Greetings, and welcome to the Distribution Solutions Third Quarter 2024 Earnings Conference Call. At this time all participants are in a listen-only mode and a question-and-answer session will follow the formal presentation. [Operator Instructions]. Please note this conference is being recorded. I will now turn the conference over to your host, Mr. Steven Hooser with Investor Relations. Sir, the floor is yours.

Good morning, everyone, and welcome to the Distribution Solutions Group third quarter 2024 earnings call. Joining me on today's call are DSG's Chairman and Chief Executive Officer, Bryan King; and Executive Vice President and Chief Financial Officer, Ron Knutson. In conjunction with today's call, we have provided a financial results slide deck that is posted on the company's IR website at investor.dstributionsolutionsgroup.com. Please note that statements on this call and in today's press release contain forward-looking statements concerning goals, beliefs, expectations, strategies, plans, future operating results and underlying assumptions are subject to risks and uncertainties that could cause actual results to differ materially from those described. In addition, statements made during this call are based on the company's views as of today. The company anticipates that future developments may cause those views to change, and we may elect to update the forward-looking statements made today but disclaim any obligation to do so. Management will also refer to non-GAAP measures, and reconciliations to the nearest GAAP measures can be found at the end of the earnings release. The earnings release issued earlier today was posted on the Investor Relations section of our website. A copy of the release is also included in a current report on Form 8-K filed with the SEC. Lastly, this call is being webcast and on the Internet via the Distribution Solutions Group Investor page on the company's website. A replay of this teleconference will be available through November 14, 2024. Now I would like to turn the call over to Bryan King. Bryan?

Thanks, Steven and good morning, everyone. Thank you all for joining us today. We plan to share a brief overview of the quarter's results with an update on our initiatives, before opening the line for questions. Starting on Slide 4, we again reported record quarterly sales, up 6.6% compared to last year's third quarter. Although organic sales were down 2.1% this quarter, what stood out this quarter was the excellent traction we are seeing at Gexpro Services that includes new customer wins and the sequential progression that continued in certain end markets including renewables, technology and aerospace and defense. More broadly, we saw a continued lackluster industrial backdrop. However, our commitment to our shareholders is to focus on what is in our control and in that regard we are making solid progress. At Lawson, after a year of adding sales tools, reimagining our sales territories and processes and implementing focused insights for customer engagements as we dig into our transactional data, we are excited to be in a position to begin adding to our sales rep count, following a period of critical investments, new processes and reconfiguration of our sales strategies that we believe will continue to allow our reps to operate at a higher level of productivity and importantly, allow us to recruit and retain new reps in the significantly more productive territories and provide them with better tools for success. We also confirmed as part of this process, an additional 130 new sales territories. We've made good progress on integrations across DSG, most notably on TestEquity, Hisco, where we've captured more cost savings than we underwrote and are seeing the cross selling wins we had anticipated with Hisco's OEM offering getting pulled into TestEquity and Gexpro Services' legacy customers. This industrial technologies focused vertical has made tremendous strides…

Thank you, Bryan, and good morning, everyone. As with Bryan, I will keep my comments brief, but we'll highlight a few key takeaways within each of the verticals for the quarter. Turning to Slide 6. DSG's consolidated revenue for the quarter was $468 million. This represents an increase of $29.1 million, or 6.6%, driven by $38.1 million coming from our 2024 acquisitions. Organic sales declined by 2.1% versus a year ago, and we will provide average daily sales by operating segment in a few moments. From the second to the third quarter, total sales sequentially grew by 6.5%, again fueled by our acquisitions, while organic sales were up 0.2%. For the quarter, we generated adjusted EBITDA of $49.1 million, up 12.4% over the prior year, and up 8.7% versus the second quarter. Our adjusted EBITDA margin improved to 10.5%, up 50 bps compared to last year's quarter and up 20 bps sequentially. As expected, the acquisition of Source Atlantic in the quarter depressed our net margins by approximately 20 bps. We reported operating income of $18.9 million for the quarter, inclusive of $12 million of acquisition related and tangible amortization expense and $11.5 million primarily due to non-cash stock-based compensation in non-recurring charges such as retention and acquisition related costs and other one-time items. Adjusted operating income improved to $42.5 million, or 9.1% of sales, compared to 38 million, or 8.7% of sales compared to the year ago quarter and a sequential improvement from 8.8% of sales compared to Q2. We reported GAAP diluted income per share of $0.46 for the quarter, inclusive of a $0.40 tax benefit as required under GAAP based on the anticipated effective tax rate for the full year. This compares to a loss per share of $0.3 in the year ago quarter. Adjusted EPS was…

Thank you, Ron. With regard to the recent hurricanes, our employees and families impacted by the storms are safe and there were no material disruptions or significant financial impacts. Customers in the affected areas were down between two and six days, mainly to power outages which I'm certain presented a challenge for many of our DSG families as well. In fact too often we can get wrapped up in strategy and financial metrics as we focus on driving the outcomes we expect and miss the humanity of a business like DSG. Ours is a company whose successes and operational improvements like the many in this last quarter are really the reflection of a lot of dedicated good people, putting tremendous effort forth in the face of lots of marketplace uncertainty as their leadership like me continue to think through ways to evolve and improve this commercial platform to be the best it can be. With many of those new initiatives and timely accountability expectations requiring even more work from them in the next period. All of our successes happened because of all of the committed colleagues across DSG's business unit and I want to thank them from all of us who represent the shareholders. Our businesses have lapped 2023 softness and will compare against somewhat easier sales comparisons over the next several quarters. But I'm more focused on demonstrating to my fellow shareholders about all the progress made by our employees across countless initiatives in a more benign marketplace backdrop by getting back to our 2022 growth trajectory. We are not letting off the gas as we tackle more growth plans and initiatives, making strategic investments, and controlling all controllables as best we can. We are carefully controlling all cash outlays expenses and working capital management. The U.S. manufacturing Purchaser…

Thank you. At this time, we will now be conducting a question-and-answer session. [Operator Instructions] Our first question is coming from Tommy Moll with Stephens. Your line is live.

Good morning and thank you for taking my questions. Bryan I wanted to start on Gexpro. It's now three quarters in a row where there's been a sequential step up in revenue there, although the rate of that increase improved. I think you were up double digits third quarter versus second quarter. So, what can you do to unpack the shape of that recovery for us? And what if any visibility do you have going forward there? Thank you.

Yes. Ron, you may want to help me on this, but Tommy the end markets that we've highlighted, the renewables and the semiconductor markets that had been real laggards last year, were an important part of -- we'd indicated that we thought we would see improvement in those end markets as we got in the back half of the year and we have been seeing that. It's not yet to the level that we've enjoyed in the past, but it is significantly better than it was as we were exiting last year. And last year was a particularly tough year for renewables as well as semiconductors. We talked about those consistently in our quarterly calls last year. And that impacted some of those end markets that were soft last year really did impact as we were investing in some of the acquisitions that we bought to fold into Gexpro. And we were really leaning into investments in those acquisitions versus leaning them out last year. A lot of times when you buy things, you try and pick up synergies. In our case, the synergies that we saw were on the top-line and really were not in the cost structure of those companies like Frontier and Resolux that I alluded to on the call. And so we leaned into the costs or into investments in those businesses, took the cost structure up at the same time as the end market softened. So that had a kind of a double whammy last year on profitability. And now those end markets are starting to spool back up and we're getting more performance out of those acquisitions, and we're getting the earnings leverage coming back our favor. So I don't know if that's helpful. Last year, Gexpro Services core carried the profitability and made up for some deterioration in acquisitions profitability where we made investments in their operating expenses and their markets had softened. And this year, we're getting some benefit on both sides both at Gexpro Services core and then also the benefit to cross sell or to expand our engagements with some of the customers in the marketplaces that are recovering from the help of those acquisitions. Ron, anything you can help me on there?

No, I think you hit it, Bryan. I mean as we look at aerospace and defense has been strong over quite a few of the past quarters. The technology side, which for Q3, our low point there was really Q3 a year ago and that technology end market for us not quite double sales from where we were a year ago quarter, but pretty close. So that is a really nice recovery for us. And then certainly on the renewable side, primarily wind, that segment, that end market continues to march up sequentially for the first three quarters of this year as well. So, yes, I think those are really the, I would say, the three main end markets that are driving the majority of the growth.

And as a follow-up, I wanted to ask this one may go to Ron just on the fourth quarter or the pacing in October, Ron. You've been active on the M&A front and so I just -- I want to get any kind of insight you can share on organic trends versus whatever acquired revenue you would expect to book in the fourth quarter. And then similar question just on the margin side, Ron, you were in the double digit range from a consolidated EBITDA margin standpoint for the second consecutive quarter. Any reason that that should not again be the case as you go into Q4? Thank you.

Yeah, Tommy. So just relative to sitting here one month into the fourth quarter, I would say that, our sales levels are -- across DSG, this is just in the aggregate relatively consistent in terms of what we saw in the third quarter. So I would say no major movements from where we left off at the end of Q3 to where we are today. Relative to Q4 from a margin perspective, yes, fewer selling days, but we would expect that we'd still be able to perform in a double-digit margin range, even with a couple less selling days in the quarter. And that's significant for us. Every day for us is even on the organic side is about $6.5 million or $7 million in sales. So two days takes $14 million or actually I think it's three days, I think it's 61 days versus 64. So But we still feel like we're going to be able to get ourselves in the double digit EBITDA range.

Thank you, both. I'll turn it back.

Thanks, Tommy.

Thank you. Our next question is coming from Kevin Steinke with Barrington Research. Your line is open.

Thanks. Good morning.

Hey, Kevin, good morning.

Good morning. Wanted to just start off by asking about Lawson and you talked about roughly 130 new sales territories there I believe. I think you mentioned greenfield. Are those all greenfield? Or are there some kind of dividing up all the territories to make them more efficient from just a routing perspective? I'm just trying to get a sense as to how much more kind of revenue opportunity you're creating with those new sales territories?

Ron, I'll let you tackle it even though I'm the enthusiastic voice here.

Yeah sure. No -- yes no problem so...

You've been working on this for 10 or 20 years but...

Yes, I know. Yes so...

I've been on Ron on this one for a decade.

So Kevin, I would really -- the majority of those are new territories that we feel as though we can put sales reps in and be more successful than in the past. As you're aware we have and we continue to work on optimizing our current sales territories within our existing sales reps. And as Bryan mentioned and I mentioned as well, we're down from a rep count perspective versus where we were a year ago, up sequentially here in the third quarter. But we are also identifying and are much more data driven today than where we were historically around, where we feel that there's opportunities that we can put a sales rep into and be much more successful right out of the gate. So even though we continue to kind of refine the territories that we have today, these are what I would really classify as more kind of new markets where we feel like we can put a rep in and get them successful right out of the gate. And to Bryan's point and Bryan had this in his prepared remarks. I mean it's -- we are targeting 900 reps by the end of this year, so that's still a net increase of 40 versus where we ended the quarter, and then we'll have a pretty heavy push on this for the first half of next year as well with our goal being 1000.

And I would -- the only thing I'd add to that is that part of the scoping these are -- the way they've been characterized to me is that they're net new from where we were more towards our peak of reps. There has been some reorganizing and some kind of trying to make the routes and the territories more efficient, as well as trying to make sure that the territories that we have available to new hires are significantly larger in terms of scoped revenue than what we might have been hiring somebody into in years past. So it's important to us to see that the reps that we're hiring are more productive out of the gate with the tools that we've offered them with the scoping of larger available revenue that is there for new reps. And then we've got an insider kind of an internal team that we developed. It worked well for us on the strategic account side. It's worked well for us on the military side, although military is a challenge right now with the order entry shift that the government is going through. It's impacted I think a lot of distributors and really is causing a mess at the military bases, where they're not able to get the kits and the product in timely. But that aside, we've got a sourcing of -- and a new business development team that will help those reps grow their street business. And so there's a lot of initiatives that we put in place to try and be much more successful with the growth plans going forward with our sellers. We rode the brake too long in my opinion about hiring reps and backfilling. We were trying to get our technology and our tools in place so that we could have the right offering when we recruited. But that caused our J curve of our sales rep count to drop further than it should have and we're all cognizant of that. And if we were going to look back over the last 1.5 years, and look at all the progress we've made on the sales front and what we think we're going to be able to do restoring a very much more effective and efficient opportunity for sellers and growing revenues going forward on Lawson, that would be our kind of our Monday morning quarterbacking of what we wish we had done differently, which was in the face of slowness out of our tech team, and getting data and tools in place and reorganizing territories, all of which take a lot of time. I think we should have been hiring more aggressively even before we had all the tools that we now have in place.

Okay. Fair enough. That's helpful commentary there. But you mentioned there the wanting to hire more aggressively obviously. Just what is the pipeline look there in terms of your ability to find reps? And I know it's very early days, but any initial indication of your ability to…

We're onboarding -- I think that we've got more tools to offer. We've got larger initial territories and we're recruiting more deliberately in the type of reps that we're recruiting. We've got a lot of years of knowledge in about trying to grow rep count and watching it be very challenging in terms of attrition. And so one of the concerns was not having the tools in place, not having the data in place, not having rescoped the open territories or the new territories that we are greenfield was to be out recruiting until we had the ability to recruit the very best candidates we could. But we have a robust effort going right now and we're confident that we will be able to add get to a 1,000 rep count number sometime mid-year next year. So that's our objective and that's what we'll be pushing to do. So that'd be 135 net new reps between now and middle of next year.

And Kevin just to maybe put emphasis on Bryan's point, if we look back historically we would be hiring anywhere from the high teens maybe 20 sales reps in a month. And if you look at the average monthly hires during the third quarter, it's closer to 30 on a monthly basis. So we're up effectively 50% versus what historically we've hired at. So we have the ability and certainly it's always a little challenging to find really good talent and we're -- we continue to push on that but we've seen a nice upward tick here in the third quarter in terms of hiring rates.

Okay. That sounds good. I appreciate all the comments. I got to jump to another call here, but thanks again. I’ll turn it back over.

Thanks, Kevin.

Thanks, Kevin.

Thank you. [Operator Instructions] Our next question is coming from Brad Hathaway with Far View. Your line is live.

Hi, guys. How are you doing?

Good morning, Brad.

Good morning. Thanks. I appreciate the commentary on what return on invested capital looks like for a mature distribution business. And I was just wondering if kind of qualitatively if you could talk a little bit about I guess the path from where return on invested capital is today to that 20% level and how you kind of think about bringing DSGR in that direction?

Yeah. Look Brad the biggest challenge on returns on invested capital, obviously, are initially when you make an acquisition and you're laying out capital and you haven't yet folded in the earnings or the earnings accretion. The synergies that you expect to get out of taking out costs or driving accelerated top-line growth as you're folding it in. So there's no doubt that our M&A activity has been absolutely weighing on our returns on invested capital the way that -- if you look at it you're going to come down some as you're building your base out. And then as you build your base out, you should start seeing it improve. When you look at -- for -- this is an example the acquisitions that we've closed this year through the ConRes close yesterday, we've spent about -- we paid about eight times EBITDA for those acquisitions collectively. And integrate -- like we would estimate that integrated over the next year or so they'll -- we'll own them at six times. And so that's kind of the first leg of trying to then drive your -- for that class that 2024 class of acquisitions driving your ROIC backup, after absorbing the capital outlay and not having the benefits of the earnings where you want them to be. Last year we had acquisitions that we made in 2022 and 2021, that had more challenging or headwinds in their end markets, as we were thinning out some of or kind of integrating shared costs or duplicative costs on Hisco with TestEquity. Now we've got those costs out. And as we look to the earnings leverage that we built into the model, we'll get a lot of up draft on the ROIC there. We've done a good job managing working capital. We had…

Got it. That's very...

You can tell me there's -- is that helpful?

Yeah. Good. That is helpful. So I mean, I guess it sounds like A, it's the maturation of the acquisitions you make obviously you lay out the capital ahead of time and then the earnings and whatnot improve. I mean is there also an opportunity on the working capital side as well to kind of increase the efficiency of the balance sheet?

So Brad, we've worked hard on that efficiency. We've brought in external resources and we have made quite a bit of progress. We've got some progress left in front of us, that on the margin that's tens of millions of dollars on your invested capital base. It's not hundreds of millions of dollars. And when you're laying out $240 million or $260 million of acquisitions in a year then your biggest driver is going to be trying to double the EBITDA on those acquisitions. And that's where …

Got it.

…that's what we're focused on is taking -- buying -- going and buying $30 million EBITDA and turning it into $60 million.

Got it.

And that's where -- that's what we've got to do. Some of that comes from integration. Most of -- some of that comes from purchasing better, the longer tail and benefit of driving ROI -- I mean, if we go back in time into the '90s and I was covering this sector back then the Fastenal and the Grainger were more acquisitive relative to the size of their base. And then once you got to a spot where your base was pretty well set and your offering was pretty well set then you started getting a lon- tail benefit of assembling all the right capabilities and getting organic growth out of them and you've got started working your way away from the original purchase price. And we've seen that model work well for us over the last two decades, as we bought distributors and we would expect that that is exactly where we sit with DSG, as we look towards the tail of continuing to compound the earnings stream out of the acquisitions that we're making. And when we compound it and we grow those earnings streams the incremental returns on invested capital are very, very high on these accretive acquisitions that we're making. The initial capital outlay is a burden, but as long as they're strategic and as long as they fit into the model right then it drives incremental returns on invested capital across the whole platform as well as the maturing and higher returns on invested capital that you'll get out of the acquisition itself. And so that should drive us, long-term to very much structurally higher returns on invested capital.

Got it. That makes sense. So just mathematically, obviously, the denominator doesn't change much, because you lay out the capital upfront and then current EBITDA is well below what you kind of believe fully synergized, fully operational, future EBITDA will be. So the numerator increased a lot with the denominator. Awesome. I appreciate the color on that.

Brad, I took -- I resensitized and just looked at 2022s revenue levels, and tried to take a more stable revenue environment for all of us and took that 2022 model and ran it back through our new cost structure, and kind of our new incremental margins and where we are. And that in and of itself has a really big lift in ROIC, assuming we aren't making the next wave of acquisitions which we will be. But that's the sort of -- and then from there, we -- when we -- in 2022, we expected that the acquisitions we were making, were going to take the slope of organic revenue growth up. We've been in a more choppy end -- set of end market. We've been doing some tuning that's been disruptive like on the Lawson sales force, but it's critical for unlocking a lot of growth in the future. And so, as we're doing all that tuning there's challenges and disruptions to it. But if you take that 2022 static revenue base to build off of the earnings leverage and how that then drives the ROIC, is very impactful.

Got it. That’s very helpful. Excellent. Thank you for the explanation. Appreciate it.

Yes. Thanks. Appreciate it Brad. Always lots of questions.

Thank you. As we have no further questions in queue at this time, I would like to hand it back to Mr. King for any closing remarks.

Thank you, operator. I appreciate everybody's interest in DSG. We continue to have a lot of confidence in what we're building here for the long-term, as well as in intermediate and short. We're excited about the team we've got, the assets that we've assembled, the colleagues that we have working with us and we appreciate your interest. On Halloween Day today, everyone stay safe and enjoy family time, if you can get it. And we look forward to visiting with you in follow-up conversations for the next quarter. Thank you all so much, for your time. Bye.

Thank you. Ladies and gentlemen, this concludes today's conference and you may disconnect your lines at this time. And we thank you for your participation.