Good morning. My name is Chris, and I'll be your conference operator today. At this time, I'd like to welcome everyone to DXP Enterprises' 2022 Third Quarter Earnings 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] Thank you. Kent Yee, Chief Financial Officer. You may begin.

Thank you, Chris. This is Kent Yee, and welcome to DXP's Q3 2022 conference call to discuss our results for the third quarter ending in September 30th, 2022. Joining me today is our Chairman and CEO, David Little. Before we get started, I want to remind you that today's call is being webcast and recorded and includes forward-looking statements. Actual results may differ materially from those contemplated by these forward-looking statements. A detailed discussion of the many factors that we believe may have a material effect on our business on an ongoing basis are contained in our SEC filings. However, DHB assumes no obligation to update that information as a result of new information or future events. During this call, we may present both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in our earnings press release. The press release and an accompanying investor presentation are now available on our website at ir.dxpe.com. I will now turn the call over to David Little, our Chairman and CEO, to provide his thoughts and a summary of our third quarter performance and financial results. David?

Good morning, and thank you, Kent. Thanks to everyone for joining us today on our fiscal 2022 third quarter conference call. I will begin today with some perspectives on our third quarter and thoughts about the full year and our future. Congratulations, DXPeople, our third quarter sales of $387.3 million is a sales record for DXP during the quarter. Thanks to each of you for your efforts to be customer-driven and you're part in diversifying into new markets like food and beverage, water and wastewater, plus growing our existing markets. We, as a company, have a more stable industrial base that will serve us well into the future. We have also added technical products and service technologies to our outstanding product and service mix that will also serve us well into the future of digital automation, compressed air filtration, biofuels and capture hydrogen that will help us make our lives better. Every day, DXPeople serve essential customers and help the environment by being more efficient, safe and environmentally friendly. Our goal is to help our customers with their sustainability goals and for us to lead by example. To be customer-driven in a changing world is exciting and fun. It is also hard work, and I thank all the DXPeople for their efforts and enthusiasm for making DXP meaningful by helping our customers succeed. o how are we doing? Nine acquisitions over the last two years in water and wastewater in this industry. This is not only a stable industry but very important to our lives and the environment. Three compressed air acquisitions, compressed air saves energy and is environmentally friendly. In 2014, Energy was 66% of our business and today, 27%. Note that this could be a good market for 2023, and we would be glad to see the 20%…

Thank you, David and thank you to everyone for joining us for our review of our third quarter 2022 financial results. Q3 financial performance reflects our eighth quarter of sequential sales increases during this COVID cycle and the subsequent interrelated challenges including inflation, supply chain constraints and a war. Despite these challenges, DXP continues to successfully navigate through the market and has been able to execute and create value for all our stakeholders. I'm excited to report that our Q3 2022 financial performance is the highest performing sales quarter in DXP's history. While a notable milestone, we look forward to continuing to strive to meet new sales thresholds and build DXP organically and through acquisitions. We have been successful in transforming growing and diversifying DXP. As it pertains to our third quarter, DXP's third quarter financial results reflect a combination of business actions we have undertaken. More specifically, Q3 takeaways are as follows; continued strong organic sales growth and contribution from acquisitions, consistent ability to manage inflation and price increases, strong service center performance marked by continued gross margin stability, further sales increases within SES, along with another quarter increase in the IPS backlog and consistent operating leverage leading to sustained adjusted EBITDA margins. Total sales for the third quarter increased 33.8% year-over-year and 5.3% sequentially to $387.3 million. Acquisitions that have been with DXP for less than a year, contributed $16.1 million in sales during the quarter. We are excited to have our most recent acquisition, Sullivan Environmental Technologies as a part of the DXP family. Sullivan Environmental will provide additional sales within the water and wastewater platform and provide margin enhancement and product and end market diversification. We welcome you Sullivan, and we're excited to have you as a part of DXP. Average daily sales for the third…

Thank you. [Operator Instructions] The first question is from Tommy Moll with Stephens. Your line is open.

Good morning and thanks for taking my questions.

Good morning.

Good morning Tommy.

I wanted to start at the top of the P&L on your daily sales. Can you give us any context on what October looks like? And then as we look towards November and December, based on your commentary, it sounds like ex oil and gas, that revenue might continue to trend higher, but then you've got the seasonality or the typical seasonality in that oil and gas market. So, I wonder on a consolidated basis, how do you see that daily sales progressing through this quarter?

Yes. So, Tommy, I'll jump in there and then maybe David can give a little color just from a market perspective. But the trend, and I'll just really go through the quarter and into October, it was $5.5 million per day, $5.9 million, $6.8 million in September and then October, another $5.8 million. Our October sales per business day is up 25.1% on a comparative year-over-year basis. So, we're seeing the trends continuing early on here in the fourth quarter. But if she had some other comments. I don't know if David wanted to jump in there around oil and gas and some other things.

Well, sure. Oil and gas, you either had to the end of the year and people have run out of budget money or they haven't and they want to spend it. And then you have the holidays. And so I mean, that's kind of how the oil and gas piece works. The general industrial piece, a lot of manufacturers will shut down a week, earn the holidays, et cetera. So, you have some softness there. So, you have a little less days. You have manufacturing probably taking advantage of -- or maybe not. I mean they may be so far behind on their deliveries because of the supply chain problems that they don't take the usual a week or two off. I'm not sure how that's going to play out. I do know on oil and gas that people are -- at these prices, they're trying to produce as much oil and gas as they can. It doesn't mean they're drilling billion holes or Halliburton and Schlumberger are doing a lot of work around workovers and DUCs and et cetera. So, that's kind of normal stuff. I mean, in general, oil and gas is going to be a good market for the rest of this quarter, really, in my opinion, and through all of next year. So, I don't know if I answered your question or not, but that's my attempt.

No, it's helpful context. I appreciate it. And if we just move down the P&L, I would ask you for your outlook on fourth quarter gross margin or SG&A as a percent of revenue although understanding it's hard to pin down the revenue, there may be some uncertainty there. But maybe we could just start with any qualitative headwinds or tailwinds on for gross margin or G&A in third quarter and the extent to which those would improve or get a little worse as you go into fourth quarter?

Yes. Tommy, I'll jump on that one. Well, I mean I don't know if they're necessarily headwinds, but we've been kind of really communicating it since Q2 is we've got a significant diversified chemical customer within our Supply Chain Services segment, that the overall profitability, including SG&A cost is in line with where we're typically. But from a gross margin perspective, it's put a little bit of weight on the downside to our gross margins. There are obviously a significant sales volume customer, too. So it's a combination of the both. And that's what's led to the business unless there is mix contribution Q4 of shifting here on us. And we're always looking for more opportunities with both our existing customers and new customers. So, net overall profitability is in line for the segment. But from a gross margin perspective, it kind of puts a little weight on our gross margins. That said, I don't think we'll continue to see too much further drag unless the sales just extremely ramped up in Q4.

So, we're close to full ramp at this point. So We do a good job. -- somebody calls us today; they need a pump. We use replacement costs and market up our normal markup. And that transaction happens just fine. There's a little bit of fixed cost. We try to avoid those and go with a fixed margin. But there're still some lag between when the supplier gives us a price increase and when we get the price increase passed on to the customer. So, a little lag there. And then on things that projects that we quote, and we quote a $4 million project and we get the order, we have the right to not take the order, obviously, if it's -- pricing has gone really astray. But if pricing is pretty normal, then it takes six months to build out the order, maybe longer labor costs go up, things still a lot of the stuff we didn't order everything exactly the day we got the order goes up. So, there's always some lag. And I think the difference between the 30% gross profit margins, which would be more of our targeted gross profit margin number, which is what we did last year at this time and the 28.9% or eight wherever we are today is because of those reasons we just listed it.

So, on to cash flow. You called out a couple of areas of investment year-to-date in terms of inventory and receivables that have impacted their performance there. I guess to start, just versus your expectations, how have operating cash flows progressed. And as you look into Q4, do you see any potential for a release of cash from inventory or receivables or a pathway to the black, so to speak, on operating cash flow line this quarter?

Yes, Tommy, I'm going to give you a high-level answer here, and then I'll let Kent deal with the details, but realistically, if we're growing organically 10% and therefore, receivables and inventory go up some percentage of that growth. Normally, we're in the working capitals 15%, the high watermark would be 19% -- 15% to 19% of that sales growth. But what happens when we grow 35% organically. Well, it takes more working capital. So, within a short period of time, you're going to have to increase your inventory levels to support the greater sales number and obviously, receivables goes up. And then Kent pointed out that we get progress billings on projects and that on those projects, of course, our customer doesn't want to pay us. And of course, we want to be paid more than our cost. We want the customer to fund the cost of those projects. And so somewhere in the middle is what ends up getting negotiated on the terms and conditions of those contracts. And really, we're -- when you look at IPS, it is coming out of a buyer's market, and sales were down substantially because of oil and gas and et cetera. So yes, have we -- have we let the customer beat us up a little bit on cash terms? Yes. Will that continue going forward? No, not as soon as we have a seller's market will get really aggressive. So, I don't think there's anything that in the fourth quarter is going to sit there and say that we're just going to have a whole bunch of money fall in our lap because that's -- I don't know what Kent thanks, but I don't -- I'm not sure that's going to happen because we need the inventory, like, we turn our inventory seven times. So, and then receivables, collection, and then we'll do the best we can to improve progress billings. But really, it all gets down to fundamentally. If you're growing 30%, 35%, you're going to spend more working capital.

Yes. And Tom, the only thing I'd add there is a couple of things. Our cash from operating activities was really actually positive in Q1 into Q2. So our -- we produced free cash flow in Q1 and Q2, which was a little bit an aberration from our historical trends where we typically free cash flow negative in Q1 and Q2 and then it's Q3 and Q4. Point being is that -- and I kind of mentioned it in my comments is. I think it's project work activity, it's the sporadic nature of the supply chains there's a lot of thing factors contributing to it. So, I not think, hey, will we collect some cash in the fourth quarter to that? Yes. Will it be larger than normal? I don't think so. I think we're always working to collect on those projects that David is talking about, and then we've made some investments in inventory. And so as we move through Q4, some of that naturally slows just from a seasonal perspective, but then we're going to be quickly going into Q1 again next year, so--

And really to emphasize one point, too, is that part of the eliminating risk in our business is the fact that when sales go down, we'll then receivables and inventory go down and we generate a ton of cash flow. So I'm not sure we want that. I think growing 30% is more fund, than growing none. But when we're growing 30%, we're going to be -- we're going to use a lot of our cash for organic growth.

Yes. Well, maybe one more on M&A. Kent, I think it was your comment about a growing pipeline there. I'm curious about -- or I'm curious whether you can put any bands around the sizes of potential deals. You've -- in terms of number of deals been quite active in terms of size of deals were, I think, probably turning below the historic average for DXP. So, I wondered if you could characterize the pipeline as it is today?

Yes, I would say the pipeline sits in a few buckets. One is, and David mentioned in his comments, I mentioned around Sullivan, but is we have a pocket or a pool of water, wastewater transactions, which I think you, kind of, hinted at. But on average, those transactions have been smaller than I think historically for DXP, meaning, I'll call it, $10 million or less. We've had some one or two sizable ones in there, but on average, you're talking in terms of revenue, $1 million or less. And then we have some air compressors, which we've done here more recently as well. And those transactions have been -- some of them have been our average transaction size. Some of them have been a little bit larger. And so I think you'll continue to see that as well. And then the last bucket is probably we opportunistic, we are also looking at some automation and some other things and some kind of closer to the Brennan PT space. And once again, some of those are much bigger than our average, and some of those are in line with our average. And so point being, it's like I said, I see a fulsome pipeline, and I see some opportunities out there for DXP and we've been able to get reasonable valuations. And so we look to kind of push into 2023 with us closing on hopefully some acquisitions and kind of keeping that ball moving forward. Once again, also valuations are reasonable. We're disciplined around valuation and it makes sense for DXP.

Appreciate all the time and I will turn back.

[Operator Instructions] And it appears that we have no further questions. I'll turn it over to David Little for any closing remarks.

Yes. Thanks, everybody, for your participation today. I think DXP is really an interesting reflection point where we have a tremendous amount of organic initiatives that we're pretty excited about. We continue to do what we've always done, which is our founding was selling pumps. But there's a lot else that we can do in terms of providing products that require technology and that require a level of expertise, which we love. And so we're pretty excited about the transition that DXP is moving towards the diversity of the markets. We're in energy, but it's moving towards biofuels and storage and carbon capture and some really neat stuff. And so that's exciting for us. And so we see energy and its relevance improving. We're also in the utility market. Water and Wastewater is a big utility market that is important to all of us. And so we're excited about that. And then the industrials normal manufacturing, chemical, aerospace, et cetera. All those markets seem essential to us, and well, I think serve us well. I think we're obviously the Feds trying to slow down the economy. And so that's probably going to happen from an overall perspective. But when we look at the things we're doing, we think we're going to fare really well. So, with that, again, thank you for your participation. Thank you for your understanding of our story, and they all have a great day.

Ladies and gentlemen, this concludes today's conference call. You may now disconnect.