DXP Enterprises Inc (DXPE) 2012 Q2 法說會逐字稿

Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to DXP Enterprises Incorporated 2012 second quarter conference call.

During today's presentation, all parties will be in listen-only mode. Following the presentation, the conference will be open for questions. (Operator instructions.)

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

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

Before I begin, I want to remind you that today's discussion will include forward-looking statements. We want to caution you that such statements or 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 second quarter 2012 results. David Little will share his thoughts regarding the quarter's results. Then, we will be happy to answer to your questions.

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

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

Sales of Innovative Pumping Solution products increased 61.3% to $35.2 million compared to $21.8 million for the 2011 second quarter.

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

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

Second quarter 2012 sales for Supply Chain Services increased 12.8% compared to the first quarter of 2012.

Second quarter 2012 sales of Innovative Pumping Solutions' products decreased 10.8% compared to the first quarter of 2012.

Second quarter 2012 sales by our Service Center segment increased 5.2% compared to the first quarter of 2012. After excluding $6.9 million of Service Center sales for businesses acquired in 2012 on a same store basis, Service Center segment sales for the second quarter increased 1.2% from the first quarter of 2012.

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

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

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

As a percentage of sales, SG&A decreased to 21.3% from 22.1% for the second quarter of 2011. This decrease is primarily a result of economies of scale.

SG&A for the second quarter of 2012 increased $4.2 million, or 8.2%, from the first quarter of 2012. This increase is primarily the result of $2.9 million of SG&A expenses associated with the acquisitions completed in 2012 on a same store sales basis.

As a percentage of sales, SG&A increased to 21.3% from 20.4% for the first quarter of 2012, primarily as a result of increased health insurance claims, incentive compensation, travel, charitable donations, and professional fees.

We incurred approximately $800,000 of legal fees for acquisitions during the second quarter of 2012. During the third quarter, we will expend approximately $1.5 million of transaction costs associated with the acquisition of HSE.

Interest expense for the second quarter of 2012 decreased 25.5% from the second quarter of 2011. This decline is the result of decreased rates on our credit facility. On July 23rd, 2011, we amended our credit facility. This amendment significantly decreased the interest rates and commitment fees applicable at various leverage ratios from levels in effect before July 23, 2011.

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

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

On July 11, 2012, DXP closed on a $325 million credit facility. The pricing grid for the new facility is almost the same as the old facility. The primary differences are the rates for the $100 million term loan component are 25 basis points higher than for the non-term loan borrowings and the unused line fees will be five basis points higher than the old agreement.

Because of this, leverage ratio is higher after the completion of the HSE acquisition. Interest rates are expected to be 50 to 75 basis points higher than those in effect at June 30th. At June 30th, our borrowings under the credit facility were at a rate of approximately 1.5%.

The amortization of debt issuance costs will be approximately $70,000 a quarter higher under the new credit facility. In the third quarter, we will write off $655,000 of debt issuance costs related to the old credit facility.

Our availability under the new credit facility is approximately $70 million to $75 million. The new credit facility also includes a $100 million accordion feature which allows us to increase the line without the approval of the entire bank group.

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

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

Thanks, Mac. And thank you to all our participants on our conference call today.

Well, given the headwinds of Europe, our own dysfunctional government and presidential election, high unemployment, and a world economic slowdown, DXP's performance continues to be outstanding. Our DXPeople's execution of our strong strategic growth strategy is taking market share and improving our bottom line performance.

We have now produced 10 straight quarters of sequential quarter-over-quarter growth in both the top line and the bottom line. Our organic sales grew 12.8% and total sales grew through 32.5% for a sequential quarter-over-quarter organic sales growth of over 1%, reaching $261.9 million.

We continue to grow our EBITDA margins, up from 8.1% in 2011 to 9.1% in the first quarter, and 9.4% in our second quarter. Our goal of 10% EBITDA margins by 2013 certainly looks achievable.

Our Q2 2012 pro forma return on invested capital was 31% after taxes. This is one of the highest returns of working capital plus successes in our industry.

Being customer driven experts in MROP solutions continues to be a win-win both for DXP and our customers. I would like to give a special thanks to our DXP family, including the new members of our family, for their efforts and belief in being customer driven experts across a large breadth of products and services.

All of our product divisions, rotating equipment, bearings and power transmission, safety services and products, metalworking, industrial supplies are growing and doing a fantastic job of supporting our SuperCenter program and our 12 regions -- helping our 12 regions through capturing new market share.

Our acquisition program is alive and well. In the second quarter of 2012, we completed three acquisitions for total transaction consideration of $36.9 million, or six times acquisition EBITDA of $6.2 million. Note total transaction consideration includes working capital adjustments plus expenses, CapEx reimbursement, etc.

Transactions completed included ALEDco and Force Engineered Products, Industrial Paramedic Services, and Austin & Denholm. Subsequent to Q2, we announced the completion of HSE Integrated acquisition on July 11th, 2012, which will begin financial reporting in Q3.

We're excited to have these three acquisitions as part of our DXP family. ALEDco/Force Engineered Products adds to our rotating equipment division in our new Northeast region, which now includes rotating equipment, bearing and power transmission, and metalworking, and positions us to serve the promising Marcellus Shale play.

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

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

Year-to-date, acquisitions have contributed $70.8 million in sales and $6.9 million in operating income for a margin of 9.8% respectively.

When we look at ALEDco and Force Engineered Products' highlights, first of all they're a leading distributor of industrial, sanitary, and oilfield pumps and process equipment in Pennsylvania and New York, LTM sales and adjusted EBITDA at acquisitions of $8.8 million and $1.4 respectively.

They have two locations in Pennsylvania, Allentown and Wysox. They are positioned to serve the Marcellus Shale. They establish a rotating equipment alongside of metalworking division in our Northeast region.

Industrial Paramedic Services highlights -- one, leading provider of industrial medical clinical services to customers in remote locations and large facilities in Western Canada, LTM sales and adjusted EBITDA at acquisitions of $21.5 million and $4.1 million respectively, three locations in Canada, Calgary, Nisku and Dawson Creek.

They establish initial presence in Canada in major markets, driving safety services standards and best practices across North America. They focus on specialty industrial medic and clinic service, and they have a strong presence in the oil sands.

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

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

Another three transactions, or $137 million in TTM acquisition sales at time of acquisition, were -- have been within the Safety Services division. Two transactions, or $109.9 million of trailing acquisition sales at time of acquisitions, have been within the metalworking product division.

Five transactions, 62.5% or $132.1 million of sales, have been within the United States. And three transactions, the other 37.5%, $134.1 million of trailing acquisition sales, have been in Canada.

Overall, we are pleased with the acquisitions we have completed since Q4 2011. We remain excited about our pipeline. We continue to see opportunities in the United States and Canada. Over the short to medium term, we will continue to see a minimum of 10% of our growth coming from acquisitions across North America.

We continue to like the opportunities we are able to uncover. Purchase multiples have remained in our historical range and financing costs are at all-time lows, an ideal environment for acquisition activity.

I'd like to point out why we are excited about Safety Services and a little bit about our last acquisition of HSE. First server market advantage -- Safety puts us at the well at the drilling site and leads to a pull through of other products and services after a well is completed, to leverage knowledge of new industrial projects in oil and gas in rigs across DXP's platform, the opportunity potential to pull through core DXP product sales after the initial onsite safety services. Ability to compete on master contract basis servicing products positions DXP for continued increase in demand for sole source, one stop product and services provided with a national and international reach.

Complementary end markets coverage and financial compelling. Core safety product end markets fit well into DXP's core markets, oil and gas exploration, production, chemical, petrochemical, refinery, power, and mining. Industrial growth in excess of GDP with greater than 10% EBITDA margins. I like that part, especially that part.

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

Sales and EBITDA for the year ending 2011 were CAD98.2 million, CAD13.1 million of EBITDA. For the 12 months ending 12-30-2012, sales and EBITDA were $105 million and $19 million respectively.

Purchase price was CAD1.08 per share, or $85 million, for a 4.5 times trailing EBITDA, accretive to earnings somewhere between $0.10 and $0.17. This does not factor in synergisms approximately of 360 -- $630,000 in public company cost savings.

Great strategic fit, complementary to existing DXP Service Center business and Safety Services division. The combination of our Safety Services division and HSE creates the number two player in safe and healthy services, giving us size, reach, and scale, immediately establishes DXP in leading markets of Western Canada, driving major safety best practices, strengthens Service Center business in the Safety Services division, strengthens DXP's Service Center business in Canada, adds strong customers for the Safety Service division including companies like Husky Oil Operations, Canadian Natural Resources, and Suncor Energy.

Certainly financial compelling. It's accretive and has strong cash flow, provides DXP with a platform in Canada. HSE has 20 locations across Western and Eastern Canada, strategic presence in major oil plays, establishes a presence in Canada's safety market and expertise in a complete suite of safety services operating in the health safety environment, opportunity to compete on master service agreements across North America.

DXP provides a national operating base to better serve customers and operating leverage to increase growth acceleration, combine other diversification of geographic mix, creates number two player, meaningful margin enhancements to DXP going forward.

One of the things we're excited about, too, is HSE provides a CFO -- a Canadian CFO. And her team is a base of operations for the other acquisitions we'll do in that marketplace.

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

Operating income increased 21.2% to Q1 of 2012 and 30% compared to Q2 2011. Several end market customer markets remain stable or slightly improving, such as oil, oil and gas terminals, chemical, mining, food and beverage, and tire manufacturing. There is some softness in some markets, but our goal is to continue to grow by taking market share from mom and pop operations by capturing more of our customers' MRO spend.

Our continued success in key end customer markets is contributing to the expansion of our Service Center network. A Q1 investment in Mid-Continent Supply, Pump & Power, and ALEDco has broadened our technical product and service portfolio, thereby strengthening our market position and providing our industrial customers with increased value.

Each acquisition and SuperCenter investment reinforces our commitment to being the one stop source for expert solutions. Each acquisition has allowed us to reinforce our leading position in the industry by widening the breadth of technical products and services we are able to bring to our customers.

Collectively, our investments will allow us to take full advantage of the leverage we have created in our industry. Our SuperCenter strategy continues to create value for our industrial customers seeking to consolidate their vendor base without sacrificing local inventory and expertise. We will continue to prioritize our Service Centers by investing in key product lines and service expansions throughout our Service Center network.

In Q2, North Texas management team successfully elevated our Conroe Service Center to SuperCenter status, broadening our opportunity. We would like to recognize our employees, customers, and suppliers in the Conroe market for their dedication in helping us create our SuperCenter.

We presently have 30 SuperCenters and 12 in progress. As we move into the third quarter, we will offer a strong network of 30 SuperCenters and a growing pipeline of in-process candidates. We are confident in our regional management team's ability to deliver an additional two new SuperCenters in Q3.

Innovative Pumping Solutions' sales for Q2 of 2012 versus Q2 of 2011 were up 61% compared to Q1 -- were up 61%, and compared to Q1 2012, sales were down 11%. The first quarter to the second quarter decline is contributed to two large orders in the first quarter.

Operating income was up 125% in Q2 of 2012 to Q2 of 2011. Gross profit increased 1.71% to 34.2% in Q2 of 2012 from 31% in Q1 2012. Most of this increase was because of those same two major orders, unusual sales that were taken at lower margins.

The IPS segment is continuing to be faced with manufacturers' extended lead time on major equipment components. We also see end users taking steps to delay delivery and production of the modular packages. What appears to be the driving force here is, one, end users' total project is suffering from delivery issues on other aspects of project. Therefore, they don't need our equipment as fast.

And in some cases, there is a definite attempt to slow down our completion of modular package by the end user. And for this reason, we see the rest of the year at Q2 levels.

Land-based activity. The extended lead times, unstable economy, uncertain political climate of the upcoming elections are contributing to a noticeable slowdown in quoting activity as it relates to the modular pumping packages in the oil and gas and mining sector for capital ex projects on the land-based type activity.

We are monitoring this closely. And on a positive note, we hear that 2013 will be a great year for the oil and gas industry.

In the Rocky Mountains and North Dakota regions, we are seeing a shift from produced ejection packaged opportunities to production equipment such as LACT unit opportunities. The current LACT unit packages being marketed by DXP at Quadna's Golden location has gained acceptance in the market and will provide additional modular packaging opportunity for these business units. This type of modular packaging may result in slightly lower margins based on the competitive nature and market of this product.

The Gulf Coast. We are seeing some signs of activity in this sector. The opportunities are projects that were in play prior to the BP oil spill, placed on hold due to the regulatory agencies' placed a moratorium on activity. The moratorium has been lifted. BP and Chevron are moving forward with projects.

We feel confident, based on the products that DXP has to offer, and our relationship with BP and Chevron and other players will result in opportunities in this sector. The projects in this sector have a longer range scope than the land-based projects and the extended manufacturers' lead times are less of an issue.

Midstream. We see the quoting activity in this sector very good and consistent with Q1 of 2012 and Q4 of 2011. In this sector, delivery is important and many opportunities can be realized when DXP and our manufacturers can provide acceptable deliveries. Working with our major manufacturers to commit and hold critical deliveries will be a key component of new equipment projects.

We feel our remanufactured products and HP Plus products will continue to provide opportunities based on our ability to provide quality products and favorable deliveries as we control the entire process of providing pump products and packages in this category.

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

Supply Chain Services. The Supply Chain Services segment continues to see increase in both top and bottom line. Sales increased 12.79% from Q1 of '12 and 17.2% from Q2 of 2011. Operating income increased 38.5% from Q1 of 2012 and 82.7% compared to Q2 of 2011.

Overall, the Supply Chain Services segment continued strong, consistent revenue growth. We have also seen the business development team active with new projects, as DXP's unique value proposition of a large breadth of products and technical expertise is gaining reputation in the marketplace.

In Q2, the operational excellence team continued to improve efficiencies by standardizing on additional reporting across supply chain locations. This allows site managers to dedicate more time and focus on freight and accounts receivable. Great cost reductions for the customer, and DXP has done a major sustaining initiative in 2012, along with staying on top of our receivables, reducing days sales.

The Supply Chain Services implementation team is busy with the implementation of two food processing companies with an onsite store and an electronic component manufacturing facility that were signed in Q1.

Q2 saw the addition of a new customer in the pharmaceutical market. This customer will have four onsite locations going live over the next several quarters. SCS also expanded the long term customer relationship with the general manufacturing through their Massachusetts plant.

DXP's proprietary software solution, Chase, which is DXP's computerized maintenance management software, was a key element in the award of one of the abovementioned contracts. The site is going live with complete storeroom integration and onsite store in Chase.

Q2 also saw the expansion of our SCS Dallas warehouse in order to handle a large product scope. This, at the request of our large beverage account, extended our 3PL relationship and enhanced our long term relation and opportunity.

SCS continues to grow personnel and accommodate site management through implementation of new locations. Two of these are Industrial Distribution graduates. As we continue, we are investing in people to grow our future.

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

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

In conclusion, we feel -- I'm going to back up. In my conclusion, we feel that there is a softness in some markets caused by uncertainties. As these uncertainties become stable, and I am not sure it matters the direction, just that it becomes clear and stable, we will see our economy grow.

Nothing we see is falling off a cliff. We believe the strong players with the right growth strategy such as DXP will grow at the expense of our smaller competitors.

As stated before, acquisitions have purpose. They expand our geographic reach, and we leverage DXP product and services divisions to take market share. SuperCenters have purpose. They expand DXP's product service divisions on a local basis to gain market share. Integrated Supply has purpose. It leverages our breadth of products and expertise to take market share on a customer by customer basis.

Modular pumping systems have purpose. They capture capital equipment that gives us aftermarket service and repairs. Bricks and mortar have purpose. It gives us local presence and being a part of the community with same day service.

Three segments and five divisions have purpose. They give us unique ways of meeting the needs of our customers in a way that makes them more profitable. Geographic expansion has purpose, to better serve our national customers and create economic scale.

Breadth of technical products and services have purpose, to build a Company of experts that is different from competition's commodity product that bring the solution -- be the solution for our customers maintenance repair and operating needs for technical products and services.

DXP continues to outperform our competition. We look forward to a great second half of the year and beyond.

We're now open for questions.

(Operator instructions.) Matt Duncan with Stephens.

Good afternoon, guys.

Matt.

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

Well, we've started -- July seems to be a really good month for us. And I think you said it right. I think it's tougher but I think it's achievable.

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

Absolutely.

Okay. Looking at the business in sort of some pieces here, you said July has started off strong. What sort of sales trend did you see through the quarter, Mac?

Well, our days sales, I guess in the first quarter per business day we averaged $3,942,000 a day. April was $3,983,000, May was $4,104,000, and June was $4,573,000.

And then, July sounds like it's probably following the normal pattern where the month may be down from -- the June month is -- always you have a hot month at the end of a quarter. But, year-over-year growth in July sounds like it started off pretty good then.

Yes, it did.

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

Well, people -- okay, two different questions. But, we're maintaining our backlog. I would say it's not particularly growing, but it's not declining either.

And then, as far as quoting activity, a lot of the quotes our people aren't -- they're quoting things. There's projects out there, but they look like they're being delayed. And the only read we can get on that is what I've said, and that is that the marketplace -- there's a lot of uncertainties out there, a lot of headwinds. People don't know the direction of where we're headed, and so they look like to me they're -- they have live projects, they're just putting them off for a while.

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

It's tied to capital spend.

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

Oh, yes. I mean, we're -- I don't want to give the impression that we feel like things are declining. We actually feel really good about our business and in most of our -- in most people's -- I think out of 12 regions, only three of them reported flat to down a little bit. Everybody else reported up.

It's just that we have to recognize what we're reading in the papers, what's happening in the marketplace, and so what PMI is doing, what ISM is doing, etc. So, we're watching those things. They don't appear to be affecting us that bad, but they could.

And I'm just a really strong believer there's nothing out there that's going to cause us to fall off some cliff. It's just not going to happen. There's -- but, I think there is uncertainty in the market so people are kind of being a little more conservative.

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

It's doing really well. It's doing better than we expected. The first part of the year, they did have a fire, a big blowout on a drilling rig. So, they had some additional business there. What we don't know is how much did that pull away from other normal business that we have.

Alberta doesn't have a unemployment problem. They have an employment problem. And so, the amount of people that we have is -- we're trying to fly people in, etc. So, business is really, really good there.

And I don't -- I know we have the thaw out, and so the drilling rig count in Canada goes down. But, I believe on a year-over-year basis that it's actually up.

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

Yes. We did have two large orders taken at lower margins that had some effect. Now, that's -- we're only talking about $8 million worth of business, so that's going to be pretty watered down by the time you look at it across $261 million. So, I don't think that accounts for all of it.

Likewise, I don't -- I know we have talked about P2. And I hate to even have to be discussing it now because I've talked about it so much in the past. But, P2, as our pricing deal, looks at velocity pricing and charges more for slower moving items, etc. We have implemented that in a couple of regions.

And I will say -- I didn't want to, but I will, is we're having some nice success with that product. Again, because it's only two regions out of 12, I don't think we can contribute it to that. And so, at the same time, I know SCS has increased their margins. Of course, IPS did mostly because of those two large jobs. And the Service Centers, they've increased their margins.

So, we always have pressure on our guys to increase their margins. And it's -- at every quarterly meeting we discuss it. So, I'm just going to have to give them a pat on the back and say they're doing a nice job.

Okay. Thanks.

(Operator instructions.) Holden Lewis with BB&T Capital Markets.

Thanks. Good afternoon. So, the EBITDA, you commented in your prepared remarks that based on the improvement you see on the EBITDA margin so far, you feel like 10% is pretty well in sight for 2013. But, we're really talking about Q1 is at 9.1%, Q2 is at 9.4%. You're talking about maybe being up 70 basis points or so shy of that 10% level.

You sound pretty confident in it. I assume you're talking organically. Maybe you're just blending in the acquisitions to get there. But, can you talk to me, if it's organic, about what the bridge is from maybe 9.2%, 9.3% right now to 10%?

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

Okay.

So, does that kind of answer the question, I think?

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

It's -- people are chomping at the bit to be next. So, I mean, we're talking about over the next six months or so.

Okay. So, you think that the -- over the next six months, you think you'll roll it out to the next 10. So, you're kind of -- the first two were sort of beta. They're working well, and it's software, after all. Rolling it out to the rest is relatively easy, or is there heavy training involved? Or, how do we sort of look at that?

Well, there's training but there's more convincing. We still allow the people to adjust the price and we track. So, like in one region, we have a 40% acceptance of the price, meaning that they use the price suggested or even a higher price 40% of the time. The other region is at 25%.

Now, the 25% region has had about a 70 basis point improvement, whereas the 40% guys had a 1.5% improvement. So, the better acceptance we have -- so, it's a matter of rolling it out, gaining people's confidence.

We've made adjustments to -- like I think people felt like we were -- we went a little too far the first go around so they adjusted that. I mean, we're trying to gain these people's confidence and it's going to require -- now, by the way, we think we ultimately drive 80% compliance.

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

They implemented it two months ago. We've had two full months not counting July. We're not counting July. We're actually back May and June.

That's pretty quick.

Well, that's -- yes, exactly. No, I mean, it took us -- well, that's the part I didn't want to talk about. But, I mean, it took us a year to buy P2, to massage the data, get all the data, get it programmed in, do all the things -- I've been talking about this for a while. So, I'm saying May 1st was the go-live date for those two locations.

Now, by the way, the go-live date -- so, you say, well, it was going to take a year to do the next one. No, we've already populated the suggested price into all the regions, but they're not being trained to use it and they're not being expected to use it at this point. So, the -- everything will go quicker now, is my point.

Okay. So, that alone sounds like it can drive those -- really continue to drive those gross margins up at a decent clip. So, that's how you're kind of envisioning getting there. Okay.

Absolutely.

I'm sorry?

Absolutely.

Okay. And then, I just want to make sure I sort of got the tone correct of your business. So, IPS, I think we got it. You're clearly seeing some slowing. People perhaps are just being a bit more cautious. Seems like that's just sort of the nature of the capital spending type world. So, IPS, you're kind of looking at revenues kind of sticking kind of where they are, maybe margins being at or slightly below current levels. I think I got that message.

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

Yes.

I want to be clear. Are you seeing maybe some of the existing work coming off a little bit or slowing?

No, that's the right message. We're -- that segment is growing. If something drastic was to happen, which we just do not see -- I mean, I think we may have a little slowness here or there.

And so, there will be some amount of business that -- some amount of existing business that we think will stay level, but let's say it goes down a little bit. But, I do believe we're putting more into the top of the funnel and we should see it grow.

Okay. Now, the margins in SCS, for a long time they kind of ran between 5% and 6%. Now in the last three quarters, they've kind of gone to 6.2% to 7.5%, 9.2%. I mean, you've seen big improvements in that business. And quite frankly, I think you're achieving margins that have been rarely seen in integrated supply.

Again, what's kind of the story there? What specifically is driving those margins, and is it sustainable?

We're -- well, as an example, we -- there was a rather large contract out there for Xerox. And at the end of the day, we just simply passed. I think in the past we were chasing the elephants, and now we're chasing the smaller plants that frankly value our level of more technical products.

And so, therefore we're able to charge a little more than just the really, really big guy that beats you up on price. And so, that's been our strategy. That was DXP's strategy way back 15 years ago. Precision had a much more chase the elephant strategy. And so, while they were running it, they stayed with that strategy.

And now that we have John Jeffery, who comes from DXP, back in the fold, we're just being more selective on the kind of accounts that value the value proposition that we bring. And then, we see a real large acceptance of that. So, when people value rotating equipment, when they value things that have a higher level of expertise to it, we win every time.

Okay. And so, I mean, has the margin been achieved because you have gotten rid of some lower margin business, or is that done and the margin has been achieved because you've been implementing and getting a larger share of new jobs that you've bid at higher margins?

Well, first of all, as you know in all distribution, there's leverage. So, if sales are going up, the bottom line goes up greater. So, we have the same amount of management over an increasing top line, so we're getting margin enhancement there.

I would say we have not lost any business in a long time. So, we have the existing accounts. Now, we may have done a better job of getting price increases through and etc. But, it's partly the leverage of increasing sales, same personnel, and then also John's -- like you said, he's been focused on freight and he's been focused on some productivity things. And frankly, they've just done a really nice job of growing the business and growing the bottom line.

Okay, great. Thanks. I'll jump back in.

(Operator instructions.) A follow up from Matt Duncan.

Hi, guys. Want to get back and, David, maybe talk a bit more about end markets. We talked some about energy earlier. What are you seeing from other end markets? And you mentioned some softness. Where are you seeing the softness and what stands out as still being strong?

Well, oil and gas is still strong. As you know, we're kind of after -- the product and services except for safety services is all after the drilling completion. So, drilling has -- the drilling rig count has declined not significantly, by the way, I might add, but it's declining. And we see that mostly being the non-horizontal stuff, the non-new technology stuff, and the stuff related to gas, which is sort of having an effect because gas is starting go up some. We might blame that on the weather.

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

And then, still our chemical markets are doing really, really well with gas prices still being relatively cheap. We're seeing some rubber products that are very active. We see -- we do see a little bit of maintaining the status quo, which is okay, around mining. Some commodities have gone down so nobody has any $100 million expansion projects.

We see general manufacturing as it relates to the oil and gas industry as with C.W. Rod and their cutting tool business. They have had a blown out year. They've been a great acquisition and another working group that's doing just fantastic. So, manufacturing around products that support the oil and gas industry are doing really, really well.

We see there are some drought conditions in the middle of the States, so ag has been slow. And that's been a good market because foreign prices and stuff like that are up, but the farmers have suffered through the drought.

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

Well, you asked several questions. I'll answer them all.

First of all, our bank lets us go to 3.5. It used to be four but now it's a syndicated loan and they let us go to 3.5. I'm comfortable at 3 and below. So, again, I think we weathered -- I'll just reiterate the fact that in 2009 we weathered a 31% -- I'd call that a cliff, by the way, where our sales went down 31%. We were able to generate free cash flow and pay down debt and deal with that.

So, we feel like our business accommodates a good amount of leverage. And so, then when we look at acquisitions, we do have a lot of bolt-on type stuff that's available to us. Again, we really want to keep it within our parameters of six times EBITDA or less, businesses that are growing, businesses that help our regions be at least super regions if not SuperCenters. And so, activity is -- there is activity there.

Okay. And the last thing for me on -- Mac, on quarterly interest expense going forward, if I heard everything you said correctly in your prepared comments, it sounds like your current debt level's around $250 million, that your current rate is probably 2% to 2.25% on that debt. So, that gets you to kind of $1.4 million of an underlying interest expense per quarter. And then, you said you've got $650,000 or so of a one-time cost flowing through that line in the 3Q.

Are there any sort of unused commitment fees that are flowing through there as well? Just what is that quarterly interest expense line going to look like at this debt level going forward?

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

Okay. So, you add that into --.

And there is an unused --.

That $1.6 million per quarter at that $250 million debt level. Is that right?

I'm sorry. Say that again.

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

Yes. There's $100 million term loan, so it's at 2.25%. And then, the rest of the debt's at 100, and then -- I'm sorry, at 200 basis points.

We have a little bit of other debt that's at a variety of interest rates, but it's a small amount of debt. Then we'd have the $187,000, $190,000 a quarter of amortization costs. And then, the unused line fee, I think, is 25 -- or it's 20 basis points. So, that's 20 basis points times the $75 million that's not used.

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

Yes.

All right. I just want to make sure I had that line right. Thanks, guys. (Multiple speakers.)

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

Okay. All right. That's helpful, Mac. Thank you.

Sure.

A follow up from the line of Holden Lewis.

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

These are all way above what we've been running. The -- buying C.W. Rod in Houston, Texas and KC and New York, we were using one attorney and things were simpler. We've bought two -- in the second quarter, we bought two companies that were in Canada. We had to have Canadian counsel. We had US counsel. HSE has investment banking fees in that $1.5 million.

So, the amounts that we spent in the first quarter and the fourth quarter, and we didn't -- the only acquisitions we had in 2011 were in the fourth quarter. And so, these numbers are much higher. They were $100,000 a quarter or something before. We've seen a big ramp up as we've -- in the second quarter and third quarter.

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

Yes, definitely.

Okay. And then, in the quarter, your intangible amortization actually ticked up. I assume that that's related to acquisitions. Correct me if I'm wrong. But, if I'm right, can you give me a sense of what is HSE going to do to that line item in the P&L?

I'm thinking we came up with -- I've got that. I've got $3 million a year in amortization for HSE was just kind of our estimate.

Okay. So, that's --.

That's just off the top of my head.

So, that's about $700,000 per quarter. So, that $2.6 million from Q2 of intangibles probably becomes something like $3.4 million. That's the way to look at it?

What all was your question?

The intangible amortization was $2.6 million in Q2. We would expect that to step up with HSE, and it sounds like a $3.4 million level is about the right one?

Yes. And also, I mean, we didn't own -- we did three acquisitions on the second quarter. They weren't there for the entire quarter. So, the -- we didn't even buy HSE. The third quarter amortization would be a little bit higher than the second quarter.

Got it. Okay.

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

Sure. Okay, excellent. Thank you.

Thank you.

Ladies and gentlemen, that does conclude our call for today. We'd like to thank you for your participation, and you may now disconnect.