Good morning. My name is Sharon, and I will be your conference operator today. At this time, I would like to welcome everyone to the DXP Enterprises 2018 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] Thank you. Kent Yee, Senior Vice President and Chief Financial Officer you may begin your conference.

Thank you, Sharon. This is Kent Yee, welcome to DXP's Q3 2018 conference call to discuss our results of our third quarter ended September 30, 2018. 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, DXP 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 to provide his thoughts and a summary of the third quarter financial results.

Thanks, Kent, and thanks to everyone on our 2018 third quarter conference call today. Welcome and thank you for joining us this morning and thank you to all the DX people for your hard work. DX people either come to a DXP facility or interact with a customer each and every day providing 100% effort to do a day's work in a day, one team sales, operations, corporate, driving stakeholder success and value creation. Our year-to-date results for nine months ending September 30, 2018 are a correct reflection of the DXP teamwork together aspiring to be the best solution for all our customers' needs. DXP had another solid quarter, demand remained strong in the third quarter and we continue to experience sequential increases in our quarterly sales per day basis. We have now gone eight straight quarters with sequential increases in our average daily sales for the quarter. We continue to believe that our value proposition to our customer is superior to our competition. Additionally, we continue to remain on track for gross margin improvement that we outlined at the beginning of the year. Our result year-over-year has been consistent with our expectations and in line with our financial goals to grow 20% year-over-year through a combination of organic sales and acquisition growth. In terms of those areas, where we have been looking for more consistent improvement and gross margin, such as DXP's engineered-to-order business and our Canadian Safety Services business, both have shown consistent improvement in gross margin since Q3 of 2017. And from a year-over-year basis have shown meaningful improvement. As it pertains to the operating environment, the ISM and PMI manufacturing index continue to be above average over the last 12 months. This supports the organic sales increase we have experienced through Q3. Additionally the Metalworking business…

Thank you, David. And thank you to everyone for joining us for our review of our third quarter financial results. As David said, Q3 was a great quarter for DXP and our results are in line with our expectations and reflect the momentum we are - we were anticipating going into fiscal 2019. As David mentioned, we're growing through a combination of organic and acquisition driven sales. The Q3 2018 financial results mark our eight consecutive quarter of increases with respect to quarterly sales per business day. Total sales for the third quarter increased 22.3% year-over-year to $308 million. Adjusting for the $12.1 million Q3 sales contribution from ASI, organic sales increased 17.5%. Total sales growth for the third quarter was supported by all three business segments, reflecting the continued expansion we are seeing from existing and new customers and the overall relative strength of our end markets. Average daily sales for the third quarter were $4.9 million per day in Q3 2018 versus $4 million per day in Q3 2017. Adjusting average daily sales for ASI, average daily sales for Q3 increased 17.5% or were $4.7 million per day. The overall growth reflects what we are seeing in some of our key end market indicators through the first nine months of 2018, including the rig count, U.S. oil and gas production, drilling, the Metalworking Business Index, the PMI, and the overall average increase in the price of oil. The ISM and PMI manufacturing index has moved from a reading of 60.2% for June to a 59.8% reading for September. The trend continues to be above the average over the last 12 months of 59.2%. This supports the organic sales increases we have experienced through Q3, in particularly in our industrial and markets. Additionally, the Metalworking Business Index continues this…

[Operator instructions] And your first question comes from Joe Mondillo, with Sidoti and Company. Your line is open.

Hi, guys good morning.

Good morning, Joe.

So I want to ask you just about sort of you've mentioned about pricing and costs, is that a net positive or a net negative in terms of trying to stay ahead of inflating cost?

So, I think it's a positive and a positive. First of all to a positive for our pump works, manufacturing and brand because it's made in America. And so therefore we don't have any incremental increase in cost. And so that helps us be more competitive in the marketplace on other pump manufacturers that are making stuff in China and et cetera. The other suppliers and people, the price increases we're seeing really are in the 3% to 4% range. They're not - we're not seeing 25%, so people either have a blended cost or whatever and so they are raising prices. And so we haven't seen that in a long, long time and as you know distribution loves price increases because our inventory increases in value, and as long as the price increases are reasonable and justified then we are able to pass those on to our customer.

Okay. And I'm glad you mentioned pump works, so I wanted to ask about that. How has the feedback and adoption rates with your customers have - how has that been over the last - how has that trended over the last few years since you introduced that? And you mentioned how more competitive you are as some of the OEM manufacturers I assume are manufacturing their pumps overseas. Could you talk a little bit more about that as well?

So, pump works as you know is not a very old company and so it is not a household name and yet when we added that to our DXP channel a pump experts. We have - we felt likely have done extremely well, we're exceeding what we've done in the past with other brands. And so now that said you know 2015 and 2016 were tough years. So we kind of - I think we did really, really good during that time, but it's really taking off in 2017 and 2018 to the point now where we're having to buy additional you saw some CapEx expenses and stuff. We're having to buy extra machines to keep up with demand. And so that as manufacturing has a fixed cost component to it. So as sales volume goes up so do profitability and so we're seeing that. And so we're very pleased with pump works.

And has the growth rates there been above or below the company average sort of revenue growth rates that you see there?

Pump works is part of IPS and IPS has had 50% growth rate.

Okay. And that leads me to the backlog that you see IPS, you stated that it was up quite significantly. I assume we can - looking at order trends that you're seeing. I assume things are really - still really healthy and the environment looks pretty good. Could you just sort of comment a little bit more on that?

Sure. We're coming to the end of the year the oil and gas people typically have capital budgets. And so there are some people that are kind of exhausted their capital budgets. But what happens this time of year is that people are working in terms of designing and using our expertise and putting projects together and getting them quoted, getting them - getting numbers so that they can budget for next year along with some people get a lot of equipment that ships at the end of the year. A lot of times our fourth quarter is our - one of our strongest quarters. It hasn't always been that case, but it can be. And so what we're seeing this year is that we're seeing a lot of quoting activity, a lot of effort, a lot of people planning for 2019, which we feel very good about.

Okay. And the gross margins at IPS were down from the second quarter. I think Kent, mentioned it was sort of a mix issue. What did the gross margins looks like in the backlog? Do you anticipate margin expansion or contraction at all? How does the mix look like in the backlog?

I think that we're driving increased margins. That said, the mix is important. If we're doing all our businesses coming from $6 million and $8 million projects where the margins are smaller, it shouldn't necessarily be, but they are. And if we're doing $1 million projects the margins are greater. So we're having a mix of those and I don't know what that really looks like going forward. I hear about all $1 million orders or all $6 million orders. But - so I'm not quite sure what the mix is there. But even on the $6 million order, trying to get our margins up, on $1 million order that we get good margins, we're trying to still get them up. So I think we should see IPS have incrementally better gross margins. That said.

With all - okay, go ahead I'm sorry.

I'm sorry

Joe the only thing I would…

Go ahead.

Joe, the only thing I was going to add is, I think to what David said is, obviously we've been harping [ph] on gross margins not just with you guys, but internally in our organization. And so I think we've got our teams focused on it. And these jobs in IPS have different lifecycles if you will some are six months, some are nine months. And so depending upon that mix, which in any given quarter, we don't have necessary a lot of control over it could impact gross margins slightly up or down. And so I think we're focused on, but we have additional measures just to make sure - I know Todd Hamlin, our Senior VP of Sales for Service Centers and IPS for examples, he's getting his eyes on some orders that maybe in the past historically we may have not looked at and will find details. And so he's just making sure that when guys are quoting they are bidding that work that if those margins are where we expect.

Joe, I want to - I think this is worth commenting on because maybe we've been around a while here. So I appreciate you covering this for the length of time you've done. So when we were back in the 2014 era, 2013 era we had a lot of offshore packaging. And we had a lot of engineered-to-order type packages that also went offshore. And both of those that market whether it was in South Africa or in the Gulf of Mexico, we made higher gross profit margins back in those days. Those were more complex jobs, there were more engineering to them, and there was fewer people that could do that type of work. And we made higher gross profit margins. Now that we have shifted to onshore, along with kind of the midstream pipeline business too, our product mix has changed. We've done a fantastic job of growing that business back. It's going to produce really good results. And - but it's probably never going to have those 2013 gross profit margins again. And last, you can bring the offshore market back for me. Then I'm really going to do really good. Does that make sense?

I'll try to do my best there.

It's coming back. It's coming back someday.

So it sounds like you - there's no sign of that sort of coming back tomorrow at least…

Yes, it's not going to be back tomorrow. But it's maybe only a couple of years out. I mean, we're here in the projections and we're seeing some stuff. There's some stuff coming, but it's not big and it's not like it once it was.

Okay, great. Well I have a couple more questions, but I'll let someone else have a shot at that right now. Thanks.

Your next question comes from Blake Hirschman with Stephens Inc. Your line is open.

Yes. Good morning, David and Kent. Congrats on a great quarter here.

Thanks, Blake.

Thanks, Blake.

First off, I just wanted to ask about monthly trends to see what the monthly sales per day looks like throughout the 3Q. And was also curious if you might give us any indication as to what October?

Sure Blake, this is Kent. I'll just walk through July, August and September and then give you a preliminary look at October, I'll catch October as a draft just because we're having our earnings call a little quicker than we have sometimes in the past. But, for July sales per business day were $4.7 million, for August $4.6 million, for September $5.5 million. The Q3 obviously average was the $4.9 million and then for October it was $4.7 million.

All right, got it. And I think you called out expecting 20% growth this year, which looks like that implies some like a 2% or so sequential decline from 3Q to 4Q, which is pretty in line with what you've seen over the last few years on average. So, A, I just wanted ask if I got that right; and B, if there's any other kind of dynamics at play we need to think about when we're looking at the seasonality here?

No, I mean, I think a couple of comments, one, yes we've been combined organic plus acquisitions kind of I'll call it roughly around the 20%, this quarter 22%. And so we fully expect that ASI has been a strong performing acquisition for us. They're ahead of budget at this point through Q3, so we expect that going into Q4. That said, you do have an additional business day going into Q4 you have 64 business days, but you have the holidays. And so you know we're mindful of kind of the more recent trends in our business mainly last year, which you picked up on and the fact that one we've got an election coming up that will stall the world for a moment in time. Then you have, Thanksgiving holiday and then you'll have the Christmas holidays, Thanksgiving falls obviously on a Thursday. So you get mixed performance the day after Thanksgiving. And then this year Christmas falls on a Tuesday. So once again we're just - we're trying to factor all that in obviously we don't have that crystal ball, but that kind of feeds our thinking. But sales per business day for a quarter we probably would expect a continued improvement is the way I'll put it. We don't formally give guidance but continued improvement.

I think, Blake, you're trying to refer to a generalize comment that we feel good about doing over 20%. We weren't trying to target that exact number. So you're reading it a decline that makes it come in exactly at 20%, I think you're reading a little too much in there. That's what you said.

Got it, all right, that makes sense. And then kind of on the same lines did not having a crystal ball here, any color as to what you might be hearing from your customers when they're thinking about their outlook for spending next year. Kind of any way to, I guess, frame up the potential growth?

No we don't hear - we're not hearing about budgets yet. But we have tremendous amount of quoting activity and a lot of big projects on the board, whether they're midstream or thereby defines midstream, upstream different a little bit. But we've kind of - we think the gathering platform is really midstream by the way that upstream is nearly drilling and fracking. And once the product comes to the surface than everything else after that is kind of midstream, but - until we get the downstream. But we have a - there is a lot of - our activity level is very high.

Got it. And then just one more and then I'll pass it on. 50% growth in IPS to your stakes almost 80%. Can you give us any sense as to how much you think the pump's overall kind of market growth is and what are some of the factors behind what I assume as pretty substantial market share gains there? Thanks.

Yes. We from pub works, engineered-to-orders, which we're really not doing very much of, but we're quoting a lot of that kind of stuff now and that has really high margins. And then our configured-to-order modular package business. Our backlogs indicating that we're going to continue to grow and our quoting activity says we're going to continue to grow. And so whether or not stack on another 50% or 10 plus I don't - I'd be guessing a little bit, but we feel really good about 2019.

All right, thanks a lot.

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

Good morning guys. This is Ryan Mills on for Steve.

Hey, Ryan.

Hi, Ryan.

Doing good. Yes, just solid incremental margins past two quarters and I'm just thinking about tougher comps heading into 2019. So I'm just curious do you believe you can maintain these incrementals in a low single - mid-single digit growth environment?

You're right. The comps obviously get harder kind of having tough call it once again call it 15% plus organic growth year-over-year. And then as we kind of roll in ASIs organically going into 2019. I think pay we also believe we got organic strategies kind of always have that kind of support that growth are coming off the bottom. So I think as we go into 2019, will you see double-digits, once again, we don't give guidance don't have that crystal ball. But we're driving growth, we believe we're a growth company. And so we're going to push organic. I think what you also hear in our comments is that our goal to David's earlier comments to Blake, which we use where he meant to our financial goals have always been 20% growth through a combination of organic and acquisition driven. So that's what we're focused on. And so in our Q3 commentary we're kind of giving you inclinations that 2019 will support it with some acquisitions as appropriate.

So, Ryan, let's understand that from a financial modeling point of view. We've invested - coming off the bottom, we've invested quite a bit in working capital and in some CapEx to grow pump works, et cetera. And so that's kind of where our money been going of late. But when - if organic goes from 22.5 to 10 then we won't be spending that kind of working capital money. And so then we take that money and go out and buy other companies and we've done that very successfully. It works from a cash flow point of view. So we feel comfortable that we're going to be at 20% one way or the other.

Okay. And then now the quarter's solid gross margin performance. And I know you talked about the potential mix headwinds and you're not sure about that. But historically gross margins are down from 3Q and 4Q and given the strong performance you had this quarter, how should we think about gross margins in 4Q 2018?

Well, I think our gross margins just to kind of maybe correct you just directionally a little bit, Ryan are in line with where we kind of discussed at the beginning of the year, I think at the beginning of the year after Q3 of last year, having that downturn on gross margins in the 26% range. We said, hey, from there, we were going to improve, call it 15 to 20 basis points a quarter. And so if you net look where we're at, we're roughly on top of that through Q3. And so I think once again, that commentary remains the same as we go into Q4. Is it a perfect straight line? No. Was Q2 up significantly? Yes. But net kind of where we're at kind of year-to-date I think we're in line with what we expected. If that answers your question.

And Ryan I'll just - I want to add something that I don't think people appreciate that as the oil and gas market just for completing the second inning of hopefully a 7 or 9 inning ball game here, we're starting to have and so was our competition having some capacity issues. And especially in terms of our desire to be the fastest on delivery of anybody in the marketplace, and the customers wanting things faster. So faster creates an opportunity to create value and we're taking that value and we need to capture it in our prices because our customer will pay for it if they see that value. And so that's what's driving sort of increases certainly in IPS and in certain parts of our Service Centers. And then SCS is just as their margins are down a little bit there they'll get them back they're just in a stage of whether investing in some new business and we're not getting the revenues and the corresponding offset to that. So that will get that back. So to answer your question very pointedly is I expect our gross profit margins to go up. And I don't see any reason for not to, besides maybe care for something that we can't pass on, but that's not very likely really.

Okay. And then…

I'm not - I can't predict from.

And then just one last question for me, just thinking about the significant EBITDA margin improvement year-to-date. And Dave, I know your goal to get to 10%. So you can walk us through on how you're going to get there. And do you have an idea in mind of the revenue levels, you need to have to achieve that target?

So we're at 7.5%, so we're 2.5% off. So I really expect to exceed 10%, because I would like to see a 2% improvement in gross profit margins and I'd like to see something north of 0.5% improvement in SG&A and that more than gets us there.

Right, thank you.

[Operator Instructions] And we have a question from Joseph Mondillo, Sidoti & Company. Your line is open.

Hi, guys. Just two follow up questions. The operating margin that you saw at the Service Center segment better than I was anticipating, I know, I've talked to you Kent a couple of times on sort of seasonality and sort of the volatility in the operating margin at this particular segment. Just wondering sort of what drove the expansion in this quarter?

They had…

It's gross.

Yes.

Gross margin, I mean we're pushing our value proposition, we deserve more.

Okay.

Yes, we roughly had a 31 basis point improvement, Joe, from Q2 to Q3 in gross margins around Service Centers. And so a lot of that felt to the bottom line. Absolute SG&A dollars went up obviously slightly, but not as much as the improvement from the gross margin. So that builds those operating income margins that you are seeing.

And then SCS, you didn't ask but I am going to tell you SCS had about $0.5 million more in expenses, that has to do with the startups of these new sites. That is the reason why their operating income went down slightly.

Okay. And the seasonality at Service Center, you tend to get a little higher margin in winter months, is that right?

Yes, in Canada, as Canada gets cooler, what's you're at, Joe, as Canada gets cooler it may go into the busy season, that create some seasonality in our financials. And so that once again we've also seen consistent improvement and steadiness is the way I'll put it from Q2 to Q3 in the gross margins of Canadian Safety Services. And so - but yes Q4 as you get into the winter seasons for Canada, and then maybe a month or so of Q1 the cold season in Canada is when they do their busy work and then break out pattern.

Okay. And last question for me, I noticed your debt level stayed pretty flattish compared to over the last couple of quarters. Just wondering sort of how you're thinking about cash flow and use of cash doesn't seem like maybe you're too focused on paying down debt, so is M&A your number one focus or…

Once again, I think the world needs to be educated a little bit on our capital structure. We have an institutional debt piece the Term Loan B, which has 1% amortization on a full year - mandatory amortization on a full year basis, so 0.25% per quarter. So, if we have excess cash it's not like we're going as we have historically, because we just had a basically a revolver and a Term Loan A and paid down the debt. We have an institutional debt piece that only requires us to amortize 1% per year. And then we have and we're going into the first year of it, than we have what we call it excess cash flow sweep at the year-end, which has a specific definition, I won't go into that now. That gives us the option basically to really pay down some debt if the formula splits that out. And so long way to answer your question, yes, from a capital deployment perspective we put that in there to focus on growing the business as we're coming out of the cycle also to optimize our capital structure and allow us just to not be drawn down in conversations with our banks unnecessarily. So, it's build for our growth strategy.

Okay, thanks.

[Operator instructions] And we do not have any questions over the phone line at this time, I will turn the call over to the presenters.

We don't really have anything there to add, but thanks everybody for your participation and your questions, we appreciate that and hope you have a great day.

This concludes today's conference call. You may now disconnect.