Q3 2022 Distribution Solutions Group Inc Earnings Call
Good morning, ladies and gentlemen, and welcome to the distribution solutions Group third quarter 2022 earnings Conference call.
At this time, all participants have been placed on a listen only mode and the floor.
Or will be opened for questions and comments after the presentation.
It is now my pleasure to turn the floor over to your host Steven Hooser, Sir the floor is yours.
Good morning, ladies and gentlemen, and welcome to the distribution solutions group third quarter 2022 earnings call in conjunction with today's call we have provided.
The Q3 earnings presentation that has been posted on the company's IR website at Investor Dot distribution solution group Dotcom.
Turning me for today's call is Brian King D. S. Gs Chief Executive Officer, and Chairman and Ron can it's M. D S. Gs executive Vice President and Chief Financial Officer.
During the call they will be providing an update on the business from an operation and financial perspective. Additionally, Brad Wallace L. P. C M headwater partner and D. S T advisor as well as the operating company Ceos as the Heartland News up Russ Crazy and Bob corners will be joining for the Q&A session.
Please note that statements on this call and in the press release contain forward looking statements concerning goals beliefs expectations strategies plans future operating results and underlying assumptions that 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 Companys views 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 reconciliation to the nearest GAAP measures can be found at the end of the Earth.
<unk> released.
The earnings press release issued earlier today is posted on the Investor Relations section of our website a copy of the release has also been included in a current report on form 8-K filed with the SEC.
This call is being audio webcast on the Internet via a distribution solutions group Investor Relations page on the Companys website.
A replay of this teleconference will be available through November 17th 2022, now with that I'd like to turn the call over to Bryan Bryan.
Thank you Steven and good morning, everyone. We appreciate your interest in distribution solutions group and we are excited to share the results for our fiscal third quarter.
These refer to our supplemental Q3 earnings presentation that is provided on our website to follow along with our prepared remarks, and we will start on slide four.
DSG represents the best in class specialty distribution solutions company operating in three separately managed high touch value added market places.
We offer customers, both replenishable industrial parts and products as well as specialized products.
We also provide outsourced solutions for companies to help solve their labor shortages and supply chain management challenges.
We have a unique offering of products services and solutions.
Our competitive advantages are compelling to customers and are important to manufacturers Oems and businesses that need specialized products and solutions and there are industrial and commercial industries.
We're very proud of our leadership team and their DSG colleagues as they work collaboratively and executed this third quarter their second quarter together.
With our underwriting objectives and pulling these businesses together.
For our combined companies on a comparable basis sales grew 46% to $347 million consisting of organic growth of 15% and acquired revenue of 31% with.
We generated nearly $35 million of adjusted EBITDA for the quarter and achieved our target of 10% of sales for adjusted EBITDA margin.
We are encouraged by these results as all three operating companies are performing at or above our expectations.
While DSG does not currently provide formal guidance. We are not currently seeing softness in our businesses and the demand environment remains strong as we enter November .
We want to remind investors Q4 seasonality lower and we have four less operating days this year.
<unk> said all three operating companies reported strong Q3 results with meaningful progress on cross selling and early wins on new customer business. We've identified hundreds of leads for cross selling expanding relationships and wallet share with many of our largest customers.
Leveraging the strong customer relationships set us up for significant organic growth in each of our three businesses.
Each of our operating companies are making significant operational progress that gives us further confidence in our overall strategy and our teams.
We've also announced today an expansion of our share repurchase plan. It was originally authorized under Lawson products and has now been expanded to DSG share repurchase program.
We will speak to this more when we discuss our capital allocation strategy in a few moments.
We are cautious in our outlook for 2023, and our ability to manage this business for value creation across the cycle. Although we are not currently seeing a slowdown we do understand how to manage through changes in demand environments, especially for working capital intensive businesses.
Our team has successfully operated distribution businesses through down cycles, and a one O eight and O nine and 2020 also I have experience with distribution companies as a director of that goes back 30 years, where we had underwritten to the benefits of owning distribution businesses, turning inflationary cycles, one where we leaned on learnings.
From the late Seventy's in the early eighties, but where.
We never experienced the inflation that we're experiencing currently.
More broadly our leadership bench has over 200 years of specialty distribution expertise between the combined L. KC I'm headwater and DSG Ceos.
And in today's environment, we understand it macroeconomic headwinds and recession fears are changing how companies think about 2023.
D S. She's working capital intensity has grown this year and at the end of the third quarter, our trade working capital is $337 million.
I am constructive on the level of working capital investment we have seen in our business in.
In my opinion sound incremental working capital investments.
To grow revenues of distribution companies are one of the best ways to drive cash flow return on invested capital and to internally compound the value of our business.
Over the last nine months the investment in working capital has been driven by tuck in acquisitions.
And pushing towards SKU can grunts inflationary pressures of replenishing sold inventory and.
And the growing topline revenue.
We strongly believe.
Disciplined investing in working capital provides the highest incremental return on invested capital.
We can walk through the math on this but I've enjoyed ranges of 40% to 140% cash flow return on invested capital for our other distribution businesses supported by strong working capital investment.
Returns can often exceed a well priced acquisition opportunity.
We will continue to manage our accounts receivable tightly and monitor inventory investments, especially as we navigate 2023.
We expect the 2022 investment we've made in working capital will support growth from these revenue levels and there are also should be some efficiency gains in working capital intensity over the coming year.
I also want to spend a few minutes today discussing our capital allocation strategy on.
On slide five we've laid out our view of the world related to prudent capital deployment.
The entire DSG management team operates under this capital allocation framework, and we continuously rank and recalibrate investment decisions to seek the highest returns in a way projects compete for capital when we consider core growth versus M&A.
Hurdle rates are always changing to reflect economic changes that affect risks and valuations.
As of the end of the third quarter.
Our net debt leverage was three four times.
We expect to enjoy significant free cash flow after the recent investment in working capital for growth and SKU alignment over the coming 12 months. We also understand how much free cash flow, we will generate out of working capital should we see softer economic environments and our combined end markets.
We can take cash out of working capital to accelerate deleveraging further as we have consistently experienced and distribution businesses and previous soft economic cycles.
We will continue to operate in a disciplined and prudent manner as we decide on the highest ROIC see capital deployment opportunities today, we reported that in Q3, we were in the market buying back shares and we also announced that the board has expanded our share repurchase program.
Since D. S. G is already over 65% owned by Okay seem headwater. We appreciate that our float can be a concern. However, we want to have a share repurchase and our capital allocation framework. So that we can return capital to shareholders when appropriate.
With regard to how we think about our capital allocation, our internal hurdle rates and IRR criteria teamed with our focus on long term strategic value enhancement.
Our lenses evolved today.
Much like the macro environment.
And our platforms are continuing to evolve.
We want to maintain flexibility and plan to remain resilient as this economy evolves for our business and for our customers.
Our goal at D. S. G is to continue to build and scale, our specialty distribution network to drive significant free cash flow with an enhanced return profile.
Remember that since we merged these companies earlier this year, we have not had the benefit of a full cycle or year of working capital flowing through the P&L the capture and measure annual returns on invested capital, which we see as currently understated relative to where we will see them in a.
<unk> a year from now.
We appreciate we are still in the early days of DSG and are putting solid objectives, where we are which are embraced by our leadership team members and.
And are all are eager to show significant progress.
With our capital allocation framework as the foundation, we have a robust acquisition pipeline for each of the businesses in our corporate development team is busy evaluating timing evaluations and fit for tuck in acquisitions.
Over the past three months alone we have reviewed numerous new opportunities multiples.
Multiples appear to be in flux currently in some cases softening and in other cases trophy assets are being discussed for the first time in decades as operators are enjoying robust demand and improved profitability, but recognize inflation and interest rates are creating a moving target on daily confidence levels of some owners like some.
<unk>.
The current environment should make transactions more compelling for us as we move forward.
Before Ron covers the consolidated and operating company's financial results. Please turn to slide six and I'll comment on a few areas of focus within each of our three companies Lawson.
Lawson products, a leader in the MRO distribution of sea parts offering vendor managed inventory services has realized significant growth in our largest strategic strategic accounts and the Kent automotive Division.
In this challenging labor market.
Lawson has successfully brought customers incremental support through outsourcing services using their intensive vendor managed inventory solutions on class C products stays are and the team at Los <unk> are also carefully evaluating new channels to market for premier level services, depending on the specific needs of the customer.
We have seen not only strong growth helped by pricing, but also a nice return to core growth from SKU and customer level activity as well as new customers embracing Lawson's solutions.
Geoff Pro services is a leader in the supply chain solutions have largely seat parts specializing in developing and implementing BMI and kitting programs to high specification OEM customers.
In a challenging inflationary market customers continue to turn ejects pro services to help improve their total cost of ownership through via my complex kidding programs and aftermarket services, Bob and the team are having success by vertically integrating manufacturing and light Assembly solutions for their customers via their acquisition partners frontier.
Your technologies Reza Lex state industrial solutions and omni fasteners.
<unk> Pro services successfully passed on material and freight pricing and continues to focus on supplier and commodity rationalization as well as synergies on acquisitions.
<unk> Pro services has been a strong leader in driving the culture of cross selling the benefits and products from each of the three legs of D. S. G with established customers as well as perspective key target accounts.
Test equity as a leading industrial technology as distributor of specialized test and measurement equipment and solutions electronic production supplies and customized toolkits from leading manufacturing partners.
Pass through pricing continues to work to our advantage as customers are accelerating orders to capture near term pricing versus risking further price escalations in 2023.
Our leadership team at test equity is accelerating their digital migration and an estimated 40% is now transacted online since the acquisition of <unk> equipment.
This percentage continues to accelerate with the release of our first E Commerce platform in Europe this quarter.
We are realizing synergies between T equipment and test equity in the product and digital sales categories and believe this will deliver further margin enhancements and operating leverage and continues to show a strong acceleration in driving ROIC metrics to best in class levels for peer industrial distributors.
Now I would like to turn the call over to Ron to walk through the financials Ron.
Thank you, Brian and good morning, everyone.
Turning to slide seven were excited this morning to share with you the third quarter results of distribution solutions Group group.
Briefly let me comment on the required GAAP accounting presentation before we discuss our results.
Also as Brian mentioned, we posted our Q3 2022 financial results presentation on the IR website for DSG.
As a quick reminder, the combination of the three operating companies is required to be treated under GAAP as a reverse merger from an accounting perspective, <unk> services and test equity acquired the stock of Lawson products as of the April one 2022 merger day.
You items to keep in mind as we review the Q3 results.
The third quarter 2022 results include all three operating companies for the full quarter of the.
The year to date GAAP information for 2022 includes <unk> Pro services and test equity for the first six months and given the merger date of April one only includes loss of products from April one to September 30.
The comparative GAAP information for 2021, only includes checks pro services and test equity as the predecessor company for the accounting acquirer or.
For ease of comparison comparing these results the slides that we are using for the conversation. This morning, our adjusted for the pre merger activity of Lawson products.
We also heard from many shareholders on the lack of visibility of prior quarters. So we're now presenting trailing five quarters of adjusted sales and adjusted EBITDA on a combined basis.
Let me summarize the third quarter results.
On a combined basis, we reported strong topline and bottomline results across the three principal operating companies.
As Brian mentioned, we reported total sales growth of 46% with organic sales growing 15, 4% through both price and volume.
Today in 2022, we have closed on four acquisitions for a total of over $180 million of acquired annual revenues.
Broadly product demand remains strong. However, however, we are cautious going into 2023, given some of the macroeconomic indicators.
We've also made good progress in realizing cross selling opportunities among the three operating companies with early wins on new customer business and cost synergies in.
And finally, our performance in all three operating companies was in line or above expected levels.
Now, let's walk through some of the numbers on a combined basis.
First consolidated sales were $347 2 million.
Although not necessarily meaningful this represents an increase of 163% on a GAAP basis, driven by the inclusion of Lawson products commencing on April one.
Organic growth of business and acquisitions.
Made by Jack for services and test equity in both 2021 and 2022.
With the inclusion of Boston from a comparative basis sales increased 46% or $109 5 million over the third quarter of 2021 was $68 million coming from acquisitions and organic growth of slightly over 15%.
Second reported GAAP operating income was $22 million compared to $5 5 million a year ago quarter.
On an adjusted basis, taking into account merger related costs stock based compensation severance and other nonrecurring items adjusted EBITDA improved by $13 5 million to $34 7 million or 10% of sales.
This also represents a sequential improvement of 3 million of adjusted EBITDA over the second quarter.
And third diluted earnings per share was <unk> 84 for the third quarter on an adjusted basis adjusted diluted EPS was <unk> 64 for the third quarter of 2022 versus 25, four a year ago quarter.
Now moving on to slide eight while slide seven included Lawson for pre merger activity and other acquisitions since the date of acquisition.
<unk> includes the full run rate of all completed acquisitions as of September 30, as if they were owned for each quarter presented.
As you can see from this page our full run rate inclusive of acquisitions has seen nice quarter to quarter growth, reflecting the strong performance of each of the three operating companies.
As Brian mentioned Q4 is typically our slowest quarter, given fewer selling days and lower seasonal customer activity.
Turning to slide nine let me now comment briefly on each of the three individual operating companies.
Within the 10-Q that we filed we have broken down our segment reporting based on the three operating companies with a focus on how they go to their end markets.
Starting with losses.
Recall that Lawson as the accounting acquirer E and is not in the GAAP reported numbers for Q1 2022 or for the comparative GAAP numbers in 2021. However.
However for purposes of these slides we've included the pre April 1st results.
Sales were $109 4 million for the third quarter of 2022.
Please note that this does not include both supply as they are now included in the all other reporting segment.
However, bolt supply had another great quarter with sales, increasing 45% with adjusted EBITDA in excess of 14% of sales.
The Lawson segment sales grew 16, 8% organically over the third quarter 2021 on an adjusted basis and one 9% sequentially over the second quarter of 2022.
The increase over a year ago was driven by strong performance within the strategic business up 16%, our Kent automotive business being up 25% the core business up 14% and government up 22%.
During the quarter unit volume increased approximately 5% with the remainder being driven by price and mix.
Los <unk> growth during the quarter was achieved through increased share of wallet with existing customers and new customer relationships in particular within strategic or large accounts.
Lawson continues to realize improvement in its gross margin percentage, excluding nonrecurring items, while customer mix is putting pressure on the overall gross margin percentage. The business continues to focus on gross margin expansion opportunities, which we envision will continue into 2023.
<unk> reported operating income.
Was $5 4 million for the third quarter inclusive of the nonrecurring items previously mentioned.
Excluding these items as well as for previous quarters, Lawson's adjusted EBITDA improved to $9 7 million compared to adjusted EBITDA of $7 6 million a year ago, primarily driven by the sales and gross margin improvements, partially offset by increased compensation and health care cost.
<unk>.
Turning to <unk> services on slide 10.
Total sales were $103 7 million for the third quarter of 2022, an increase of $39 5 million over Q3, 2021 of which $38 million was driven by acquisitions and $8 7 million from organic growth.
In 2021, <unk> Pro services closed on the omni <unk> and SaaS transactions in.
In 2022 Jacks Pro services is closed on Reza locks earlier in the year and on frontier on March 31.
Excluding the impact of these acquisitions in the third quarter organic sales grew by nearly 14% of which approximately 7% came from price.
The end markets. The <unk> pro services operators are expanding with the exception of headwinds in renewables.
The increase in aggregate sales was primarily driven by new customers and the expansion of existing customer relationships.
Reported gross margin was down slightly from a year ago on larger on lower margin profiles of the acquired businesses.
Gross margins continued to be managed by the <unk> Pro services team through strategic sourcing improvements new supplier development and the movement toward longer term supplier agreements.
<unk> services, adjusted EBITDA expanded to $12 5 million or 12% of sales as compared to $6 3 million or nine 8% for the year ago quarter Act.
Acquisitions drove approximately $5 1 million of the earnings increase.
And lastly, I'll turn to tax equity on slide 11.
Sales for the quarter grew $48 9 million or over 72%.
During the second quarter of 2022 test equity closed on two acquisitions T equipments and national test equipment of.
Of the $48 $9 million sales increase for the quarter approximately $37 6 million was generated from the 2021 and 'twenty two acquisitions, while organic sales increased 16, 9% with approximately 8% coming from price.
We anticipate that sales in the test and measurement business will continue to be lumpy for the remainder of 2022 and into the first half of 2023, given some of the continuing chamber supply chain challenges.
Customer orders remained strong and we were able to ship quickly upon the receipt of product. However delivery has been sporadic due to ongoing supply chain issues.
Having a higher level of customer back orders create positive momentum as we move into 2023.
On an adjusted EBITDA basis, the third quarter ended at eight 7% of sales or $10 1 million, representing an increase of $4 6 million over a year ago quarter of which approximately $2 5 million came from the 2021 and 2022 acquisitions.
As previously mentioned.
Moving on to slide 12.
<unk> previously commented on our approach to capital allocation, so I wont repeat his comments.
However from an access to capital perspective, we have approximately $25 2 million of cash and $75 1 million available under our existing credit facility.
As part of our credit facility. We also have an additional $200 million accordion feature.
We ended the quarter with.
With a net debt leverage ratio of three four times on increased earnings.
During the quarter, we continued to invest in the business to support the 15% organic sales growth while at the same time had approximately $11 million of nonrecurring cash items that impacted our cash flow during the quarter.
Net capital expenditures for the quarter were $3 2 million and $6 6 million on a year to date basis.
Before I turn the call to Brian for some closing remarks, let me just reemphasize the continued strength that we realized in the third quarter on top of our previously reported strong additional second quarter.
We are very pleased with the progress on both the financial results as well as the underlying operations of the three operating companies.
We firmly believe that we are on a strong path as exhibited by our adjusted EBITDA of $34 7 million for the quarter or 15, 4% organic sales growth and the incremental benefit of our acquisitions.
We hit our 10% margin target for the quarter and continued to be excited about our future on a combined basis.
While the third quarter was strong we are also paying close attention to the macro economic trends in the marketplace.
We will prudently manage our financial position, including our financial leverage as 2023 develops.
I will now turn the call back to Brian .
Thank you Ron.
Turning now to slide 13.
We accomplished what we set out to accomplish since merging the businesses in April .
The teams are working well together and I would say that we have achieved more than we expected by September 30th with much more expected in front of us.
Let me highlight a few of these areas as an acknowledgment of the strong successful effort and shared accountability by our colleagues throughout DSG.
We've enhanced our go to market strategy for the three businesses and importantly expanded our channels to market.
As I mentioned briefly we've rolled out an incentive program for our sales team to support ambitious cross selling goals for our largest strategic accounts for DSG and.
And we have pipeline lead and win to support our growth initiatives.
Also maybe quite differently than you typically hear on earnings calls like this we've operationalized LK cm headwater and our operating partner team, mostly retired C suite distribution executives at each of our operating companies.
There is not a management fee for this work as is typically done by other groups and consultants.
As this support team in collaboration with the management teams are fully in line with.
Investors as shareholders to improved financial and operational performance generate cash flow and build long long term enterprise value through stock price appreciation.
Turning to slide 14 third quarter results demonstrated our ability to report strong growth organically and by acquisition.
And to drive substantially adjusted EBITDA with a 10% margin.
We believe the DSG has the best operating leaders in the industry and they are working hard to grow sales improve margins and generate cash flow.
We remain confident about the opportunities to further scale the business and drive margins structurally higher leverage the working capital investment and generate accelerating level of free cash flow off of each dollar of revenue.
And generate cash.
We believe our MRO OEM and test equipment products.
Services and solutions provide customers with a comprehensive set of industrial distribution and supply chain support that are increasingly being reaffirmed by our customers and vendors daily in the marketplace.
Thank you for your time today and now we'd like to open up the line for Investor questions Operator.
Ladies and gentlemen, the floor is now open for questions. If you have any questions or comments. Please press star one on your phone at this time we have.
While posing your question. Please pickup your handset if listing on speaker phone to provide optimum sound policy. Please.
Please hold while we poll for questions.
Thank you. Our first question is coming from Ken Newman with Keybanc capital markets. Please go ahead.
Hey, good morning, guys.
Hi, Ken Good morning, Todd.
So I.
I guess I will start on the demand side here.
Obviously, youre, saying that youre not seeing any evidence of customers delaying projects are pushing orders out.
I'm not I know, you're not ready to guide to 2023 or Youre not youre not guiding at all but I'm curious if you have any color on just how much of your current backlog provides visibility into the into the following year at this point.
Well on the MRO side, it's more demand driven.
We don't usually.
Keep a backlog, but we are seeing consistent activity levels with what we've seen throughout this year.
The.
So there is there.
On the.
On <unk> pro.
More tightly aligned with the Oems.
And.
The.
Bob might have more perspective on exactly what he say, but across most all of our verticals with the exception of renewables demand has stayed consistent and elevated raw.
Renewables has been impacted throughout the year and we've been waiting for the.
Inflation inflation.
Tax.
Or the inflation the congressional whenever they're calling it the contrary inflation, but the.
Production tax credit extension that should reaccelerate that one vertical.
From kind of the depressed levels that we've experienced this whole year.
In markets.
Bob on your end markets would you want to comment on it.
And the best way to look at it.
Five of the six vertical markets are up double.
Going into Q3 so.
We're seeing a nice tailwind in aerospace and defense and consumer industrial.
At nice lift in transportation.
Technology, where we are seeing headwinds is sustained headwinds is green.
Renewables and we anticipated that as Brian said, the inflation reduction act has been.
Extended so we know that the the wind and renewables market over the next 10 years is going to be well positioned for growth so to Brian's point.
We're well versed in operating and <unk>.
Tailwind and headwind environments, and if going forward into 'twenty three we see some cautionary headwinds we'll adjust accordingly.
Okay.
And then obviously organic growth and Ken It may be helpful. Just because this is so on everybody's mind.
Probably let say is already speak about loss and in the end market demand that he is saying I mean, we're seeing an acceleration in SKU activity and we've had actually good solid demand increase at La said, but I think that there's there's no topic. That's on any of our minds more than what end markets are doing right now and <unk>.
Man, So why don't we let.
Sales are in Ross each answer your question as well so they can speak about their end markets. So that we can get to get that out there for everybody to understand what we're saying.
So as I wanted to say something about lawson's end markets.
As well.
Thanks, Brian .
Like like you heard from Brian earlier.
Micro market, we continue to see the demand flowing through our different end markets that we serve which is very diverse industries, we're serving a lot of industrial.
Waste management companies utilities fleet.
Bleed out emotive you name it.
So we continue to be very sticky with our customers and play a significant role when it comes to labor shortages.
In.
As we as we've been.
Growing our business the piece that we continue to feel strong about it is our approach for new customer acquisition and increasingly share of wallet across the board.
When it comes to seen any any type of softness across the different end markets.
We're not seeing any significant or major signal right now, but as you heard from everybody, we're very cautious coming into 2023.
I think that your end markets are all performing.
But we're all can kind of.
Everybody is looking at the end markets and kind of wondering what we might see but we arent seeing it Ross you've got the business with the strongest backlog.
Indications why don't you speak about your end markets.
Our end markets have remained steady throughout the year steady to growing.
We've seen a little softness in the beginning of the year at aerospace and defense, but that seems to have stabilized a bit of technology could be lumpy.
Seeing that has us going forward and thats, mainly due to the supply chain, but we're not seeing any indications from our customer base right now on anything significant softening in the market we continue to build.
Significant backlog due to the lumpiness in the technology sector as well.
That's all really great color and I appreciate all that.
My follow up here is really on the price side, obviously organic growth was strong across all the three segments.
I'm curious if you could just kind of help us understand how much price was taken in the quarter any color on what price cost was across the three segments and then maybe also.
How much do you expect from a carryover as a carryover benefit from pricing actions that you've taken so far this year.
And into 2023.
Yes, Kevin this is.
Yes, I was just I was going to.
I see you, Ron but I, just would say that.
One of the thanks, Ken that we've really prided ourselves now for really 30 years in distribution investing is staying really nimble on pricing, particularly when you get an opportunity to.
Raise prices due to inflationary pressures and we had spent a lot of time studying in the seventy's and eighty's, which I alluded to earlier.
How inflation can be.
Can work to the advantage of.
Cash flow on a normalized working capital cycle for distributors and that let us.
In our desire to compound money and distribution business as it kind of led us to distribution over our long standing investments.
In banks and financial institutions, just had higher.
Return on invested capital profile, especially on incremental dollars and particularly in inflationary cycles.
When normalized for the increase in working capital that you have to step into.
As you are replacing inventory with higher dollar cost inventory.
And receivables that are.
So I think that that Ron and his team was set up well for it as where each of our companies.
Going into it we talked about whether or not we were going to roll into an inflationary cycle and so we started taking some price actions pretty early and we've continued to take them.
We've had to.
Work, where we have contract pricing to make sure that we're getting.
We're working collaboratively with our customers that are longer standing.
Larger customers.
Customers, where we have some contracting elements with them.
That's more probably over <unk> with Bob's business than it is in others.
But even there we've been able to be very constructive and being able to lift or our pricing.
Consistent with on a percentage basis with our cost of goods sold.
We're getting more flow through or we expect to continue to get more flow through on that and we've got some more pricing actions that we've got prospectively in front of us.
And we've taken a little bit this year or this quarter, but Ron why don't you speak to where specifically you've taken it or you've seen the other verticals take it.
Sure Yeah, Thanks, Bryan so.
In terms of in terms of how large the <unk>.
Price increase was for each of the businesses.
Within the within the deck, we laid out the organic sales.
And to Brian's comments really all three companies took price increases in realized benefits throughout the quarter projects Pro services.
Organic sales were up about 14% about half of that about 787% of that was price.
Test equity organic was up about 17% and about again about half of that 8% was price and then on the loss side, we were up about 17% organically and our volume was up about was up about 5%. So that's.
Call it 12% on price and mix and to Brian's comment I think that.
Particularly within the loss in business.
We have been.
Throughout 2022, I would say catching up a bit.
Versus 2021, so I think thats why a larger portion of our increase is price related and the other three operating companies.
We have continued I think all three organizations, who have continued to see cost increases come through from our supplier base I will say.
What we saw in the Washington side in October .
Tempered itself a little bit so maybe that's a good sign moving forward.
But.
At this point.
All three companies and you can see this in the margin gross margin percentages are staying ahead of those vendor cost increases. So certainly there is.
There is some of that thats going to spill into 2023 in terms of a price certainly any actions taken throughout the year, we'll get the full year effect.
For next year, but right now we're anticipating that even though October was maybe a little bit softer from a vendor cost increase that.
Those will those will continue to move into 2023 as well.
Got it.
One more here.
Could you just talk a little bit about how you think about the M&A strategy obviously.
Correct me, if I'm wrong, but it sounds like Brian that you are cognizant of the macro uncertainty.
We've seen you kind of shift some capital back towards share repurchases.
And then back towards internal growth initiatives.
But you also talked pretty positively about the pipeline being full.
Just to clarify I mean with interest rates rising and just where the leverage profile with where we're at.
It is today should we assume that it's not the top priority for capital deployment in the near term or is that an unfair statement.
Okay.
Well I would say that.
I don't want to say that it's an unfair statement, but also don't want to anchor.
Expectations around us being <unk>.
<unk> around acquisitions, such that we'd be in any way reckless with with a business that we believe longer term, we're going to continue to compound a lot of value.
As partners with the public shareholders.
There are.
Very attractive.
Tuck in acquisitions that are in our queue right now that we're working on actively.
And that we think will be.
Revenue accelerating for our core.
So doing something for financial engineering purposes alone is absolutely not our objective with this is not a <unk>.
Cringe at the roll up a term I always have even going back into the nineties.
Theres not a deliberate reason to make an acquisition, where you think it makes us the.
<unk>.
And the.
Long term sustainability of your core better.
Then there is not a real reason to go out and lay off that capital because like I tried to.
Talk about it in the <unk>.
In the prepared remarks.
The incremental returns on invested capital on invested capital and working capital.
<unk> are so high.
In distribution businesses that you can compound your business very attractively.
Most attractively group capital invested in working capital or an internal initiatives and so we have no shortage of those opportunities right now on the platform that we've pulled together, but there are some some key elements that we think are going to continue to buying some of what we've got together tighter and also allow for the organ.
<unk> slope of revenue growth to be accelerated from where it might be otherwise.
Sometimes that's acquiring key customers that you think you can.
Where the sales cycles really long I know.
Bob's business Jets Pro services.
These cycles are long and so if you can get.
Deeper into some customers or some customers that you know you've got a lot more.
SKU.
Expertise.
The company you're acquiring.
If you are being asked to go into a geography like we were with test equity in.
In Europe by our key vendors than you might make a small acquisition that's accretive financially, but more importantly, it's going to allow for a <unk>.
Jumping all spot to be a better partner for your vendors and for key customers that you've already.
We're working with in North America that have asked you to go to those other geographies.
We are really focused on north America to be clear, but there are some reasons why our customers and vendors are asking us to look.
In on small acquisitions some other areas.
There are there are a couple of trophy assets that we are a direct dialog with the owners.
It did.
Did I.
But I think our transformational to the whole platform candidly.
And so as we look at how to bind together the capabilities of test equity.
On their engineering and production supply business and the.
The <unk> pro and loss in it.
The OEM jet for services and loss in OEM and MRO SKU.
Technical knowledge Theres, some theres some pieces in the marketplace that fit really well that pull that kind of have long been part of our vision of pulling those those elements tighter together as one solution.
<unk> solution.
And so those.
Conversation started many years ago and they are still going in and sometimes you don't know when those opportunities are going to land, but in terms of pushing leverage.
In this environment, that's not our objective our objective is to build a really good business long term.
And so that's the that's the.
But I wouldn't want to.
Overly skewed the lens towards not doing anything on M&A, because we probably will but it'll be very careful and judicious.
And it will be as we continue to get visibility around what's going on in our end markets.
And confidence that we're going to generate a lot of cash next year, which we have a lot of confidence in that we invested so significantly in working capital this year as part of pulling the businesses together that.
Most of our analysis would indicate that we can grow top line quite a bit without.
Investing incrementally in working capital now if inflation continues to push hard forward then.
Replacing inventory that you're selling to.
10% higher than <unk>.
Paid for it.
Can put some pressure on the inventory investment side and if you are continuing to realize that through receivables that are growing because your topline is growing but all that would indicate that we ought to also be dropping more dollars then.
And then we have dropped in the past.
All helpful color. Thanks. Thanks.
Yeah.
Thank you. Our next question is coming from Kevin Steinke with Barrington Research. Please go ahead.
Morning, Kevin.
Good morning.
In the prepared comments.
You mentioned Lawson products is flooring, some new channels to market.
I don't know if you could expand on that at all.
Those are.
Ah you're probably best to look.
Tackle this.
Thanks, Brian Hi, Kevin.
Hi.
Elaborating a little bit more on.
Brands node when you think about it we got 90000 customers.
Active customer base and we go to market one single channel right now with our field Rep.
Are there every day for our customers.
But as we as we as we think through the future in terms of better looking for ways to better.
Serve our specific needs of our customers with such a diverse.
<unk> customer base that we have within a segment and different end markets, but both.
Sized as well, we're very carefully working with the field and our sales team to develop different testing in different ways to continue to become stickier and being able to allow our.
More precious time for our sales team to be in front of customers. So that's something that you continue as you continue to hear us talking more and more about it over the next coming quarters as we continue to develop these.
One way to alternative.
Ways of serving different customer sites.
Okay. Thank you.
Also at <unk>, one of the things that has been most exciting for us has been the ability to look into.
<unk>.
For instance, <unk> pro services.
Tight relationship with their OEM.
Customers is pulling.
Lawson MRO and some of the test equity.
Engineered.
<unk> solutions into those engagements and so that's.
Some ways that's another channel expansion.
Expansion to market for La Sed, because it may require and it really does require a different way to service those accounts because Jack for services already has people embedded inside of those OEM facilities.
So the vendor managed piece of it can be picked up by Jack Pro services and their colleagues.
Even though the product and the revenue is going to be hitting on velocity topline.
So I hope that's helpful.
Yeah. It is absolutely thanks for the color.
You are.
Obviously, you had some nice adjusted EBITDA margin expansion there.
Order, but you.
I did call out higher compensation and healthcare costs can you just maybe elaborate on that a little bit more.
How meaningful that was.
Yes, Kevin this is Ron good morning, so on the compensation side.
That was really more variable in line with our with our organic growth in sales.
So it was a it was a dog.
Sizable dollar amount just to support.
For the sales team and so forth to support the high organic growth, 15% that we saw for the quarter.
On the health care cost across three companies.
About 60 bps on our margin so all in it was about a $2 million increase in our.
And our cost just in the third quarter and so.
What we saw I would say is.
Cross the three companies probably higher claims coming in in the first quarter it seem to seem to settle down a little bit in the second quarter, and then jumped on us a little bit again in the third quarter in particular within the loss in business was the probably the biggest driver of that.
So the answer to your question about 60 bps on our on our net margin just on the health care alone.
Okay. Thanks for the detail.
You've talked about in the past the goal of.
Exiting 2022 with an adjusted EBITDA margin of.
Greater than 10% is that something we should continue to think about it I know the fourth quarter is seasonally slower.
And generally lower but I'm just trying to think about how to think about the margin exiting the year.
Yes, Kevin this is Ron again, so you're spot on in terms of.
Seasonality the fourth quarter is typically.
A little a little slower for us really across across the three companies.
And.
And <unk>.
Generally three or four fewer selling days as well in fact.
We have 60 selling days in Q4 of 2022 versus <unk> 64 in Q3, so that does cause a bit of.
Kind of a deleveraging effect on us.
But.
Once we get past the fourth quarter again.
Sure.
Can't give you a specific number on the formal guidance for the quarter itself relative to the 10% but.
As we enter into 2023.
Certainly we're looking to expand those margins really based upon the continual organic growth that we're seeing the M&A that we've talked about a lot of the initiatives that are taking place across all three companies in terms of sales expansion as well as some some cost opportunities that we're identifying as well, which we feel.
The more of those will be realized in 'twenty three than what are currently coming through the P&L in 'twenty. Two so we feel really good about the first.
Part of 2023.
Relative to margin expansion again understanding that Q4 softens up a little bit not.
Not dramatically, but just a little bit and then were off to the races again in the first quarter.
Okay, great. Thanks for.
All the color appreciate it I've got a jump on another call here, but ill catch up with.
Some more tomorrow. Thanks.
Thanks, Kevin.
Thank you Kevin.
Once again, if there would be any remaining questions or comments. Please press star one on your phone at this time.
Our next question is coming from Brad Hathaway with far view capital. Please go ahead.
Good morning, Brad Hi, everyone.
Hi, good morning. Thank you so much for the incremental financial disclosure and for the capital allocation discussion that was really helpful. I appreciate that.
With regards to I guess, obviously potential recessions are top of mind for everyone right now.
And as we're all getting to know better the businesses that.
Are included in the new <unk>.
Just maybe if you could discuss qualitatively.
Kind of how.
Boston, but especially test that we didn't get through kind of responded in a recessionary environment in terms of kind of factors that impact demand volatility.
Detrimental margins and things like working capital, just obviously not necessarily numbers, but just maybe help us better understand some of the factors that influenced how each piece of the three businesses behave in a downside scenario.
Sure I'm going to I'm going to start on it and then I may.
Ask others to participate.
Brad one of the things that.
Kind of Big picture.
We've invested so much money in working capital this year, mostly as we were bringing the companies together and the tuck ins and trying to get students SKU can grow into as I alluded to that I would say that that we have the working capital in place.
Notwithstanding inflationary pressures on it going forward to be able to either manage a larger revenue base and watching our working capital intensity come back down several percentage 100 percentage points.
Several hundred basis points.
Or.
Being able to pull a significant cash out of working capital, which is what we've been able to do historically in these businesses.
Even and across our distribution companies during softer periods. These businesses we were.
Associated with them all during the Covid cycle.
So there was.
Good.
A bit of a good lens into the question you're asking in terms of how they responded.
You know Hal Lawton respond, it's I'll speak Jack Pro surprisingly Frost <unk> pro during the Covid cycle actually.
Grew.
The top line activity outside of project revenue, which was.
Is non contractual revenue with.
With stable and grew through Covid during.
During 2020, and so profitability actually improved as we were able to.
As a key supplier, we got some pricing on the gross margin side and it flowed through the P&L as we continue to tighten up our growth initiatives during COVID-19 and so are we ran our P&L.
Adjusted Pro services tighter or Bob did and so it threw off more cash.
Alright throw off more EBITDA not to mention the fact that the cash conversion then.
Was very attractive.
Invested a lot of capital and <unk> services.
Since then.
As a key vendor to a lot of our Oems.
During the supply chain disruption that kind of were a fallout of COVID-19. It did require us to.
Some inventory positions.
And then obviously with inflationary pressures.
With contracted revenue there, we elected to take some inventory position there as well.
Pre pre repricing with suppliers.
We would expect that some of that will abate during a recessionary cycle. If there is one next year on our topline.
On test equity our biggest challenge there during COVID-19 was actually are as much our vendors.
And that issue is still facing us.
Some of our key large vendors like T side in electronics had supply chain issues of their own.
And that.
Caused us to have less.
Sell through on our equipment side.
Even though there was still constructive demand in the channel it was.
It was softer.
The equity.
More akin to the MRO activity that we saw softening.
Over at Lawson.
It wasn't.
Our biggest challenge there was making sure that we had supply to meet demand from our customers much more so than end market softness.
The decremental margins.
Uh huh.
And art.
Times and trying to figure out as.
As much as it is a science often times I try and think about.
On these businesses kind of like the operating leverage that you might think about in terms of incremental drop from an incremental revenue dollar off of each of the businesses are different.
And so therefore I kind of reverse the same when I think about operating leverage although.
I mean negative operating leverage or decremental.
Hum.
Margins in a contraction, but we're.
We also have been investing in growth and we've made acquisitions and.
We're still early in realizing some of the benefits of pulling the businesses together on a cost basis.
And so while we've itemized and are working through.
Some purchasing.
Benefits of consolidated purchasing and with Dollarized some of those and we are dollarized.
Some cost savings and back office, we've worked through.
Consolidated healthcare purchasing benefits dose of not yet flowed through the P&L and then there are some benefits too.
General support of three G&A that if.
If we ended up in an environment, where the top line was softer.
Just like we took.
Cost actions at Lawson daring.
The Covid recession.
<unk>.
Like we took them and businesses in a way.
Hi.
We've got a pretty solid vision, our perspective on things that we can take out of the business that are current costs that we're enjoying an eye.
Organic growth environment.
And that we've been investing in both in terms of people added.
Just cost that we've been had.
Ben.
Comfortable bearing.
Guys or is there anything else there that you think that we ought to add.
Bob you roster of states or Mike.
Talk about what kind of what your experiences our decremental margins or how you would think about it.
Incremental.
Cost to profitability we've got.
Headwind next year.
Yeah, Brian I think.
First of all we're fortunate that we have seasoned executives leading these businesses.
Just our experience with GE and rec so over the past 30 years. So I mean first thing you do is.
You look at your customers in a recessionary environment customers are asking you to help rationalize their supply chain.
They want to go too fewer and fewer suppliers. So that it becomes a strategic supply chain. They are looking for labor productivity.
They are looking for value engineering everything that that we excel at so to me when we walk into a situation. That's a headwind environment. We just view it as an opportunity Brian had communicated earlier you can still drive SKU expansion you can still drive wallet share you can still drive new business development.
Still drive cross selling.
Identified over 120 new opportunities.
<unk> four <unk> Pro services test equity in loss and just mining the installed base. So our thought processes will just reallocate resources and kantar.
Continue to expand it takes share in a multibillion dollar vertical market.
With the test equity, we've actually changed the structure of the company somewhat.
The first recession with co, but we've added product lines that will lower end product lines that people customers Phil.
And to purchase even in a down cycle.
And frankly, we're increasing our business digitally exponentially every year. So as we go to market digitally that makes it much easier to get to the recessionary times.
Brought the horses or size or jumps then you talk about.
For Brad we've added 3600 Skus 30.
300, Skus in the last 90 days on our digital platform part of kind of that investment in working capital in the last six months.
That's taken place in test and inject pro services.
And Lawson as well.
Talk about the skews that.
Kind of a little bit of the SKU perspective additions that you've got.
Sure sure I can start with that one.
Basically through our digital platform monitor what customers are looking for that we don't currently stock, but as we go through that we expand our product lines and we expand.
Talkable product lines as we go forward, adding new products to our digital platform and that automatically.
Increases the sales as customers look for those items that we have them and have them in stock and that tends to increase our sales excellence initiative.
Okay.
Yes, Brian in our case.
On the loss side very similar to what Bob described predicts for services, we see these times as opportunities for us to continue to support our customers because they are looking for partners, who can help them to reduce their costs.
Save money and that's where we shine in that that's where.
Our team goes out there and help our customers too.
Really drive through these difficult times and shuffle, our resources from one weight from one place to the other and leverage the cross selling opportunities that we have across the different.
Our portfolio of companies today.
And Brad you're familiar with the license performance.
Just a couple of years ago in 2020, so we have the ability to cash flows to Brian's point I mean cash flows were remained really strong during that time period.
On the working capital side.
From a cost perspective as well so we know we know what levers to pull in fact.
Our EBITDA margins were flat, even though our from the previous year, 19% to 20, even though sales fell off quite a bit. So we know what levers to pull to make sure that we.
We can still continue to deliver the financial performance.
I remember the lesson.
Okay.
I was just going to say, yes, I remember that.
Alright, guys.
Yeah.
I've talked about this before.
You know in these down cycles, our cash conversion off of EBITDA tends to be 100% or larger.
And certainly we and the <unk> down cycle right. We bought ITG took it private in August of OA, and we're faced with a significant decline in revenue right afterwards, much more of a shock and awe.
Then I think any of us expect here, even in the worst scenarios and so that <unk>, we were deeply embedded in a lot of companies and their supply rooms.
Purchases declined and we threw off a lot of cash at the same time as we were very tight on spending.
So we held EBITDA flat on significantly lower revenue and our cash conversion coming out of working capital de Levered the business significantly and so we actually had much lower.
Debt to EBITDA.
Ratios.
During the trough of the recession than we had going into it in most of our work. This model a lot of different ways and all of mine.
Efforts on that would indicate that we would delever out of working capital should we go into.
A recession, so our EBITDA may come down or May.
Assuming we arent, taking drastic cost cutting initiatives at the company level, but were holding most of our costs flat. We take advantage of the synergy cost benefits that are still in front of us and we have a decline on the top line.
Cash ought to come out of the business at a level that would be an assistant are greater than EBITDA.
Great. That's very helpful. Thank you that that was a very useful discussion. That's good good to learn more about <unk> and test equity, especially because obviously when you have more experience with the loss of an historically. Thank you very much Joe Congrats on a great quarter and looking forward to continuing to see what Youre building here. So thank you.
Thank you Brad for your support.
Once again, ladies and gentlemen, if there are any remaining questions or comments. Please press star one on your phone at this time.
Okay.
Okay, there appear to be no further questions in queue. So I will hand, it back to Brian King for any closing comments.
Okay. Thank you operator.
Thank you for those that participated today, we appreciate your interest in DSG.
We're excited about where we are which certainly are further along than in many of our initiatives and we expect it to be by September 30th.
<unk> are performing at or above how we.
They would and our visibility at this point in time continues to give us a lot of confidence in the near term as well as the intermediate term. Although we we appreciate and are respectful of the changing environment with interest rates and inflation.
I wanted to.
Particularly call out the effort of our management teams and their colleagues over the last.
Six months as we've been working together.
There's been a tremendous amount of effort by everybody to get to where we are today.
We really appreciate our employees across the ESG.
Working as hard as they have to make the businesses.
Teed up for the prospective year.
As.
Profitably and successfully.
Pulled together as it is so thank you for everyone's efforts.
And.
We look forward to talking to you either throughout this quarter, please reach out to us.
Or we will hear you how are you.
Please engage with you at the end of the year.
Thank you everybody.
Bye.
Thank you ladies and gentlemen, this does conclude today's conference call. You may disconnect. Your lines at this time and have a wonderful day, we thank you for your participation.