Good morning. My name is Chris, and I will be your conference operator today. At this time, I would like to welcome everyone to the DXP Enterprises Third Quarter Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers remarks there will be a question-and-answer session. [Operator Instructions] Mac McConnell, Senior Vice President and Chief Accounting Officer, you may begin your conference.

Thank you. This is Mac McConnell, good morning and thank you for joining us. Welcome to DXP's third quarter results conference call. David Little, CEO; Kent Yee, CFO, 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. Now I will turn the call over to Kent.

Thanks, Mac, and good morning to everyone on our call today. We will begin with a summary of our key financial information and then Mac will go into more detail regarding our year-over-year sequential and year-to-date performance. David will conclude with comments about DXP and shares his thoughts on our financial results. So starting with our third quarter fiscal 2017 income statement. The Q3 financial results reflect continued sales growth since Q4 of last year and consistent improvement year-over-year in EBITDA. The third quarter performance was broadly line with all of our key financial metrics and our expectations at this point in the cycle. Total sales for the third quarter were $251.9 million. Total DXP sales grew 9.5% year-over-year and 0.5% sequentially. Average daily sales for the quarter were up 0.5% over Q2 over $4 million per day in Q3 versus $3.8 million per day in Q2. The sequential growth was predominantly driven by our Innovative Pumping Solutions segment, which experienced 14.8% sequential growth or an average of $810,000 per day in Q3. Additional drivers of this growth include our Rotating Equipment and metalworking product division sales performance. We also experienced strength in both of our industrial and oil and gas driven regions, specifically the Ohio River Valley, South-central, Texas Gulf Coast and net – North Texas regions. The overall growth year-to-date is great to see and reflects what we see in some of our key end market indicators. In terms of our business segments, all 3 business segments sales are up year-over-year with IPS showing the greatest improvement increasing 28%, Service Centers increasing 5.8%, followed by Supply Chain Services increasing 4.9%. Turning to our gross margins. Gross margins declined 92 basis points from 27.5% in Q2 to 26.6% in the third quarter. This was disappointing given the positive gross…

Thank you, Kent. Again, sales for the third quarter of 2017 increased 9.5% to $251.9 million from $230 million for the third quarter of 2016. After excluding third quarter 2016 sales of $7.1 million for Vertex, which was sold on October 1, 2016, sales for the third quarter increased $29 million or 13% on a same-store sales basis. Sales by our Service Centers segment in the third quarter of 2017 increased $8.8 million or 5.8% to $160.9 million compared to $152 million of sales for the third quarter of 2016. After excluding 2016 Service Centers segment sales of $7.1 million for Vertex, Service Centers segment sales for the third quarter of 2017 increased $15.9 million or 11% from the third quarter of 2016 on same-store sales basis. The sales increase is primarily the result of increased sales of rotating equipment, metalworking products and bearings to the oil and gas and industrial customers. Sales at the Innovative Pumping Solutions products increased $11.2 million or 28.1% to $51 million compared to $39.8 million for the 2016 third quarter. This increase was primarily the result of the 1P nature of IPS sales combined with increased capital spending by our oil and gas customers in 2017 compared to 2016. In connection with the increased capital spending in 2017 by our oil and gas customers, our IPS backlog has increased sequentially each month since December 2016. Sales for the Supply Chain Services segment increased $1.9 million or 4.9% to $40 million compared to $38.2 million for the 2016 third quarter. The increase in sales is primarily related to increased sales to customers and the oilfield services and oilfield equipment manufacturing industries. When compared to the second quarter of 2017, consolidated sales for the third quarter of 2017 increased $1.2 million or 0.5 of 1%. Third…

Well, thanks, Kent and Mac, and thanks to everyone on our third quarter conference call today. Before I review our results, I would like to address the recent hurricanes. Our thoughts and prayers continue to be with all those that have been devastated and damaged by what was left behind in a bad weather – as the bad weather subsided. These events were especially close to DXP with our headquarters in Houston and a direct impacts of our DXP family. Of our 600 plus employees within the Gulf Coast region, 54 were directly impacted on some level, including flooded homes, vehicles or other similar damage. As we work through the long road to recovery, we have focused our efforts on supporting and helping them to rebuild their homes and lives. Let me thank all of our DXPeople for their support of our fellow employees and the countless calls, e-mails and texts that we received during that time. I look forward to all of us individually and as a company finishing the year strong and building a path to an even better 2018. That said, go Astros. Can we believe that we beat 3 awesome powerhouses, Boston, Yankees and LA? Pretty fantastic. Like I say, go Astros. Moving to our results. This is DXP's third quarter of sequential increases in total sales. Year-to-date through 9 months, DXP sales are up 3.4% over the same period in 2016, adjusting for the sale of Vertex. As such, we are encouraged by the improvement of sequential and year-over-year financial performance and remain focused on growing our business and finishing fiscal year 2017 with strong sales and operating results. The ISM PMI manufacturing index, which uses an indication of how DXP's broad industrial markets will perform, expanded from July 5 – 56.3% reading through September,…

[Operator Instructions] Your first question comes from Matt Duncan of Stephens. Your line is open.

Hey good morning guys.

Hey Matt.

So first thing, I may have missed it, did you quantify the revenue impacts from the hurricanes?

Yes, Matt, this is Kent. As everyone knows, kind of, our business tends to surge at the end of any month. And so when we looked at that surge and the impact on August really tearing into September, that impact roughly was about $5.2 million. The surge was not a strong at the end of August, and that's when the hurricane started to hit back as early as that Thursday, if you will. And so it was about a $5.2 million impact.

Okay. But Kent, if I'm doing my quick math right here, the write-off of debt issuance costs was about $0.02. And then the hurricane impact seems like at a corporate average, gross margin maybe that was about a $0.05 impact had you not had the hurricanes. Is that sound reasonable?

That sounds reasonable. In terms of gross margin, one thing you got to keep mindful of is we did – it guarantee certain pay even though we were down for individuals during that 5-day period, if you will. So our margins for the quarter at 26.6% reflects some, call it, inflated cost on a gross margin level. But yes, and so if you look at gross margin excluding the noise we discussed, you can really look at gross margins at 26.75% or so, call it and put that against the 5.2%.

Okay. So – and that sort of leads to my next question. If 26.75% is what it would have been without the impact from the hurricanes. You talked a lot about the 2 items, the weight on your gross margins sequentially. Obviously, I think, everyone is trying to figure out how much we need to extrapolate that forward? How quickly can your gross margin recover? It sounds like you've got a pretty clear plan to get both items fixed, 4% to 6% price increase is something you can do or at least attempt to do pretty quickly on the Safety Service business side in Canada. Obviously, at IFS, that may take a little bit longer to push through. So 27.5% is where you were from a gross margin perspective back in the second quarter of this year. How quickly can we see you get back to that rate? Is that something you can start to 27 plus in the 4Q and then by first quarter next year, we can maybe be back to that level, especially given that they'll be on the Canadian Safety Services business as entering a strong part of a year here. So how do we think about the recovery in the gross margin because I think that's really going to be really important to helping us solve forecast profitability going forward?

So Matt, I think you stated the obvious very well. But to be specific. So yes, the price increases for Canadian Services can happen pretty quick. I think one thing missing in the equation is on IFS. This new strategy was sort of implemented, really, let's say, as long as 6 months ago. And so we have built a backlog of nonengineered type fabricate modular systems already. And so those are – it looks kind of like the third quarter was the pinnacle of the low point. And we should see things improving pretty quickly going forward because we have booked I don't know, it's something like $7 million for those types of business. So we should see a little quicker improvement than you might think. And then lastly – no, you go ahead.

I was thinking given that, can you get back to the second quarter level in the fourth quarter, especially since the Canadian Safety Services business is entering the strong part of its year?

I think we – yes and no. I think that was likewise missing part of the equation is that IFS, when they do an engineered, one source engineering fabricating job, of which they haven't had one of those to longer period of time, those margins are 50%, okay? So we – we're not walking away from that business. We're still working on that type of business in, et cetera. But we don't have one of those. We're just – it's not in our backlog right now. We're working on lots of quotes and they will come, and let's say when they come, we normally are relying on 2 or 3 jobs a year. This year, we've kind of had the tailwind of the one. And now, we had don't have any. But they're significant. So this business is, at IFS is still going to kind of be lumpy to the extent we can – that we get those kinds of jobs because they're great and we make a lot of money at them. So the business it's coming. It's going to be better, much, much better than not having any business because they will be more in the 25% type range, 20% to 25% type range of fabrication work. And so we'll get some improvement, but if the weather goes all the way back to 27.5%, I don't know. The other piece I was going to comment on is that, as we continue to certainly, pay people that were along the Gulf Coast, when we take all the people that were in fabrication, I really want to make this clear, we still pay these people in fabrication, but we didn't charge them to the job. So they become unobserved overhead. And so that hurt – that directly hurt our margins, not when we close the job. But today, we – a guy works an 8 hour day, we charge 8 hours to the job and it's recorded in absorbed overhead. So we had all this unobserved overhead that will go away. And so will have an immediate pickup on that in the fourth quarter. Now I think we've calculated that out to be $400,000 or $500,000. So it's not like a tremendous picks, but everything helps.

Okay. Yes, all that color helps a lot. So we probably don't get back to that level in the 4Q, if I'm hearing you correctly. But we're well on our way to fixing gross margin. And if we're not there in the 4Q, we probably should be in the 1Q is the way to think about it.

Absolutely. And really, I would like to think in terms of margins being higher. I mean, we really need to get, as business improves, our people have to go from a mindset of trying to win every order to now, let's win orders in that we can make money on. Our IPS is working double shifts right now. Our manufacturing people are working double shifts. So we've got to turn our attention from – we've got to win every order to keep busy to no, no, no. Now, we have enough orders. We just need – we need to make sure we make some money on them. And so as we shift to that kind of a seller's market and not being such a buyer's market, we should see margins improve.

Okay. Well, and that's kind of where I was going with my next question. You said that your backlog in IPS was up 15% on an average run rate from 2Q to 3Q. What is the margin profile look? Is your backlog is changing? Have you already gotten your people to start thinking profitable growth as opposed to take all volume? Or is there still a little bit of margin squeeze in the backlog?

We're very slowly improving margins, very slowly.

Okay, all right. And then last thing and I'll hop back in the queue. On your Service Centers business, it sounds like a lot of the hit from the hurricane is probably there. But you also had the sale of Vertex that layed on year-over-year growth in that segment. And I think you may have had one less selling day this quarter too, correct me if I'm wrong. But what was the average daily – organic daily sales growth rate if you normalize for Vertex, let's not worry about the hurricane piece, but the one less selling day, if I'm right about that, what was your average daily sales growth for the Service Centers business this quarter?

I think it was – we calculate it's 14.8%.

That's obviously really helpful, guys. I mean, is that more energy driven at this point? More industrial driven? Is it – you're seeing good benefit from the both? And then again, clearly, the Americans, if not for the hurricanes, it would be even better.

It's both.

It's both. It's both, Matt. Obviously, the indicators we look to PMI, the metalworking business index, they support the industrial piece of our business in the region. Some of the regions we mentioned are kind of more heavily industrial driven versus oil and gas, higher River Valley, North Central, frankly, year-to-date, if you look at year-to-date and year-over-year. And so in the industrial pieces definitely beginning to show strength. And then, obviously, oil and gas is, call it, in the aggregate in 2017 has been in recovery mode. And so we're getting a positive feedback when we go through our planning as well as in the results. So...

Okay. Alright, I appreciate it guys.

Thanks Matt.

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

Hey Joe.

Joe.

Your line maybe unmute sir.

Good luck to talk to you.

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

This is Ryan on for Steve.

Hey Ryan.

Hey Ryan.

My first question is, can you kind of talked about the trend you're seeing during the quarter on a month-to-month basis and so far what you're seeing from preliminary October results. Sorry if you already brought this up. I kind of got on the call a little bit late.

I guess you're asking sales per day?

Yes.

Sales per day for July were $3,785,000; August, $3,643,000; September, $4,622,000, for an average for the quarter of $3,999,000 a day. Our October, which includes some estimates of sales for the month comes out at $4,005,000. So essentially, definitely better than in the July and August sales per day, below the September, but perfectly flat with the average for Q3. Do you want to know about the first 2 days of November? Is that what you're asking?

No, no. I wasn't asking that. And then looking at a incremental margins during the quarter came in at about 7% or 9% roughly 9% growth. I think, I was expecting a little bit of a higher number. And looking at IPS and supply chain services, I mean, you put up a 2% incremental on all those 30% growth in IPS. I assume a lot of that was from the gross margin pressures. But was there anything else in that kind of drove that low incremental during the quarter?

No, that's it, Ryan. It's the gross margin pressure we discuss in IFS within IPS. And so, ideally, at this point in the cycle, even though we're still working through the pricing pressures, if you will, in the market becoming more favorable to us, the operating income margin is probably frankly, should be up 100, 200 plus basis points at least at IPS at this point.

I really would like to say it, that's all correct technically. But really, what's intriguing and important and just kind of, I guess, the people have faith that the things are going to improve is that IFS simply only sold engineered product and modular systems. And they only did that type of business. We have simply added all of our other products that DXP does, other types of modular systems, other types of large pumps, et cetera, to their product offering, which is already made great dividends and the increased sales. And yes, they make a little. We make less than that. Margins go from 50% to 25%, let's say. But it's going to make their business so much more dynamic and so much more profitable going forward. This feast or famine thing is ridiculous, and so we fixed that. We fixed that a while back. And so it'll start paying dividends going forward here. And the other is that I kind of get that they oilfield companies want to hold your margin, they want to hold pricing down as much as they can so they make money at $50 a barrel. But the truth of the matter is they are making money at $50 a barrel. And so us holding our prices firm on safety services where we basically rent people, and those people, though, have said, "Look, we haven't had an increase in 2 years." Well, I don't blame them. I think the people deserve an increase after 2 years. But we have got to pass that on to the customer. We can't – we're not a non-profit organization here. They can't pass that on to the customer. So that simply has to be done. The fact it wasn't done is pretty – I didn't like that. So let's just say that there's some things that are very logical here and very simple fixes and they're in the process of happening, and we'll get this thing. We're just simply not hitting on all cylinders and we're going through pretty quickly. So...

Okay. Then my last question going back to the Service Centers in the gross margin pressures you're seeing there. Are you seeing any pricing pressures from nontraditional distributors such as the Amazon business primarily within your safety products as price transparency increases? I mean, are you seeing any pricing pressures from that?

I'm well aware of Amazon, well aware of people that have a lot of headwinds against that company in the industrial sector. I'm really aware of the fact that their whole model is based on 3 things, and we'll kill them all – 2 of them, but the third one is a little concerning at times. And that's speed, convenience and price. That their whole model is based on speed, convenience and price. We're frankly faster to market with our type of products because they're technical, they're solution driven, they're not just a simple part number, and we can do it faster than anybody else can in the industry, quite frankly. Our customers are not mass marketed customers. They're specific customers where we have a relationship. We call them the account. And we do everything we can to serve that customers, like – be like Mac having somebody drive his car everyday versus Kent who drives himself. We're out there driving that guy's car. We understand his business, et cetera. So I'm not at all worried about Amazon. I'm not really worried about other mass market retailers and industrial people. I am worried a little bit at times on some of our stuff that's not as technically. If it's technical, there's no worry. But if it's not as technical, if it's just part of safety products that are hardhats and things like that, that we – we only have those things to capture more spend of each customer. We want more of each wallet of each customer we have, and our customers are specific. We got – I don't really know how many of them they are today. But 30,000 to 40,000, 50,000 customers are very specific. We're not trying to cover the world. They – we get call through…

Hey, Ryan, just to put the sequential growth.

Sorry to take you through my lecture, by the way.

So just to put in the gross margin sequential performance in the context. If actually, our gross margin in Service Centers, we don't necessarily disclose it. But from a basis point perspective, it's actually up 14 basis points from Q1. And so – and when you look at our gross margins for Q3, they're well in line with where we performed last year. So once again, we get the backdrop in the question and query around Amazon ultimately, and David gave us the global view. But from a performance perspective, we're really not seeing it impacting our Service Centers.

And to add to that, just one thing. The area that we are going to fix pretty quickly here, Amazon doesn't touch. Amazon doesn't make modular package system. They do engineering work. They don't even touch that. Amazon doesn't have Mac McConnell's train to the safety technicians. They go out and set on a drilling rig. They don't do those types of services. So the area where our margins got pulled down and we told you specifically what caused that, that's not even – Amazon is not even in that business.

[Operator Instructions] There are no further questions at this time. I return the call to our presenters.

We are done.