Ladies and gentlemen, thank you for standing by, and welcome to the DXP Enterprises Fourth Quarter and Fiscal 2019 Conference Call. At this time, all participants are in a listen-only mode. After the speaker’s presentation, there will be a question-and-answer session. [Operator Instructions] I would now like to hand the conference over to your speaker today, David Little, CEO; and Kent Yee CFO. Please go ahead.

Thank you, Kenzie. This is Kent Yee and welcome to DXP's Q4 2019 conference call to discuss our results for the fourth quarter and fiscal year ending December 31, 2019. 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 but 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 is now available on our website at ir.dxpe.com. I will now turn the call over to David to provide his thoughts and summary of fiscal 2019 in the fourth quarter results.

Thanks Kent, and thanks to everyone on our 2019 fourth quarter and year-end conference call. Kent will take you through the key financial details after my remarks and after Kent's prepared comments, we will then open for Q&A. DXP started fiscal year 2019 with the intention of making meaningful investments internally to grow sales and become more productive. We took on various initiatives that require short-term added expenses and capital investment. Some of these large initiatives, included enhancing, improving and consolidating our corporate operations to better support our internal customers, moving our flagship fabrication facility in Houston to a new 100,000 plus corporate facility to provide more capabilities and faster deliveries for our customers, implementing several new software applications to support supply chain services, accounts payable and human resource teams, expanding our aftermarket service and repair business, new programs around vendor-managed inventory and supply chain services, and created multiple new sizes of our PumpWorks private label brand, including two new products PWA-SL’s and PW-PC’s. We are pleased with these initiatives to make us fast, convenient and technical experts. Capital expenditures for fiscal 2019 were $22.1 million, of which $13.1 million was entirely growth related and in support of these initiatives and positioning DXP for the future. Our growth initiatives were largely supported by our end markets for three quarters of the year. And as we finish Q3, we experienced a deceleration in our backlog. Subsequent to Q3 oil and gas activity continued to slow and in some instances halted as we closed out the year. Additionally, our industrial end market indicators started to show signs that pointed to a slowness in activity that caught up with our results in Q4. However, we feel optimistic about 2020 despite the volatility in the market environment given the strength of our balance sheet,…

Thank you, David, and thank you to everyone for joining us for our review of the fourth quarter and fiscal 2019 financial results. Q4 financial performance reflects a shift in the operating environment, specifically, by our oil and gas customers. All three business segments were impacted, but the greatest impact was felt within Innovative Pumping Solutions. That said, DXP finished the year in a strong position, poised to execute on our acquisition strategy, having closed two acquisitions since year-end, drive further improvements in gross and operating margins within Innovative Pumping Solutions, which I will touch on in my comments later and continue to drive free cash flow generation, as we move into fiscal year 2020. As David mentioned in his comments, fiscal 2019 was focused on internal investment and positioning DXP to continue to serve our customers, employees and suppliers. We executed our plans, while navigating the changing macro and industry environment. Our initiatives were focused on improving our facilities and expanding for growth, enhancing our software tools to be more efficient and manage the business smarter and offering products and services to continue to be a one-stop source for all our customer needs. Total sales for the fourth quarter decreased 5% year-over-year to $295.5 million, reflecting the stall in activity we experienced from our oil and gas customers. Total DXP sales for fiscal 2019 grew 4.2%. First six months of 2019, we were on a pace to grow 7.9% and through three quarters we were still on track to grow 7.3%. The majority of the drop-off occurred in Q4 and the shift or halting in spending from our oil and gas end markets. As such, for the second half of 2019, Q3 and Q4, we grew 0.6% on a year-over-year basis. Average daily sales for the fourth quarter were…

[Operator Instructions] Our first question comes from the line of Blake Hirschman from Stephens. Please go ahead. Your line is open.

Hi. Good morning guys.

Good morning, Blake.

Good morning, Blake.

First one and I'll just start with IPS. The margins are essentially breakeven there. You talked about the $1.6 million, I believe of one-time costs. Can you talk a little bit more about that and kind of help us bridge to how we got all the way down to basically flat. Yeah, I'll start with that.

Well, Blake, this is Kent. First of all, I started off with that. We just simply had some jobs that had negative gross margin dollars. So the first adjustment you would do that's very uncharacteristic for us. As we said it was in an effort to build market share and some aggressive nature on the sales side of our business, if you will. And so that was roughly a $2 million impact. So if you just -- and that's just a breakeven, that's not to say, hey maybe that those jobs could have performed at closer to our average gross margins, but it's purely a conservative view to just assume those jobs broke even. And so that's a $2 million impact. Then in Q4 as well you had some SG&A items some were cash, as well as non-cash that related to the IPS segment. And that's where you get that additional kind of $1.6 million impact that you flow through the SG&A. And so that's where you get the additional kind of $1.6 million there as well. So total you're really looking at $3.6 million in IPS alone, that's just flowing through. And so that -- if we didn't have those items, obviously you can do the math, we would have been in the positive operating income territory. We would not have been at the margins, we were at in Q3 but we surely wouldn't had basically a breakeven quarter. And so, that's kind of how we looked at it. But once again that doesn't reflect that, had those jobs performed at our average gross margin you could potentially add another $2 million on top of that from operating income perspective. So…

So okay. And have the majority of the -- more aggressively bid jobs flow through? Or is this something we should be thinking about carrying over into the next few quarters or year within that IPS?

Yes. No that's a great question, Blake. What I would say is, we can see another four to six jobs that it could ship kind of potentially in 2020 and even as late as 2021 just depending upon the timing of those jobs. And so we have some more, if you will in the funnel, not in terms of volume of the number of jobs a majority went out in Q4. And so -- but there could be some more -- well there will be more into the future. We just don't know the exact timing right now at this point but we can see it.

Okay. And then on the gross margins that took a little bit of a step back. Was that mainly kind of due to these IPS segment issues that we've talked about? Or is there more geographical product segment noise? Just kind of want to get a better feel for some of the pieces there.

I guess I'm not following there Blake. Just maybe clarify the question versus the previous one.

Was the step back in gross margins that we saw was that mainly due to IPS or where there's some other headwinds in there maybe in the other segments as well?

I got you, as well. Yes. No the majority of the head was I apologize there Blake. I follow you now. You're talking total DXP gross margins? No, the step back was primarily IPS driven. There was a small quarter-to-quarter decline in the service centers, but nothing notable. A majority of that headwind was IPS related.

Okay. And then just lastly, can we get the sales per day trends? And any commentary you guys have around how things is, bounced or if they have come back at all since the end of the year? And how we should be thinking about the market with this Coronavirus situation?

In terms of sales per business day, I'll just read you the numbers as I normally do and I'll start as I normally do Q4 and bring you through estimate for February. October was 4.6 million, November 4.7 million, December 4.9 million per day, January 4.4 million per day and then February 4.6 million. So definitely a pull off from the 5 million per day we were averaging 2019, but we're picking up as we kind of -- if you will bottomed, a little bit here. And March is typically a big month for us, Blake. So we're anticipating a big month in March as we normally have when we finish the quarter out.

All right. Thanks a lot. I will hop back in queue.

Our next question comes from the line of Joe Mondillo with Sidoti & Company. Please go ahead.

Hi guys. Good morning. I apologize. I missed the beginning of the call so I apologize if we covered something already, but a couple of things; first off, IPS. So in terms of the revenue much lighter than we were looking for, just going back to the third quarter call back in November, it seemed like relative to the backlog you stated that backlog was I think you said slightly down. But this is a long lead time type business. And so I was thinking that would be a 2020 type of effect. And you even stated that you thought fourth quarter should be trending pretty good and revenue off what 10% or so much lighter than I was looking for. So could you help understand how the fourth quarter progressed relative to I guess your expectations?

Joe, this is David. The fourth quarter is -- I wish we had more color on that. It just seemed like that everybody is stock buying. This just looked really, really quite -- by the inactivity. And our capital, you'll be asking -- you're talking specifically about IPS. So they're working off backlog in the holidays or have a tendency to produce quite as much during the holidays as we normally would. But there was plenty of work. So really, there's also though a component of just weekly business where we get an order and we ship it in a week that also happens in the capital project side. So that kind of slowed pretty drastically. And so -- and then I don't really have an answer for it except for the fact that our rolling gas customers they -- the word on the street was that they were -- they were not going to spend any money for the rest of the year, build up their cash flow and try to get their stock up.

Okay. So it sounds like the bookings at least in the first half of the quarter, the orders didn't trend so well. How did the -- how have the orders trended over the last five months or so? Could you help us understand the trends there in terms of new orders and where your backlog is today?

Yes. You said you missed the earlier part of the call so that would -- Joe that was in David's comments. But essentially on a year-over-year basis, the backlog is from a dollar point of view it's just down 1.1% meaning where we stood at December 2018 versus where we stood at December 2019 is just down 1.1%. That said, if you look at the Q4 monthly average backlog were down 11.4% versus the total fiscal year 2018 average backlog. So from our perspective, the absolute dollars point to that hey there's still activity. And that follows up and firms up with what we're hearing from our team in the field interacting with the customers. And so dollars do appear to be down, but not materially. And there's projects that we know have been won in our backlog that are showing in our backlog in February and likely in March. And so we feel good with where we're at. But from an absolute percentage point, it is down 11.4%. But once again, that's coming off our -- from an absolute dollar perspective, you got to remember 2018 was up 40-plus percent off of 2017. And so net-net, what I'm getting at is, we're still comfortable with where we are at and our Q3 commentary was really that there was this deceleration occurring in the backlog. And that's still continuing, but we're seeing in the IPS backlog a pick up here as we go into the beginning of the year. And so we'll have greater clarity once we get to Q1 our Q1 earnings call.

Okay. Could you just clarify I thought you said that it was down 1% at the end of 2019. And I thought you just said towards the end of your remarks there down 11.4%. Could you just clarify?

Yes. Yes, I'm just giving you two different data points of how we dissect our backlog without giving you the absolute numbers. But if you look at where we ended 2019 versus where we were at, at the end of 2018 backlog dollars are only down 1.1%.

Okay. And then I thought...

If you look -- and then if you look at the average monthly Q4 backlog and compare that to the entirety of fiscal 2018 average monthly backlog that's only -- not only, but it's only down it seems we had such a strong year in 2018, but that's down 11.4%.

Okay, okay. I got it. So to follow-up on that. And relative to your comments that you made regarding margins and some of the lower-margin projects that you're trying to take share. It sounds like -- and this could be a total coincidence. But it sounds like maybe you're trying to go after some share with some pricing strategies in a more competitive weaker demand time period. So while your backlog is down 1% at the end of 2019, is the margin -- is the margin lower? And is that just a coincidence relative to the comments that you made regarding some of that low-margin or negative margin type projects?

So I'll answer this the best I can. Sales, we actually gained two brand-new customers never done business with used to buy from Sulzer. And so they bought from us and we won that business. And I really don't mind the fact that the sales wouldn't get really aggressive and we're trying to gain market share et cetera. That's a common thing. What was not right and what's not common and not acceptable to me is that we actually would take orders below our cost. So there might be a reason to maintain account and sell at costs. There might be we need work in the shop to maintain and so we might take an order at cost. But it's not acceptable to sell jobs where we're just going to give the customer equipment and money at the same time. And so that was happening and where the check point on that is it's not the salespeople. Salespeople did their job. They got an order. It was the manufacturing side where we didn't have good checks and balances. We had checks and balances but the person there wanted the order and so we took it and we lost money.

And in terms of the I guess internal process that you guys manage, was there effects to this or in terms of the strategy and the process?

Yes. We've looked at the process. There were some personnel changes. And so we fully expect while, Joe I don't know when you jumped on the call but in the previous question there are some jobs we still got to work through. But we've put in some changes in personnel changes. And so we expect that there will be improvements as we go throughout the year.

Okay. And then Kent, I was hoping that you could clarify exactly what the $1.6 million of one-time items were?

So the $1.6 billion is a lot of stuff. Some of it was some R&D costs that got categorized incorrectly that you could argue had to do with some of these jobs and so that was roughly $769,000. We did -- from a corporate perspective buy out one of the machines there. So that was another $251,000. But also that was just reflecting some bad financial decisions being made there. And then there was an impact related to an inventory reserve that we needed to take in the magnitude of $442,000 and then another $181,000 once again specific to another job that had been on the books for a while. So you add all that up in Q4 and you get another $1.6 million that we -- that impacted their SG&A.

Okay. And so I guess just last question for me and then I'll hop back in queue. So to look at the margin I know this is sort of addressed, but could you maybe pinpoint a little more defensively of what you're thinking margins, at least maybe in the near term? Or I mean, the drop was just so drastic in the fourth quarter. You were doing 10% to 15% earlier in the year and you went to zero in the fourth quarter. Could you just help us maybe directionally, if anything just more definitively point to where you're thinking in the near-term at IPS in terms of margins?

Yes. No. I mean, hey I think the place if I imagine, we don't provide guidance Joe. So here's what I'll say is, those one-time items that's $1.6 million that we should not see impact if you will IPS going forward. So that's one place, obviously just to start just in terms of you're thinking about IPS margins going forward. I do think it's fair. We had a disproportionate amount of these jobs. I'll call it 10-plus jobs in Q4 that had negative gross profit dollars. And so, you can quantify to breakeven at another $2 million impact but that from my perspective would be conservative. But then the question is what margin should you bake in on those dollars if they keep the volume at that same level, would those jobs performed at. And so would they have performed closer to our historic average level, of that may be appropriate and that could be anywhere between another, I'll call it $1 million to $2 million impact and so from the gross margin line. And so that's probably the best -- best I'll do in a world where we don't provide specific guidance but I think that gives you a good feel that, hey part of the drop in IPS performance in Q4 is purely volume related, take any of the noise out. But then on top of it you have this noise. And so that's probably what I would say anecdotally.

Okay. Thanks. I have a couple questions more but I’ll hop back in queue. Thanks a lot.

Okay.

Our next question comes from the line of Carl Schemm with KeyBanc Capital Markets. Please go ahead.

Hi, good morning.

Hey, good morning, Carl.

So just quickly on the acquisitions. Can you just kind of describe what the -- kind of the rationale, if they're expanding product lines or geographic expansion? Or what else those acquisitions might bring to the portfolio?

Yes. No absolutely. Carl I appreciate you mentioning that. At the beginning of the year we closed Pumping Systems Inc. They were based in Atlanta Georgia and they provided us a good amount of new geography for us. We were not in the South Atlantic. We did not have a rotating equipment location. We did have some existing bearing and PT locations but we did not have our core product category rotating equipment. Rough sales on a 12-month basis, they are about $18 million to $19 million in sales. And so we're excited to have them as a part of our portfolio. They also bring with us good end market mix. So they're primarily chemical pulp and paper water, wastewater, food and beverage and some other general industrial markets. So we're excited to have the Pumping Systems team with us here at DXP. And then kind of in February, we closed the Turbo Machinery Repair transaction. It's a single location, roughly around $4 million in sales and it's on the repair side. Once again end market exposure is meaningful chemical water, wastewater, municipal power and some other industrial markets. So new geography, new end market coverage and in our core products.

Great. I guess then just looking at future deals. What kind of leverage ratio are you comfortable getting to? What's sort of the upper limit on net debt-to-EBITDA that you would want to push to?

Yes. No, and I'll answer that two ways Carl. First and foremost, we actually have cash on the balance sheet at year-end. We had in excess of $50 million worth of cash on the balance sheet. And as of today, I had about $47 million worth of cash on the balance sheet. So, as long as I'm doing these onesies and twosie acquisitions as I call them, we're going to be -- we can work through that cash. And so, leverage actually shouldn't rise all things being equal. That said, your question about, where are we comfortable. Historically, we've -- when we've gotten closer to the four times EBITDA, we've probably taken what we call a pause and really kind of delever the business. That said we do have some covenants that you could kind of look up on our Term Loan B that kind of govern us as well. And so, we think about it more just in terms of having access to capital as well and how we're able to structure the transactions.

Great. Thanks.

Our next question comes from the line of Joe Mondillo with Sidoti & Company. Please go ahead.

Hi guys. Just a couple of follow-up questions. At service center, what would you say really weighed on the business mostly? Is it because of the rig count and everything that's going on in oil and gas? And then number two, in terms of the margins, I continue to have a tough time predicting where these margins are. They jump all over the place. It doesn't seem to be seasonal. Could you address the sequential tick down? And also, I guess the year-over-year drop? What drove that outside of volume if anything? And how you're thinking about that going forward?

Yes. The Service Centers and I'm sure David will chime in here. But the Service Centers once again you got to remember, they still have the oil and gas exposure, but they're more on the MRO side. So, if we see a curtailing activity Joe in our oil and gas end markets, the service center end market mix. For the most part approximates, what DXP's total end market make sense, so today roughly that's about 50% of what they do. They have a mix of MRO and they do have some OEM customers and those OEMs tend to be more oil and gas then. And so, I think some of that volatility here in Q4, that's what you're kind of seeing impact those guys just to touch. Once again, all segments were impacted by this halt that we saw in the oil and gas spending. Even Supply Chain Services was even though they're up 15.4% year-over-year, but it kind of impacted all segments that have -- which we've always had oil and gas exposure. David, I don't know if you have some thoughts there?

Well, are we talking operating margins or are we talking about gross margin?

Operating margins within Service Centers.

Because I think Service Centers did quite well actually.

Yes. No the -- for the year...

Our goal for the year was to get gross profit margins up and our Service Center business did a really nice job of that. And IPS blew up a bunch of jobs. And so, the overall GP came down for them. I will say this for you Joe just kind of help you a little bit. The mix of jobs that were not -- did not perform well in IPS was much higher in 2019 than it's going to be in 2020. There's still a few lingering jobs, but the mix is going to be less. So, the 9.5% operating income margin that IPS made overall for the year had more of the jobs that were not -- did not do well than it's going to happen in 2020. So I mean, we kind of got on to this way before at the end of the year. I mean, we started seeing this coming. So it was -- so we've been on it. So, you should see IPS gross or even operating gross margin, operating income margin, either one go up in 2020.

Okay. And everybody else…

Go ahead.

I was just going to say just a follow-up regarding my question on Service Center margins. I think and I was sort of referencing just the fourth quarter alone. I understand the year actually was really good definitely. And part of the reason why the year was good as far as I understand was especially in earlier in the year in second quarter or third quarter; your rotating equipment was really strong. And then, I think your business in Canada improved pretty nicely. Could you talk about the fundamentals of those two things rotating equipment and the Canada business, as we're entering into 2020? Just to get a sense of whether those margins are sustainable in 2020.

So, Canada is still faced with a pretty strong oil and gas headwind. Of course, the Eastern Canada is more water related. So, it's doing fine and doing real well. The oil and gas side has got business, got activity. It's going to have a -- what I think we're forecasting sort of flat. So, it is doing well. And then, where we picked up margin in Canada was on the safety service side and we had hired a new guy and he's doing a great job and we're -- we kind of changed our structure up there. So, everybody's playing well together and really doing a nice job. So, I expect that to continue. So, I don't have any reason to think that it's not. So, I would say flat sales and continuing to be profitable, pretty much the same level as last year, maybe a slight improvement still on the safety services side.

And then just rotating equipment and the fundamentals here--

Well, rotating equipment where we're having all the issues that we're really talking about just for a little clarity there. It's not our fabrication business. It's not that we don't know how to estimate how to fabricate things and et cetera. So, we're really just a little more on the pump side. So -- but again, the market is only going to pay us so much for these pumps and we have to manufacture it at a cost that's less than what the market will pay. And so we have a little work to do there that the activity in midstream is getting softer, but it's -- we've got a really strong backlog headed into this year. And so the activity is -- I'd really start worrying more about 2021 than I would 2020. 2020 looks to be shaping up to be better than 2019. And a good part of that is just that we don't have as many of these jobs that we kind of got a little over aggressive on. So, I think that's kind of what I have to say.

Okay just last question. Where is your -- after executing on these two acquisitions this year, where is your leverage today? And what comfort level do you have to go with leverage and in the context of your M&A strategy? I guess that's my question.

Yes, Joe, this is Kent. Our leverage ratio as defined in our credit agreement is 2.2:1. And that does reflect only using $30 million of the $50 million worth of cash on our balance sheet just in terms of calculating the ratio. So, we're really a little bit less than that if you add the additional $20 million we had at year end. We had a total of $53 million worth of cash on the balance sheet. Today, we have $47 million worth of cash on the balance sheet. So, we were able to execute those two transactions. And really frankly almost hold flat in terms of the level of cash that we have on the balance sheet. Your question just regarding kind of comfortability. At this point, if you will, I don't know if it's appropriate to say at this point in the cycle, you've got a lot of macro Black Swan events, but we feel comfortable. We built this capital structure when we redid our debt to give us the flexibility for times like this. And so we're undrawn on our ABL which we have at $85 million and then we're in the process of creating some additional capacity there. We have an accordion feature where we can flex it up an additional $50 million based upon net growth of DXP. And so we'll probably do that but it will still be undrawn. So, a long win away of what I'm getting at is we have ample capacity to go forward and opportunistically pursue acquisitions meaning get them at the right multiple, get them structured properly, and also be sure the businesses are performing. And so if we do that and it's some of these smaller transactions, it's going to be a net win for DXP, a net win for the shareholders and it's not going to impact leverage as much. Obviously, it's the tends to be the larger transactions that tend to cause us and we haven't been necessarily looking at those here more recently that in the past is when we've kind of peaked the leverage. And so a lot of what we're looking at today, a lot of what's in the pipeline is closer to what we saw here more recently in pumping systems in turbomachinery. Pumping Systems was roughly $19 million in revenue and then Turbomachinery was $4 million in revenue.

Okay. And you used cash to finance those acquisitions?

Yes, we did. Yes.

Okay, all right. Thanks. Have a good day.

[Operator Instructions]

We have no telephone questions at this time. This does conclude today's conference call. Thank you for your participation. You may now disconnect.