DXP Enterprises Inc (DXPE) 2014 Q4 法說會逐字稿

Good day and welcome to the DXP Enterprises, Incorporated fourth quarter conference call. Today's conference is being recorded. At this time I would like to turn the conference over to Mac McConnell, Senior Vice President of Finance and Chief Financial Officer. Please go ahead sir.

This is Mac McConnell, CFO of DXP. Good evening, and thank you for joining us. Welcome to DXP's fourth quarter conference call. David Little will also speak to you and answer your questions. Before we begin, I want to remind you that today's discussion will include forward-looking statements. We want to caution you that such statements are predictions and actual events or results can differ materially. A detailed discussion of the many factors that we believe may have a material effect on our business on an ongoing basis is contained in our SEC filings, but DXP assumes no obligation to update that information.

I will begin with a summary of DXP's fourth quarter 2014 results. David Little will share his thoughts regarding the quarter's results, then we will be happy to answer questions. During the fourth quarter of 2014, DXP performed its annual goodwill impairment test for each of our reporting units. As a result of this test, DXP determined a pretax $117.6 million write-down of B27 and Natpro goodwill was required. After tax this charge was $102 million, or $6.66 per share.

Additionally during the fourth quarter, DXP finalized the purchase accounting for customer relationships for B27 and amortized these relationships on an accelerated basis. This revision increased 2014 amortization expense by $4 million, or $1 million per quarter. The first three quarters of 2014 have been revised to reflect this increased amortization expense in each quarter. This revision will result in 2015 and 2016 amortization expense being $3.5 million and $2.8 million greater than before the revision respectively.

Sales for the fourth quarter increased 21.9% to $382.5 million from the fourth quarter of 2013. After excluding fourth quarter 2014 sales of $51.1 million for businesses acquired, sales for the fourth quarter increased $17.7 million, or 5.6% on a same store sales basis. Sales of innovative pumping solutions products increased $35.5 million, or 66.1% to $89.1 million compared to $53.6 million for the 2013 fourth quarter. After excluding 2014 IPS segment sales of $30.59 million for B27, IPS segment sales for the fourth quarter of 2014 increased $4.5 million, or 8.5% from the fourth quarter of 2013 on a same-store sales basis. This increase primarily resulted from continued demand from upstream production and midstream customers. This fourth quarter organic sales increase of 8.5% is better than the 2014 annual organic growth rate for IPS of 3.9%. Sales by our service center segment increased $28.2 million, or 12.6% to $252.5 million, compared to $224.3 million of sales for the fourth quarter of 2013. After excluding 2014 service center segment sales of $20.1 million for businesses acquired, service center segment sales for the fourth quarter of 2014 increased $8 million, or 3.6% from the fourth quarter of 2013 on a same-store sales basis. This sales increase is primarily the result of increased sales of cutting tools and safety supplies and services.

The fourth quarter organic sales increase of 3.6% is better than the 2014 annual organic increase of 2.5%. Sales for Supply Chain Services increased $5.1 million, or 14.2% to $41 million compared to $35.9 million for the 2013 fourth quarter. The increase in sales is primarily related to increased sales to new and existing customers serving the automotive, oil and gas, mining and general manufacturing markets. The fourth quarter organic sales increase of 14.2% is better that the 2014 annual organic increase of 11.2%. When compared to the third quarter of 2014, sales for the fourth quarter of 2014 decreased $4.6 million, or 1.2%. This 1.2% decline is less than the 3.1% fewer days in the fourth quarter than in the third quarter. Sales per business day in the fourth quarter increased 2% over the third quarter. Fourth quarter 2014 sales of Innovative Pumping Solutions products increased $450,000, or 50 basis points compared to the third quarter of 2014. Sales per business day increased 3.7%. This increase primarily resulted from continuing demand from our upstream production and Midstream customers.

Fourth quarter 2014 sales by our service center segment decreased $2.6 million, or 1% compared to the third quarter of 2014. Sales per business day increased 2.2%. Fourth quarter 2014 sales for Supply Chain Services decreased $2.4 million or 5.6% compared to the third quarter of 2014. The decrease in sales is primarily the result of 3.1% fewer business days in the fourth quarter, combined with several customers that closed for a week for the holidays in December. Gross profit as a percentage of sales for the fourth quarter of 2014 decreased to 27.9% from 30.2% for the fourth quarter of 2013. This decrease was primarily the result of decreases in the gross profit percentage for each of the three segments.

For service centers the declining gross profit percentage is primarily the result of the decline in sales of higher margin safety services work and equipment rentals, primarily related to workover rigs in the US, and drilling and well completions in Canada. This decline in sales of safety services and equipment rentals to the upstream oil and gas industry, was offset with increased sales of lower margin safety products to industrial customers, which contributed to the decline in gross profit margin. The decline in the gross profit percentage for the IPS segment is the result of three orders with lower than normal margins being completed in the fourth quarter. The decline in the supply chain gross profit percentage resulted from a change in product mix to our customers.

SG&A for the fourth quarter of 2014 increased $14.5 million, or 21.8% from the fourth quarter of 2013 compared to the 21.9% sales increase. This increase is partially the result of $8.1 million of SG&A expenses associated with acquisitions completed during 2014. As a percent of sales, SG&A was consistent with the fourth quarter of 2013. Excluding the effect of the $2.8 million reversal of the Natpro earnout in 2014, and expenses from business acquired on a same store sales basis, SG&A increased by 5.5%. This increase is primarily related to the 5.6% organic increase in sales. SG&A for the fourth quarter of 2014 decreased $1.5 million, or 1.9% from the third quarter of 2014.

As a percentage of sales, SG&A decreased to 21.2% from 21.3% for the third quarter of 2014. The decline in SG&A is partially the result of the 1.1% decline in sales in the fourth quarter from the third quarter. Corporate SG&A for the fourth quarter of 2014 decreased $1.6 million, or 12.2% from the fourth quarter of 2013 and decreased $300,000, or 2.8% from the third quarter of 2014. The decreases partially resulted from decreases in incentive compensation in connection with lower pretax income, and on comparison to the fourth quarter of 2014 due to the fourth quarter of 2013 including $1 million of B27 acquisition expenses. Interest expense for the fourth quarter of 2014 increased 117% from the fourth quarter of 2013. This increase was primarily due to the increased borrowings to fund 2014 acquisitions. The increased borrowings also increased the interest rate on our borrowings compared to the fourth quarter of 2013. Interest expense for the fourth quarter decreased 11.1% from the third quarter of 2014. This decrease was primarily due to our reduction in the average debt balance between the two periods. Total long-term debt decreased approximately $38.1 million during the fourth quarter, despite spending $5.1 million of cash on Treasury stock, and $3 million of cash on purchase of fixed assets during the quarter. In fact, we reduced debt by $80.3 million during the second half of 2014. Total long-term debt was $411.5 million at December 31, 2014.

At December 31, 2014, the amount available to be borrowed under our credit facility was approximately $51 million, and our bank leverage ratio was 2.9 to 1. At December 31, our borrowings under the credit facility were at an average interest rate of approximately 2.2%. Cash on the balance sheet at December 31, was $47,000. The December 31, 2014 Accounts Receivable balance was $239.2 million. The inventory balance was $115.7 million at December 31. Now I would like to turn the call over to David Little.

Thanks, Mac. And thanks to all those participating on our call today. DXP accomplished a lot in 2014, and we would like to thank all of our DXP people for the financial results they had this year. We were focused on improving and managing our growth, culture, expenses, working capital, and ease of doing business with our segments and product divisions. We made meaningful progress with Natpro, and positioned ourselves at B27 for future success in 2015 and beyond. Additionally during the quarter of the year, we were faced with increased volatility in the upstream oil and gas market and a drop in oil prices.

That said, we remain focused on executing our strategy, achieving our goals of growing sales and the EBITDA line, efficient working capital management, and strong cash flow generation. Q4 sales were up organically 4.64%, and up in total 21.91%. Q4 sales were basically flat compared to Q3 2014 when compared on a same day basis. Gross profit as a percent of sales was down because of three different jobs in our IPS segment. One at our 529 facility was a large job taken at low margins to beat the competition, and strengthen our position with a large midstream account. The second job with B27, this was an $11 million order was taken in the low teens to keep out the competition of one of our good accounts, so we matched the competitor's price. The third job was a cost overrun to get a job out before the end of the year, and we had to outsource a lot of the work at a higher cost.

It is not unusual to have these types of orders, but not usual to have all of them in the same quarter. Note these orders were received much earlier in the year and are not considered a trend. Q4 expenses were in line at 20.93% of sales excluding the impairment charge and the additional amortization. Interest expense was down compared to Q3 2014 as we continue to pay down debt. Our leverage ratio improved from 2.92 to 1, to 2.9 to 1 as our debt was paid down $38.1 million in the quarter. For 2014 versus 2013, sales were up 20.8%. Sales organically was up 3.8%. Gross profit is down as a percent of sales 1.13%, and the reason is that the service center segment has reduced gross margins of 1.04% caused by a reduction of safety services business, which has high margins and replaced the safety product sales with low margins. Safety sales were up slightly $1.7 million, with gross profit being down $8.3 million. The IPS segment gross profit was down 86 basis points because of the three jobs in the fourth quarter. IPS gross margins would have been up without these jobs. Of course, we did make money on these jobs, just not as much as normal. Supply Chain Services was also down 74 basis points.

Expenses are down as a percent of sales by 29 basis points excluding the impairment charge and additional amortization. Segment operating income was up $19.3 million, but down to 11.51% of sales versus 12.36% of sales at 2013. The decline in the service center and IPS segment was for the reasons that were given on the gross profit missing our target. Our oil and gas customers are wanting cost reductions, and DXP can help them. First, Supply Chain Services can help big time with guaranteed cost saving, and our Safety Services division can reduce our labor charges without hurting margins.

My point here is DXP believes it can gain market share by helping our oil and gas customers reduce their costs without reducing our operating margins. DXP safety is building one of the best safety companies in our industry. We will get stronger in the industrial plant turnarounds, which will help diversify our oil field safety services. We want to be the best safety service company, in both industrial and oil and gas, plus grow our safety products revenue. DXP rotating equipment division is doing a great job to help our customers save money. Natpro and B27 are going to be a big part of our future success. DXP metal working is working hard to make all of DXP easier to do business with by creating multiple channels. The customer can decide how he wants to place the orders with us. Acquisitions in this space is working great, and we continue to strive to build a $1 billion company in metal working. DXP Bearing and Power Transmission is doing well by being innovative. We like what this business division does for our local customers that appreciate supercenters and people expertise. We were also doing great things on preventative maintenance and reliability.

Allow me now to focus on summarizing activities within the three business segments, service centers, supply team services and Innovative Pumping Solutions. DXP service center segment had sales increase of 11.61%, with an operating income margin of 10.91%. Organic and acquisition sales growth was driven primarily by Texas Gulf Coast region, Ohio River Valley region, North Texas and North Central regions. While these regions showed improvement in contributed profit margins over physical 2013, additional regions also improved profit margins included South Atlantic, Ohio River Valley, and the Alaskan region. Natpro also showed meaningful progress through the year. For my product perspective, DXP service centers saw strong growth from the metal working and rotating equipment divisions, with margin improvement within the bearing and power transmission business and the rotating equipment product division. That said, DXP safety product and services division lost service work to a major customer during the year, and was able to replace those sales, but with product sales which have a much lower gross profit margin. During the year, we acquired Machinery Tool and Supply, and completed three integrations, Tool Tech, Tucker Tool, and Alaska Pump. We look forward to all of their growth under DXP, and becoming a part of our business model.

While DXP service center segment performed well overall, 2014 proved to be a challenge. Several factors contributed to the challenges we faced this year. Modest GDP growth, negligible price inflation, overall margin pressures, specifically from upstream oil and gas companies, and a shortage of skilled labor in key energy markets. The cumulative effect of these headwinds impeded efforts to grow our historic growth rates while impacting markets. Throughout 2014 our service center management team successfully converted five in-process service centers to supercenters. As we move to 2015 our network of 42 supercenters has the momentum to convert an additional 4 by the close of the year. Our improved ability to convert service center prospects to supercenters, have led to a decrease in the number of in-process service centers currently in the pipeline. We continue to actively seek out new supercenter candidates, and will report our progress throughout the year.

Moving into Q1 of 2015 we remain optimistic about our end markets that are not tied to the upstream oil and gas market. Our service center network is powered by five product division platforms that are designed to provide sustainable business results for our industrial customers. We will continue to review our locations to find opportunities for customer and product expansion, the cornerstone of our branch-based model is our supercenters product. This customer-driven strategy continues to create value for industrial customers seeking to consolidate their vendor base, without sacrificing local inventory and expertise. Broadening our portfolio of technical products and services, recruiting top sales talent, and acquiring great companies will continue to be our recipe for supercenter expansion. We believe that 2013 and 2014 investment in people, facilities, and acquisitions will help to offset decline in the upstream energy market. Our investments in the form of acquiring sales personnel, while remaining committed to growing from within, through training and mentoring programs are paying dividends. Collectively our investments allow us to take full advantage of the industry-leading grip of technical products and services.

It is this local breadth of technical products and services that provides us with a sustainable advantage over small ma and pop distributors during market turn downs. Industrial customers are looking to their suppliers for help in weathering economic storms through product consolidation and added value services, that help improve productivity and lower their total cost of ownership. We are looking forward to competing and winning in 2015, our focus will remain on further strengthening our North American service center platform through the creation of super regions and supercenters that will provide sustainable benefits to the industrial customer looking to improve their overall production and financial performance.

The data points and service center America locations we have 168 service centers, in Canada we have 34. Supercenters, 42, supercenters in progress 4. Distribution centers, 7. Fabrication centers, 10. And we are in 34 states. IPS. Upstream oil and gas and mining sector. Land-based productivity and order hit rate in this sector show a slight softening towards the end of Q4. This it the result of lower oil prices. We expect this profile to remain consistent through Q1. We come into 2015 with a comfortable backlog. Currently we have had minimal exposure to cancellations of orders that we have booked, to be placed on, to be placed on hold or canceled. Based on customer feedback, the equipment was for wells that have not been drilled yet. Mining cap projects in the copper mining segment continue to be depressed through the low cost of the commodity based on the customers' feedback we are gathering.

Midstream, upstream as reported last quarter this sector continues to produce the majority of quote and order activity. The Eagle Ford, Permian, the Bakken shale plays, continue to provide a majority of this activity. The Marcellus and the and the [Avaro] continue to provide opportunities, however not as great as the Eagle Ford, Permian, and Bakken shale plays. The order profile for the majority of products being quoted and sold in the Bakken continues to be associated with [LAC] units, there has been a resurgence in activity in saltwater injection market, and other production facilities and terminal pump packages. The equipment from the terminal loading and offloading facilities utilizing our centrifugal packages, are being fabricated in 529 Houston and Golden, Colorado locations. Our LAC units being produced in west Texas are being utilized in the Eagle Ford and the Permian shale plays. We have had recent success in securing several orders of LAC units in the Permian basin on new well sites.

The LAC unit market in the Eagle Ford and the Permian shale plays has traditionally been a low margin market. Our strategy was to take this business and capture market share with existing customers, where we have a great relationship with and allow us to make an acceptable margin. Our high end multi-stage remanufacturing equipment and rerate business remains robust. The equipment is being utilize in the Midstream sector, gathering stations and booster station applications in the crude oil and LNG application requirements. We continue to provide a delivery proposition for our horizontal pumps, centrifugal pump equipment, and our remanufactured high end equipment, with lead times that allows us to outperform our competition when delivery is a major factor. This capacity will allow us to maintain our margins when delivery is critical. B27 the market opportunity for this product, both domestic and international are providing impressive quote activity and order rates. This product is primarily used in Midstream and Upstream markets.

The delivery proposition, quality and price point we provide is very attractive to the customers, with requirements for new equipment in this product line. We are very optimistic our US Midstream Upstream opportunities remain strong through Q1. Gulf of Mexico this sector continues to remain soft. We currently are engaged in a fiberglass project that we were awarded an order in Q4. That was significant win for our fiberglass pipe division. We are currently active with upcoming new platform projects for modular rotating equipment opportunities, that are expected to start issuing orders for the equipment in 2015. Canada. Municipal markets in eastern Canada continue to be slow to rebound. Oil and gas. The low oil prices have had a significant impact on this sector as it relates to capital projects.

We expect to experience price and margin pressures on capital projects as they get approved. Innovative flow solutions. We are optimistic that the upcoming opportunities for modular rotating equipment packages in North America, we have had recent success with our modular packages designed to filter the liquids and gas products produced at the wellhead and gathering stations. Increased regulations by the pipeline transmission companies require filtering certain components from the liquids in gas prior to the product being put in the pipeline. These type of project opportunities are expected to be robust in 2015. Mideast. The modular packing opportunities have not developed as we expected thus far. We remain focused on the region and all opportunities. Our quote activity is consistent. The current state of unrest in the region is definitely having a negative effect on the project opportunities.

We are optimistic Q1 performance will be in line with Q4. We feel that our opportunities on approved CapEx projects will be competitive price sensitive. This will require strategic rationalization of market, to customer complete scope of the project, the equipment, then the competitors we are quoting against. What is the realistic full expectation of the customer, what is most important to him, and what value is he placing on each. Understanding all of the aforementioned components will allow us to make the proper strategic business decision to take market share at margins that support our business model. Supply Chain Services. DXP Supply Chain Services team rounded out the year with a solid contribution to both top and bottom line. While securing additional customers and renewals in the fourth quarter. Year end is typically slower based on fewer billing days and weather. The majority of the customer base is closed through the holiday season, as a result of the continued slow business climate, as well as mid-week holiday schedules.

SCS secured the renewals of several customer contracts in 2004, and two additional sites, increasing our site locations to 74. The renewals were with major customers with three-year extensions, ensuring continued revenue and potential for more locations. In Q4 and Q1 the SCS team began five on site implementations which are scheduled for completion, and will begin generating revenues in Q2 and Q3 of 2015. These new customers are a mix of markets of chemical, oil and gas, manufacturing, adding diversity to the SCS customer base. SCS could see some fallout from the downturn of oil and gas markets as customers are tightening their belts, and looking at alternative solutions to decrease the chance for employee layouts. However, we view the oil and gas downtown as a great opportunity to save our customers money, by using SCS' proven guaranteed cost savings program. We are strongly pushing our sales team to increase all leads and opportunities for cost savings, and lead supply chain has become a high priority. The markets we serve are always a challenge as they are never all up or all down. We have done a deep dive into our customer base to determine our market potential. DXP identified 31 market categories as follows. Onshore upstream drilling and development, Onshore upstream completion, Onshore upstream production, Midstream, Downstream refining. Downstream petrochemical. Offshore Upstream drilling development and completion. Offshore upstream production. Engineering and construction upstream. Engineering and Construction midstream. Engineering and Construction downstream. Chemical, Building Products, Food and Beverage, Transportation, Telecommunications, Automotive, Mining, Sanitary, Steel, Resellers, Military, Agricultural, Municipal, Power, Pharmaceutical, Alternative energy, Aggregates, Pulp and Paper, Wood Products, and Other Industrials. To give everyone some highlights, Onshore Upstream production is our largest category at 22%. And DXP feels that this market will be flat. Onshore Midstream at 17% is our next largest market, and we feel that this market will be flat. Third largest is Onshore Upstream Drilling and Development at 8.7% of our business, and it will be down. Fourth at 4.8% is Onshore Upstream Completion and it will be down. Food and Beverage at 4.7% is our fifth largest and it should be up. Chemical at 3.9% the sixth largest and should be up. Offshore Drilling Development and Completion at 3.3% will be down. Onshore Downstream Petrochemical at 3.1% should be up. Onshore downstream refineries at 2.6% should be up. Engineering and Construction Upstream at 2%, should be down. Engineering and Construction Midstream at 1.1% our best guess is flat. Offshore Upstream production at 0.6% could be up. Engineering and Construction Downstream at 0.5% should be up.

I am grouping everything else as industrial, and it should be up with some more than others. This is not perfect, as some customers were hard to break down into just one category, so we dove deeper into the orders, and did the best we could. The point is to manage our resources the best we can, and to make smart business decisions on people and investments, we also broke this data down by segments, and compared this to our salesmen's forecast for a sanity check.

As you know, we do not give forecasts ,but organic growth which comes from price increases, the economy, and market share gain should be up for our industrial business, and slightly down for our oil and gas business, with midstream and production being okay, and drilling, development and completions being down. We will continue to grow through market share gains and profitable acquisitions. And since earnings per share is meaningless, we are an acquisition growth company, DXP will focus on growing cash flow, sales, and EBITDA. We are now open for questions.

Thank you. (Operator Instructions). We will go first to Matt Duncan with Stephens Incorporated.

Hi, guys.

Hi, Matt.

So David you went through lot of detail there, and that was very helpful for a better understanding where the exposure is, and I think what we are all probably going to be trying to certainly ultimately get at here, is when we aggregate all that, do you feel like the business is going be up or down this year? And when you look at it, maybe the easiest way to do this is to lump it into the three buckets from the press release, on the 19% for Upstream oil and gas that is clearly going to be down. 41% is a combination of Production and Midstream. Depending on what production does this year, that could be flat, or I guess if we see a tail-off in production at the back half maybe an impact, but it is too early to tell. But the 40% that is Industrial is going be up. How do we think about how all of that sort of comes together? What do you expect to see happen to your sales and profits this year?

Well, I'm encouraged that I feel pretty strong that our profit margins should be okay. Our safety services which is directly tied to drilling is going to, we would ask to lower our prices 20%, and so we have done so, so that we can grow market share, and at the expense of others. But at the same time we have asked, which they accepted, was to take our labor costs down 20%, so that we will maintain our margin. So the sales dollars will go down in that area, but we think our operating income will as a percent of sales will be able to be maintained. We have gone through all kinds of gyrations of saying okay, that business is going to be down 30%. The industrial business up 3% to 7%, this should be flat, this should be okay, could grow, our backlog is pretty good.

And then I guess then the other question is, just how long do oil prices stay depressed before they reach, they are not going back to $100, but whether they go back to something that makes everything a lot more normal. And there are just so many variables there. But based on what our salesmen are forecasting and what they see, and based on our own knowledge and I think we really did a deep, deep dive into an analysis of not only just the market, the 31 markets, but how much that we participate in each one of those, and we don't see it being that bad. If I was guessing, and I think most people are forecasting for us to be a little bit down, I hope that is not the case. And of course, that could be offset by acquisitions, et cetera, going forward. But if you want to just put it on my neck and hold me down to something, I think it is a very small percentage down.

Okay. And maybe I think the segment that we are probably all struggling with the most, at least I know it seems to be the one that is least clear to me is, what happens with IPS this year? That business has got a lot of CapEx lean to it, but I understand that it has lot of production and midstream lean to it, which seems to be a little safer, although I'm not sure those things will be growing much this year, in terms of I don't think we are going to a whole lot of investment in growing those, but you also a pretty good backlog going into the year. What do you expect to happen to that segment in terms of revenue this year? Will it be down in all likelihood? And if so, how much?

Everything at B27, our innovative flow solutions, and their API-610 product, is telling us that they are going to be, they are actually going to be up. And that partly because IFS kind of had a bad year last year, and so this year they are feeling much, much better and stronger about what they going to do.

And their backlog supports that so far, David?

Yes, they have gotten, I forgot what they told me. It was something like in the last four months orders that equal all of last year, or something like that. I mean it looks good. That might not be quite right, but it is a very substantial increase in orders. And then we continue to be successful with the API-610 product in Midstream, and so that is still blowing and going. The other part of the business, entered the business with you know kind of more than half of the year made with backlog, and then we continue to still get orders. The HP-Plus product is sold in saltwater injection, and we are seeing these people that are producing X amount of oil today, if they didn't grow it at all they have to get rid of that water, because when they are making that product it comes with water, and so they have got to dispose of it, so we are seeing a lot of activity in that area. So we just don't see IPS cratering really in any way. It should be okay.

Okay. Two more things, and I will hop back in queue. I heard you talk a lot about the margin pressure you saw in the quarter but it also sounds like the mix is going be lower margin at IPS this year, the mix is probably going be lower margin in service centers this year, because the safety service business as I understand it is a very high end margin business and that is going be down. How do we think Mac about the gross margins going forward? Most of the year it was running up a little north of 29%, fourth quarter it was 27.9%. But it also sounds like there was stuff that may not repeat. I'm trying to think about how to put that all together, in terms of what might happen with gross margins going forward?

You asked Mac the question, but I would like to answer. The fourth quarter had unusual gross margin events. We don't necessarily see that happening. But on the other hand, we have to feel like that the industrial side doesn't have margin pressure, and in fact I think there is a lot that we need to do to raise margins on that particular side of the business, and at the same time I think our oil and gas people are, there is bound to be some pressure there. And so I see it declining some. But I don't see it falling off the table. The stuff we are doing now is we are not cutting the price.

Somewhere between the all-in then David sounds like it is somewhere between you know low 29's and what you saw in the quarter, because there is a lot of stuff that isn't going to repeat?

I would pick 29 if I was guessing.

Okay. And then last thing just and M&A. One, how big is your appetite? And two, how much are you going to be able to do, because I think the leverage ratio covenant is now 3.25 to 1. You are at 2.9, so this is really kind of to a degree a function of what you expect your free cash flow to be. I know you guys target 10% topline growth through M&A. Do you expect to be able to do that this year?

I think we probably will not do that, not because I don't believe we have the resources, because I think there are always ways of doing good deals, but I think that there is enough uncertainty in the market that we certainly don't want to catch a falling knife. But that said, metal working is really moving forward quite nice. And so is rotating equipment. Our long-term ability to put together a great rotating equipment company is just so exciting to me, I can't tell you how exciting it is, because there are a lot of people listening to this call. But it is just really exciting to me. And of course, a lot of things we are doing are really, really good. And then I think we will gain market share so that you know when things kind of turn around from an oil and gas perspective, that we are going be so well-positioned both in safety services and rotating equipment, and so I'm pretty pumped up about where we are headed.

So then we should expect some acquisitions with a metal working and rotating equipment focus, but you may not get to the 10% revenue growth through M&A number. Okay. Very helpful. Thanks, guys. Thanks for all of the detail.

Sure.

We will go next to Joe Mondillo with Sidoti & Company.

Hi, guys.

Hi, Joe.

So in terms of I guess first I want to start with a follow-up on the B27. Do you have any idea why B27 is doing so much better over the last four or five months, given that it does have a pretty heavy exposure to oil and gas?

Yes, I mean we are simply not, IPS doesn't have anything to do with drilling and so you know the rig count is way, way down and capital budgets are down, but they are not down on things that are going to produce more oil, they are down on drilling and finding new stuff. So we have a continuation I think everybody has projected part of the problem of getting demand and supply back in shape is the fact that we are going grow our production this year with CapEx budgets being down 30% to 50%. And so I think you have to disconnect us from what is called CapEx, Apache cuts their budget 40% but it is their drilling budget that they are cutting, and we are not, IPS isn't about drilling. Now that said, Joe, if we don't get normalcy at some point in time, then the amount of drilling that is not done will eventually show up, but it is going to show up a year or two or three down the road. It isn't going to show up today.

Okay.

It is not going show up in 2015.

So the 19% that you cited that is related to Upstream, that is largely in the service center?

The 19% is drilling activity, and it is in the service center, and it is really pretty specific to our safety services business.

Okay. So staying on the IPS segment, could you cite a percentage or where your backlog is compared to a year ago? I know you don't want to give out the exact number what it is, but in terms of just percentage comparison year-over-year?

It is probably slightly up.

Okay. And in terms of the orders in say the first two months of this year, are you seeing stable orders? Are they in February did you start to see any pressure, or is it pretty stable in terms of IPS orders in the first two months of the year?

Well, we are still getting our $5 million orders and smaller orders and things are pretty consistent, I think with what David Vinson was trying to say in Q1, that we expect our order intake to be good.

So the orders that you are seeing in, say, the first two months of this year, are sort of comparable to what you saw a year ago? Yes. Okay.

Absolutely, slightly better because of IFS. IFS is seeing--

So what is the biggest driver to that? Are there infrastructure projects that are still needed to be built out? And is there a risk at a point, we get to the mid part of the year and we sort of built those out, and given if oil prices sort of stay or remain where they are now, do we get to a point where maybe the orders start to catch up, and you start to see pressure, or how are you thinking about that part of the oil and gas sector?

I have to look at it this way, we did an analysis of all of the down oil cycles by the supply side and demand side. And almost every cycle we saw something in the neighborhood of a 50% swing in the price of oil. Now we have never had anywhere close, there are no cycles we looked at our sales, and they have never been down more than 5%, except for 2009. 2009 was just an anomaly, I don't know how to deal with that one. But anyway, don't give me another one of those. But so that is part of it. But it also, you are correct we know that if drilling goes down significantly, we start feeling the effects of that a year later. So basically oil started down in October, and so somewhere if we don't get back to something normal, normal to me by the way is probably $70 a barrel, then you are right, then the future in 2016 we could start seeing some sales decline.

Okay. In terms of the margin at IPS, I know 2014 was sort of a mix type issue with some lower margin type mix with B27 which sort of pressured the margin if you compare it to 2013. But we have seen two years now with margins falling at that segment, and then the fourth quarter there were some issues that depressed it so the sort of 12% levels. Wondering what your thoughts are on the margins that you are realizing in IPS, and sort of your outlook or thoughts for 2015?

Mac, why don't you give me,- I'm thinking that the first, second, third quarters our margins at IPS were going up.

You're correct.

Well, the first quarter I think it was pressured by the B27. That is the quarter that you saw pretty depressed margins.

Right.

But you're right. The second and third quarter were up. But if you look at the overall year including the first quarter and including the fourth quarter, the overall year margins were down and then so the recent, - the most recent quarter was you said there were three orders in there that were lower than average margin. I guess let me ask it this way, the orders that you are receiving lately, how are the margin profiles of those orders?

They are good. There is only one reason, well, this are two reasons. Two reasons for IPS' margins to fluctuate. One is that we just simply have competition, we have got accounts and many, many, many times with our relationships, et cetera, we are getting the last look, and so we decide to take something. The other which we have just not had for a long, long time is that the shop gets empty, and we have got a lot of talented people and we are better off taking a job to keep people busy, and to make some money than to not make any money. But we haven't had that environment for a long, long time. And one of the orders that we got this past year that showed up in the fourth quarter, was really an order we really weren't doing a whole lot of fabrication to it, and we just took it because we didn't want our competitor to get it, especially since the account was really the competitor's account, and we wanted to get stronger with that account.

So because we were selling them HP Plus, and some other things, so we just wanted to strengthen our position with that account. So it is not an exact science about our, I mean we don't go in and say okay, we going to make 30% on every job we do, and then we have this one cost a little more than we thought, so we only made 28%, the other one don't cost quite as much as we made, and therefore we made 32%. It truly is every deal is different. So it is really, really hard to look at that. And here is another example, the API-610 stuff we don't make that high a margin, but it has very little low overhead, so they have 14%, 16% EBITDA margins so we are happy with that, when in fact the gross profit in the mix kind of brings it down. And a little bit we said about the same thing with HP Plus. But I think to answer your question is, there is nothing about 2015 that is making us think that we are going to lose 4 points of margin. That just doesn't seem to be in the cards.

Okay. Let me just ask a follow-up to that then. In terms of pricing discipline, could you talk about that? Because I have been trying to understand this for a couple of years now. Back in 2012 when your sales growth was, you were seeing 60% sales growth obviously demand was going through the roof, and there probably wasn't a lot of capacity, or at least enough capacity to meet the demand in the industry, so I'm sure your pricing power was much better than maybe it was today, where you are seeing organic sales growth of modest single digits. So how do you manage pricing discipline in a period where maybe you are seeing sort of stable, maybe a little bit of growth, and if we do see a sort of a softening say in the back of the year, how does that translate into the profits of that IPS business?

So we start off with a salesman who is working with a client to meet his needs, and so they are helping design this modular system to make that happen. And then an application engineer gets involved, and he starts putting the bid package together and he is buying motors, he is buying engines, he is buying valves, he is buying piping, and then we are estimating how long it takes to us build that thing. Has it got 2,000 hours on in, et cetera. So there are a lot of moving parts, so to the best of our knowledge then, we take and there are certain types of jobs that we know we have a very high probability of getting, and so we are going to try to make as much as we can. Then there are other jobs that we are kind of on equal footing with other people, so we try to bid that accordingly, too. And we lose jobs. I mean if your not losing jobs you are not pricing them high enough. So it is not an exact science. It just is not. But at end of the day, we make a really, really nice EBITDA margin and so I don't know. And if we make 16% EBITDA margin one year, and we make 14% the next year, I'm not going to lose any sleep over that.

Okay. Okay. But it sounds like in the near term margins could be comparable to what you, the 15% or what you saw in 2014?

That's right. And you are correct, though, if things get soft, then we will have more pressure on us to lower those margins. There is no question about that. But we are not seeing that yet.

Okay. And in terms of acquisitions, it sounds like you are going to continue to be involved this year? Can we expect?

Yes.

We should expect some this year?

Yes, yes.

Okay. Okay. I will hop back in the queue. Thanks a lot.

Thanks, Joe.

(Operator Instructions). We will take a follow-up with Matt Duncan from Stephens Incorporated.

Hi, guys. So the next thing I wanted to dig into, is how you guys are responding to the downturn energy from a cost perspective? What are you doing on the SG&A costs? Are you guys trying to cut those expenses this year? David, if you assume that revenues are down a little bit, can we expect the same thing out of SG&A costs?

So always remember that we are a highly incentivized company, so we have an unusual amount of variable costs in terms of commission and bonuses and et cetera. But yes, at the same time, there better be a lot of justification for raises, so I would say in general there are not any. And that is tied specifically you have got to be a little smarter about that, because that is tied to our branches that are really heavily involved in oil and gas. But if you are an industrial guy, we are expecting them to grow, we are expecting them to increase their margins, increase the activity, so we would see things in that area. You would give raises, you would have maybe hopefully bigger bonuses and things. So we are trying to be smart.

We work really, really hard at trying to manage what I will call house cats, and we don't need any of those. And we try really, really hard to always be pushing the envelope in terms of productivity. And so we are constantly even in good times really trying to manage our second largest expense, which is our payroll with the first expense being cost of goods sold. So it is about the people. And you want to take care of the good ones as good as you can, and you want to get rid of the bad ones, and so we are constantly doing that. Everybody down to our people in our stores, we share financial information with them. They understand what they are trying to manage. And so the only thing that is a little different this year, is every pay increase is going to be approved by me. And I haven't had to approve too many.

What about on the fixed cost side, though? Are you looking for opportunities to cut out fixed costs? I mean I understand obviously the variable costs structure and clearly it has worked well over the years. What are you doing with fixed costs?

Yes, that is typically in the form of that we have branches or stores that aren't performing, and so therefore we certainly try to consolidate them first, with some other entity that is not too far away. Or, ultimately we close it down, and then give up on it. Whereas when times are good you kind of continue to ride it out, and try to get the right people in there to make go of it. Today you don't. We don't have the luxury of doing that. So we will shut them down. As far as bigger expenses than that, we are also constantly integrating everybody to our same computer system, and as we do that we normally can trim some administrative costs. And so we are working on that as fast and as diligently, like not too far distant future Natpro will be on our system, so we are moving forward with things that will save us money.

Okay. Okay. So the right way to think about it then, is with being proactive with fixed costs, and the variable side taking care of itself, if sales are down SG&A costs are going to be down, would be the right way for to us look at it?

Yes.

That is helpful. Thanks, David.

And we will take a follow-up from Joe Mondillo with Sidoti and Company.

Just two quick follow-up questions. One in terms of the capital allocation and acquisitions, first is share buybacks. Just wondering how you are thinking about that any differently compared to a year ago with your stock down here? How do you balance, how are you thinking about balancing capital allocation versus acquisitions and stock buybacks?

Well, we have been buying back enough to, I think we started the year with fully diluted shares of 15.3 million and we ended the year at 15.3 million, so we are trying to buy back enough to kind of keep the dilution effect down zero. Beyond that, we are awful attractive at 8 times EBITDA, even though we are buying unknown companies at 5, but DXP is kind of a known company to me, and it is at 8. Well then I think the price is too low so we are buying, we are looking at that. So we would certainly not go out and pay 10 times for somebody when we are trading at 8. Just doesn't make any sense.

But if we can buy a really good company, a profitable company, the reason why, let me just say this. The reason why I think our M&A activity will be lighter this year than in other years, is because we are going to be more selective in terms of what we buy. If it is a solid company, they don't have a jillion eight add backs, and they make really good money, then that is the kind of acquisition we will do, and it is one that won't have any surprises, versus one that is kind of marginal but we want to, it is in Seattle, Washington, so we want to be there kind of deal. So we do that kind of deal. It is not that we don't expect it to be good, but it is just not a slam dunk deal. So I think we will just be more selective. But you raise a good equity question, one of my jobs is to control our equity, and so we are definitely a little tighter than we normally would be.

Okay. And then just on the tax rate, Mac, is there anything unusual this year that we should expect a different tax rate than the sort of 37% level that you have been?

I think the tax rate when you pull out the impairment charge is probably 38.1% or 38.2% for 2014, and I would expect that to be the rate for the future.

Okay. Okay. That will do it. Thanks a lot.

That does conclude our conference. Thank you for your participation.

Thank you.