Good afternoon. My name is Kelly, and I will be your conference operator today. At this time, I'd like to welcome everyone to the DXP Enterprises Fourth Quarter and Fiscal 2018 Conference Call. [Operator Instructions]. Thank you. I would now like to turn the call over to Kent Yee, Senior Vice President and Chief Financial Officer. Please go ahead, sir.

Thank you, Kelly. This is Kent Yee, and welcome to DXP's Q4 2018 conference call to discuss our results for the fourth quarter and fiscal year ending December 31, 2018. Joining me today is our Chairman and CEO, David Little. 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. DXP assumes 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.dxpe.com. I will now turn the call over to David to provide his thoughts and a summary of fiscal 2018 and fourth quarter results.

Thanks, Kent, and thanks to everyone on our 2018 fourth quarter and year-end conference call. DXP started 2018 with some very lofty goals and coined the term smart recovery. Internally, this described our objective to grow the top line 20% and the bottom line 100%. We accomplished both goals. Congratulations to all our stakeholders and a special thank you to our DXPeople you can trust. Customers can trust DXP to be fast, convenient and technical. Experts with whom our customers enjoy doing business with, DXPeople, they like and trust. Thank you DXP sales professionals. Thank you, DXP operations, for making our sales professionals look good. Also, thank you to corporate support. One team making the customer happy. Thanks, DXPeople, for an awesome year and our future looks bright. Our smart recovery plan for 2018 included organic growth strategies for both local, regional and national accounts: such as tech program for finding new accounts, VMI to make the point-of-sale faster, selling pumps through our bearing and PT channel and custom API pumps sold through our global and national relationships. IPS expanded our effort to sell measurement equipment and better communicate around leveraging local plants into multiple plants or corporate accounts. Supply Chain Services continues to add new customers and new sites for existing customers. We have a suite of smart programs to expand value-added services and technology to existing sites. Candidates rotating equipment is in a tough market. Yet they had a great year taking market share from the competition, congratulations. PumpWorks, aftermarket, remanufacturing, all had great success selling their products and services through DXP's sales channel. Quality products, made in America and a faster supply chain gives us tremendous success. IT, accounting, inventory management are all working hard to support DXP's sales organization and manage our return on invested capital,…

Thank you, David, and thank you to everyone for joining us for a review of our fourth quarter and fiscal 2018 financial results. Q4 was another great quarter for DXP and allowed us to finish the year strong, while building momentum going into fiscal 2019. As David mentioned, we are growing through a combination of organic and acquisition-driven sales. Our balance sheet is poised for us to be acquisitive, and we look to continue the execution of that part of our strategy in 2019. And Q4 2018 financial results marks our ninth consecutive quarter of increases with respect to quarterly sales per business day. Total sales for the fourth quarter increased 17.1% year-over-year to $311 million. Adjusting for the $12.4 million Q4 sales contribution from ASI, organic sales increased 12.4%. Total DXP sales for fiscal 2018 grew 20.8% with 16.1% coming from organic sales growth. ASI contributed $47.5 million in sales for fiscal 2018, and we're excited to have them as a part of the team. They have performed ahead of plan and they have been a positive addition to DXP. Total sales growth for fiscal 2018 was supported by DXP's three business segments, reflecting the differentiated go-to-market strategy of each segment, the opportunities available given where we're at in the cycle and the continued expansion we are seeing from existing and new customers. Average daily sales for the fourth quarter were $5 million per day versus $4.4 million per day in Q4 2017. Adjusting average daily sales for ASI, average daily sales for Q4 increased 10.6% versus Q4 2017. Average daily sales for fiscal 2018 were $4.8 million per day versus $.4 million per day in fiscal 2017. The overall growth reflects the execution of our strategy supported by our key end market indicators through fiscal 2018. While we…

[Operator Instructions]. Your first question comes from the line of Joe Mondillo from Sidoti & Company.

Kent, can you just repeat the gain on sale, how much that was and confirm that it hit the fourth quarter? And what segment - did that hit one of the segment operating income lines?

No. The gain actually occurred earlier in the year. You may not remember, Joe. The gain was actually in Q2, and it was just - reflects the sale of our corporate facility, and it was $1.3 million.

Okay. Right. Okay. That's what I thought. I just wanted to confirm. On the Service Centers side of things, organic growth was pretty good. I thought you guys were going to be going up against - or I guess, you were going up against sort of a tough comp the fourth quarter of last year. Could you just talk about the trends that you're seeing there? You mentioned that you're seeing some really good growth in the Rotating Equipment and Metal Working equipment, but the deceleration was not as much as I anticipated. What are you thinking as we are now into 2019?

Yes. A fair question. You always got to remember. Our Service Center business is 80% MRO, roughly 20% OEM. And so I think I saw your note just in general on the industry. And so we - for a majority of our business there, we benefited from that - from a maintenance spend. We also benefit from ASI. ASI was a contributor. I don't know if you're looking at that on an organic or a total basis, but ASI finished the year roughly $47 million, and that was ahead of plan. And so that kind of pushed us through on the Service Center side as well. And so, we saw strength, yes, on the Rotating Equipment side, on the MRO side, but also ASI was a huge contributor throughout the year.

Okay. And then, I feel like I ask this question almost every quarter. The margins at the Service Center segment, just sort of really tough for me to get a hands around. It seems like it's a quite volatile spend - actually pretty consistent the last few quarters. Could you just comment on where you are in terms of the Service Center margins and is there more room for expansion? Are we going to have a tough comp in 2019, given the expansion that you saw in 2018? Any sort of color or insight that you can provide there that would be helpful.

Sure. Joe, I'll just walk through the trends in terms of operating income margins from Q1 in 2018 through the fourth quarter, and then I'll kind of jump to your question. Q1 operating income margins for our Service Centers were 9%, for Q2 11.3%, for Q3 10.9%, and then for Q4 11.6%. So directionally, what I'm getting at is there was, call it, a little bit north of a 200-plus basis point improvement of operating income margins. For the year, 10.76% operating income margins. Historically, that business has kind of been, call it, in the 12%, maybe at the most 14% operating income margins range. And so we're seeing improvement, and we did through 2018. If we keep the trend, we're starting to get to the higher end of that. And so - but that's natural. That typically comes once again as we get strength in our Rotating Equipment business and somewhat becomes a reflection of mix.

So some of that, Joe - Joe, some of that is scale. I think the bouncing of those margins, I think, are consistent with whether we had a higher sales month - sales quarter or not. And realize that our peak in 2014 was $1.5 billion. So we still have ways to go to get back to where our peak was. And so, as we do that, certainly, our operating income is going - as a percent of sales is going to grow. The other piece of that is gross profit, and that's a function of people, again, not being so scared to get a decent margin on stuff instead of just feeling like they have to sell it at any price. So I feel good about that. The only thing coming that we look as - we look at this as an opportunity is that our manufacturers that we represent are having price increases. And so our customers are kind of accustomed to price increases. So we tag along and add a percent for ourselves, and that tends to work.

Okay. And then - so looking at 2019 as a segment of the - as a whole Service Center, it seems like growth is moderating in the industry. I'm not sure if you agree or if you've started to see that within your business for the first two months of this year. Is it fair to say that you should probably see a moderating growth at Service Center in 2019? And maybe not as much of an expansion in margin, but continue to see expansion margin in 2019. Is that sort of the general theme that you're sort of expecting?

We're not expecting any decline in sales for the Service Centers.

No, I was talking about growth, like a deceleration of growth. It's still growth, but moderation.

Yes, yes. Right, right, right. And I think that's fair, certainly fair based on - it was fair back in the November and December when we thought the sky was falling. But it's - it hasn't played out. We seem to be tracking January and February pretty nicely. So we feel like yes, we're going to do 16% organically again. It's possible, but it's not probable. And so, I'm going to have to, knowing what I know today, think that it will be less, but I don't still know how much less.

Okay. Just a sort of a broad question on the oil and gas sector. It seems like the estimates out there are calling for sort of E&P CapEx budgets being slightly down this year, integrated companies sort of flat to slightly up. So the CapEx budget seems sort of maybe flattish to maybe potentially down, maybe potentially up. Given that environment and looking at the rig count and all these other indicators, it looks like a pretty significant slowdown, but you're coming off of a end of 2018 that was very volatile and oil prices have since rebounded. What is your sort of take on sort of how 2019 looks? Are you anticipating continued growth in your oil and gas markets? Just any sort of color there would be really helpful.

Right. So the midstream people and the people putting new pipelines in, in the States, that activity - first of all, we have a large backlog of that kind of activity where we've already sold it, and then our quoting levels still are good. So we're probably seeing nice growth in midstream. And then, when we look at drilling activity, which we don't care about, I think, that there'll be lesser of that. I think when people cut their CapEx budgets, I think, the drilling activity is one of the areas that they'll look at cutting. The question becomes where we play is after they frac a well, so they create a duct, they drilled it, but it's not completed yet. There's $4,000 to $6,000 amount there, I don't know exactly. But when they complete those and the oil gets above the ground, that's when we really start playing. So in the area where we play, we're not thinking that we're going to see a decline.

Okay. And then, so IPS, that's obviously a big part of this sector and the fundamentals that you just spoke of. What does the backlog - you mentioned that backlog grew - continue to grow throughout 2018. Has it started to decelerate in terms of the year-over-year comp? And how is that sort of trended into 2019? Just trying to get a sense of what kind of growth we're sort of anticipating for 2019 there.

So that's a good question. And really, yes, we've seen - our backlog is still growing, but it has - it isn't as robust as it was at the beginning of last year. So the question that we have is why - and because there's still a lot of activity, there's still a lot of quoting activity, so question is, are people just starting to be a little more conservative because they think - they got to kind of watch supply and demand. They don't want to get way too far ahead of the demand curve because then all of a sudden oil prices will go down and they have financial difficulties. We all remember '15 and '16 quite well. And so, I think, there's a lot of conservatism out there. But again, we think that if OPEC continues to cut production, if Russia continues to follow suit, if we're not giving Iran a free path, and if China and the United States can kind of get their - this tariff back in some sort of reasonableness, then we could - in oil and gas, we could still have - we can go back to a pretty big boom. I want to really make this distinction that the industrial market has been on an upcycle for this 10-year period. It looks like everybody thinks that after 10 years, it's got to go down. And that may or may not happen. I don't quite know how taxes and those things are going to play out. But from an oil and gas point of view, we've not been in an upcycle. We didn't even get an upcycle until '17. So we got '17 and '18, and so there's really not any reason to think that oil and gas will continue to be a really, really good market. And really, we prefer - if I could just say this, we prefer a more stable oil and gas market than the one that shoots up to $110 a barrel of oil and gas goes down to $2. I mean, if we could just have stability, then that's really better for us, and we'll perform really quite nicely.

Your next question comes from the line of Blake Hirschman from Stephens.

First, just wanted to ask about the ex ASI organic margins. I think I heard you say 27.7%, and I think that was full year but wanted to clarify. And then as a follow-up to that, could you kind of talk through some of the drivers of that organic margin expansion. I think you mentioned engineered-to-order and Canada, but just kind of wanted to get a little bit more color there.

Yes. You're correct, Blake. Sans ASI gross margins were 27.7%. Just to retrace a little bit of the history real quick. We troughed in Q3, and we troughed partially because of the two businesses you mentioned, Canadian Safety Services and our engineered-to-order business. We've seen continued improvement in both of those businesses throughout 2018 really since Q3 of last year. So that's - on the Safety Services side, it's in spite of their revenue actually being down on a year-over-year basis, but their gross margins are not back to where they've been. Their gross margins are probably still off roughly around 39 basis points from some of their peaks. And so, while we're pleased once again with the direction and kind of what they've done, you heard it probably in our comments, there's still room for improvement on the gross margin side. And so, we love to continue to see that going forward. Engineered-to-order part of that was just a scale aspect. We needed volumes to pick up. Engineered-to-order is within our IPS business segment. And so, we saw some of that - in David's comments, he throughout last couple quarters has quoted the IPS backlog, and that's continued to grow. So with that scale, some of - there's just some fixed cost leverage you get out of that business as you move through the cycle. And so, I think that's what you're seeing in that business as well.

Got it, all right. And then, wanted to see what the monthly sales per day looked like throughout the 4Q and curious if you could give us any update on what January or February looked like?

Yes, no. Absolutely. So sales per business day through the quarter for Q4, for October was $4.7 million. November was $5.0 million. December was $5.4 million. In 2019 here, a little sales flash for January and February, $4.5 million for January and $5.1 million for February.

$5.1 million, okay. And then, lastly, on capital allocation and more specifically M&A, wanted to get an update on how you're thinking about things? How the conversations are going? And if you guys think you're getting closer to kind of closing anything here?

Yes, no. In terms of acquisitions, obviously, 2018 was a year where we were coming fresh off our refinancing towards the back end of '17. And so, we did a repricing. We paid down some debt. We have light amortization on that facility, and then we're also building cash in the year with $40-plus million of cash on the balance sheet. We're - we can never time those conversations as I always say, but we engaged more heavily in dialogues in 2018, that is for sure. And so, hopefully, we'll see some of the fruit of that here in 2019 kind of as we move through the year. And obviously, that's always been a key aspect of our strategy, and we look to accelerate that, but you heard that in David and my comments. But we don't have any secret sauce in terms of turning these guys into sellers immediately, so.

Your next question comes from the line of Steve Barger from KeyBanc Capital.

This is Ryan Mills on for Steve. Again, I wanted to talk about IPS and PumpWorks. I think it's obvious to say you've taken share, given the top line performance. So can you talk a little bit about what your customers are saying and what's driving the momentum for that business?

Sure. This is going to sound interesting, but we actually have produced a made in America pump versus oftentimes others with pumps in Italy or components made in China, et cetera. So we usually have a more expensive pump. It's not out of line expensive, but it tends to be a little more expensive. So why are we successful? Well, we're successful because the flip side of that is, is our supply channel is all in America. And so we can simply do it faster. And if delivery is important, which in the oil and gas and midstream marketplaces, that's important, downstream not so much. So we're not quite as successful downstream. But we make a better pump, we make it exactly like the customer wants it, and we do it faster.

Okay. And then, I believe, on your last earnings call, you said you had advantage because your pumps are made in America. So how are your prices shaping up compared to the competitors who are experiencing tariff-driven inflation? Is that kind of leveling the playing field, because on your last earnings call, I think you said the price increases you're seeing in your pumps business is 4% to 5% compared to the double-digit increases some competitors who source overseas might be seeing?

Right. So we haven't seen the major players closer really come out with any kind of 20% price increases. So that hasn't panned out as much as we would have hoped for. The key, again, is that our - and really made in America is great as long as you're competitive. It's not - people aren't going to buy made in America if it cost twice as much. They're just not going to do it. So they'd like to, but they're not going to. So we have to be competitive. So we're close. What really drives the premium is fast delivery. That drives the premium. The American - if we're equal and we're made in America, that may win us the order. If we're 20% higher made in America, well, we're not going to get the order. We'll get the order too is that our salesman have relationships with these accounts. So we have some influence on the channel as it relates to our salesman and the customers that we're dealing with. They like us. We're fast. We're convenient. We provide technical support. We get - we build the customer the pump that he wants. It's custom-made oftentimes. So all of those things add up to a differentiation that allows us to make a good margin, even though our product is a little more expensive. And so - and then to answer specifically, the tariffs had not panned out to be a big, big deal.

Okay. Just couple more from me. Solid free cash flow this quarter and your net working capital actually ticked up throughout this year. So I'm just curious about your free cash flow expectations of 2019. And should we start to see working capital drawdown or do you still expect that to be a use of cash in 2019?

Yes. Ryan, what we experienced in 2018 was this gradual pickup. I think we peaked out in terms of working capital as a percentage of sales around 18%. And that really reflected our growth in the cost and estimated profits of basically our project business. And so if that backlog continues to build, we'll go through that similar cycle more than likely in 2019. But what happened at the back end of 2018 is a lot of those job ships - shipped and we did a better job, which act, and there's stress organizationally in terms of collecting on those jobs. Those jobs are subject to progress, billings and some other things. And so we - you see that the difference between those balance sheet account narrowed in Q4. And so, that created the free cash flow and thus a lesser drain on working capital as a percent of sales ending the year at that 16% range. And so, I think, that's what - we would normally expect just in our core distribution business, the 15% to 16% range and then with our project business, when we invest in that, it tends to drive it up slightly, so.

Okay. And then going to the oil and gas markets that you play in, earlier this week, there is a report out describing lower productivity rates from wells because they were being drilled too close together. Are you hearing anything from that in regards to that from your customers? And what are your thoughts on the implications for dock completions if this is true?

Well, oil and gases are both depleting resource. So the question is, are we experiencing depletion faster than what we anticipate? And I'm not hearing that. We know and I know - I happen to participate in oil well in the Eagle Ford as an example, and I mean it comes in at thousands of barrels a day and then it drops down. It drops down 80% by the end of that year. So - but then at that level, it kind of levels out and how long it will last, who knows. But they don't keep going down to just zero. So there is this cover where you drill a well, you get a lot of production for a year and then it drops down. That is the reason why, I guess, the oil and gas business until we all go to solar or wind turbines, we'll continue to exist even if we're not trying to do any more than just maintain existing production. And so, we feel good about that. We actually make more money on parts and aftermarket. And because we're kind of a newbie on - with PumpWorks, we don't have a lot of parts and aftermarket at this particular, say, your aftermarket business is frankly our competitor's pump, not our pumps. So there is things to come that'll be beneficial. And as long as we don't have huge swings, where price of oil goes to $24 or it goes to $100, either one of those things, really stability is a lot better for us, and it's really better for the country too. So I don't know if that answer your question, but that was my thought process.

No. That's good. And my last question. IPS has been growing at a solid clip for about seven consecutive quarters. So I'm just curious, when do you expect to see a nice benefit from that aftermarket business? Are you starting to see that now? And then could you just talk about the margin profile?

So we actually are a parts business at PumpWorks, I believe. I think this is right. I'm not sure, I could get you the exact number, but it doubled. It doubled from the year before, but it wasn't a big number. You double zero it's still zero, no. But it's - we doubled it. It'll continue. It'll probably double, again, this year. And so, it's just a matter of getting pumps out there. Now, PumpWorks' API product line has been out there. They were in the business at least five years before we purchased them. So they have some history out there and et cetera. So we're getting some of that business, and it is at high margins. And then we - like I said, we get the competition's aftermarket also.

Ryan, just bouncing back on your free cash flow question. Another way to think about that obviously is our free cash flow conversion. Our conversion on there - sometimes when I'm talking to folks in a more growing market usually, we typically expect 25% to 35% free cash flow conversion. And so I think for the year, this year, we finished around that 30% range, so that's in line. But the quarters in between is where the noise is at, I guess, was my point earlier I was just trying to make, so.

Sort of my point - am I wrong about this, Kent? I think, if we have organic growth of 20%, we'll then - we're going to use a lot of our free cash flows supporting that 20% growth. So if it - but if it's more normal and it's 10%, well, then we'll have a bigger buildup of cash. I mean, so it's just a function. And then the number is, well, can we have 15% to 17% of sales in working capital? So that's a pretty low number. So we can have a pretty high growth number and not burn all our cash, which is just proof of the fact that I bought the company in 1986 and grew it to $1.5 billion. And during that time cycle, we only raised $25 million onetime. So the cash flow is being generated.

Yes, yes.

Yes. That will make sense. And so just to add targeting that 25%, 35% in '19 as well.

Yes. I think so. Once again, I was just trying to emphasize that there is noise just to pin upon because our project business, but to David's point, it's also a mix of where our growth comes from, once again. If we - I think it was - Joe at Sidoti who asked about Service Centers, but it's more of our growth is coming through Service Centers, but that's not going to require as much. And so once again, it just depends on the quarters where that growth comes from to.

Your next question comes from the line of Joe Mondillo from Sidoti & Company.

Most of my questions were actually answered. I actually tried to withdraw, but just one or two clarification questions. The tax rate that you're sort of thinking about for this year, what would that be?

Yes. Going back to tax reform, Joe, I gave a range around 28% to 30%. This year, we're around 27%. I think the lower end of that range is still applicable. Year-over-year, we had some remeasurement adjustments. It makes us look different than most where our tax rate actually looks like it went up in 2018 versus 2017. But I think just in terms of kind of directionally, where product at lower end, if you will, that range back at the end of '17 when I said 28% to 30%.

Okay. And then last question. Just the 13.4% operating margin at the IPS segment, how do you think about that as sort of a benchmark or I mean - as we go into the beginning of 2019, are you going to see sort of potential of under that number? Or is that sort of a low bar and going forward, you should see improvement from there?

Right. So once again, I mean I'll just trace the trends for everybody else on the call. IPS through the quarters we had 9.4% operating income margins, 12.1% operating income margins, 11.4% operating income margins and then we ended the year with 13.4% operating income margins. We do have a different mix of business today than we had historically. If in the past, I know we've peaked up around a 20% operating income margin today, but I wouldn't want anyone necessarily to have those higher end expectations. I think our business today, the mix is totally different. That said, is there room to go from 13.4%? Absolutely. Once again, I mean, it's also going to depend upon mix. We have a measurement business i.e., LACTs and ACT units that tends to be a little bit lower margin and that's some of my comments around mix. But then we also have some other higher-margin API different things related to that. So it's all going to be a mix and how we fall out.

So Joe, you remember - Joe, you remember when we had 16% operating income margins in that area. And basically, in those days, we were doing a lot more offshore work and the complexity and the value add was higher, and so we made higher margins on offshore stuff. And so today, we don't - we do very little offshore. So it's more onshore, and so, it's not quite as technical. And so, therefore, the value adds, it's easier for other people to do it too. So our competition is a little greater. So that, that's right part of it, and so I'll just remind you about that.

How does the PumpWorks - wasn't there sort of some funky way of accounting? I remember this from a year or two ago, at least, I guess, where the revenue up until breakeven was accounted for in the Service Centers segment and then sort of the profits beyond that were accounted for in the IPS, is that anywhere is correct? Or how does the accounting in terms of profitability at the PumpWorks business play?

That's not - it doesn't play like that. What does happen is that a manufacturing facility like the PumpWorks almost everybody's has a pretty high fixed cost versus a distribution business where people really - or your highest fixed cost is people - yet people are variable too, so if you can get rid of them whereas when you have this plant and got all this equipment, you got all that stuff, you got to have a high fixed cost. So what does happen almost for everybody is that as you cover that fixed cost, your variable costs are not that high. So your margins will go up with volume.

Right. Now that make sense. But where is your in-house manufactured pumps accounted for? Is it in the Service Centers segment or IPS?

No. It's in IPS.

It is in IPS, okay. And that would - as we go down the road, maybe it's not in a quarter or two, but as that start - ramps up becomes a bigger percentage, that should help increase the ceiling to margins over time, correct?

Yes, you're correct.

Absolutely. Yes.

And there are no further questions at this time. This concludes today's conference call. You may now disconnect.