between upstream and midstream and such as a percent of the company. 2015 was a huge downturn, though, so just wondering if you have any idea if you’ve updated that, where your oil and gas in terms of upstream, midstream as a percent of the total sales pretty much heading into 2016, because obviously it's going to be a lot smaller than what you listed a year ago.

Yes. I'm thinking that our upstream exposure was 20%.

Yeah. But we saw a decline in 2015, so your industrial piece declined slower than the upstream. So I'm sure upstream is less than 20% now, do you know what your overall oil and gas exposure is going into 2016?

I have not seen that number in a while, I can get that for you, but you’re right, I believe, I remember it being 20% and then so it should be down some, but if it's down more than to 18%, I’d be surprised. It’s still a pretty sizeable number.

Okay. I'll just follow up with you guys. All right, thank you.

And we’ll take a follow-up question from Matt Duncan with Stephens Inc.

Hey, guys. Just two quick ones. First, on gross margin, Mac, it sounds like you had the under absorption of overhead that hurt that line and you expect that to sort of ride itself by the end of the second quarter. So should we see gross margins go back towards where they were in the 3Q, kind of by the middle of this year and it also sounds like maybe IPS, there are some things you can do a little bit better there. So, the 70 basis point drop we saw 3Q to 4Q, can you recoup most of that by the middle of this year?

I think we haven't really talked about the first quarter. We saw January down from the fourth quarter and that triggered, we had hoped that that wouldn't happen, but it did, and so that triggered a big movement on our part to get back heavily involved in expenses and so we’re doing that, we’re making very significant strides, but a lot of that isn’t going to show up in the first quarter, it's going to show up in the second quarter. So I would say that we would, we would kind of take some of the unusual things out, so I think somewhere between the third quarter and the fourth quarter is probably the EBITDA number we’ll have, but again that's based on March being a typical March that’s much better than January.

Okay. So the gross margin gets a little bit better than in the first quarter. Should gross margin should step up again in the second quarter, back close to where we were in the third quarter of last year, probably about the third quarter of this year, is that a fair step function of what that’s going to look like?

I think we’re thinking that margins are going to be under pressure and that, but we have things that we’re making higher margins on and some things we’re making less margins on, so I think if we were modelling margins, we would think of them in terms of I believe they were, what were they for the year, 28.3 or something like that.

28.2 for the year and 27.6 in the fourth quarter.

[indiscernible]

Okay, that's fair enough. That makes sense. And then you kind of got to my other question, which is just the revenue trend that you’ve seen through the fourth quarter into January, it sounds like January kind of stepped down, but if you follow the normal quarter, March ought to be a much better month than January, I would assume relative to the average in the fourth quarter?

Right.

Matt, you usually ask this question about days sales during the quarter, you haven't asked, so I’ll give it to you. The days sales in the fourth quarter averaged $4,495,000 and the way that worked is October was $4,365,000 a day, November increased a little to $4,471,000 a day and December was $4,653,000 a day. None of that would make any sense when oil prices were declining during the quarter. So it just shows how our trend typically works, the business gets better as we go through the quarter. Sales in January where days sales were approximately $4,088,000 a day in January and that works out to be right, a 9% decline from the average for the fourth quarter of 2015.

Right, but then you get the build in February and March in all likelihood like you saw from October, November to December, because that's the sort of the way your typical quarter looked?

February actually is running about close to 2% below the days sales for the same number of days in January. So they hadn't necessarily seemed to pick up, but that's not unusual, I mean, it’s usually [Technical Difficulty]

That's hard to look at because we still - 20% of our business gets done on the last two days.

That's right. So you just don’t really know.

I’m not too concerned about that yet.

All right, guys. Fair enough, thanks.

And there are no further questions in the queue at this time. I'd like to turn the conference back over to our presenters for any additional or closing comments.

Thank you all very much.

And that does conclude today's conference. Thank you all for your participation.