Q3 2023 DXP Enterprises Inc Earnings Call

Participants

David R. Little; Chairman of the Board, President & CEO; DXP Enterprises, Inc.

Kent Yee; Senior VP of Corporate Development, CFO, Secretary & Director; DXP Enterprises, Inc.

Thomas Allen Moll; MD & Equity Research Analyst; Stephens Inc., Research Division

Presentation

Operator

Good morning. My name is Krista, and I'll be your conference operator today. At this time, I would like to welcome everyone to the DXP Enterprises Third Quarter Earnings Conference Call. (Operator Instructions)

I will now turn the conference over to Kent Yee, Chief Financial Officer. Kent, you may begin.

Kent Yee

Thank you, Krista. This is Kent Yee, and welcome to DXP's Q3 2023 conference call to discuss our results for the third quarter ending September 30, 2023. 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 it 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 Little, our Chairman and CEO, to provide his thoughts and a summary of our third quarter performance and financial results. David?

David R. Little

Thanks, Kent. Thanks to everyone on our 2023 third quarter conference call. Kent, we will take you -- Kent will take you through the key financial details after our remarks, after my remarks. And after our prepared comments, we will open for Q&A.

It is my privilege to share DXP's third quarter results with you on behalf of over 2,799 DXPeople. Congratulations to all our stakeholders and a special thank you to our DXPeople you can trust.

We are pleased to see end market demand and DXP's performance continue through Q3 and remain at record levels as we move through the second half of 2023. This allows us to achieve another quarter of both solid sales growth and 10%-plus EBITDA margins. We are pleased to announce strong third quarter results, with sales, operating income and earnings per share all up over the prior year. This is a great way to start the second half of Fiscal 2023.

We continue to deal with the macro uncertainty and the impacts of inflation and elevated interest rates, but we remain focused on serving our customers, providing products and services that help them save money, consolidate their MRO spend, manage inventory, provide solutions to solve their evolving needs. Being customer-driven and growing sales profitably is our goal.

We continue to focus on driving organic and acquisition growth, increasing gross profit margins and increasing productivity. Our execution has resulted in the Fiscal 2022 and '23 top line growth and bottom line organic and acquisition growth.

That said, our growth has not been as large as we would like. So we expect to add some acquisitions to our results as we close out Fiscal Year 2023 and going into Fiscal Year 2024. We continue to be excited about the future and delivering differentiated customer experiences, creating an engaging winning culture for DXPeople and investing in our business to strengthen our core capabilities and drive long-term growth.

Year-to-date through September 30, total sales are up 18.3%, and operating income is up 46.9%. Last 12-month sales and adjusted EBITDA were $1.68 billion and $164 million, respectively, and EBITDA margin of 9.8%.

Moving to our third quarter results. Total DXP revenue of $419.2 million for the third quarter of 2023 was an 8.3% increase year-over-year, with adjusted EBITDA of $44 million for the third quarter. In terms of Q3 financial results, Service Centers led the way, growing sales 13.2% year-over-year; followed by Innovative Pumping Solutions, essentially, performing flat, at $59 million in sales; and Supply Chain Services declined 3.5%, or $2.4 million, to $65.8 million year-over-year.

In terms of Service Centers, the diversity of our end markets and our MRO nature within Service Centers allows us to continue to remain resilient and continue to experience consistent top line year-over-year growth. From a regional perspective, a majority of our regions continue to experience year-over-year growth, including the North Rockies, Northern Central, Alaska and Texas Gulf Coast.

Additionally, we continue to see strength in our air compressor product division. We continue to expect that our end markets will remain constructive over the near future.

As it pertains to energy, we believe that we could be in the early stages of an up cycle supported by the energy transition, which has been consistent with our commentary over the last 3 quarters.

In terms of IPS, Innovative Pumping Solutions, our Q3 average IPS backlog continues to stay ahead of the Fiscal 2022 average. Additionally, our year-to-date average continues to exceed our long-term average of IPS going all the way back to 2015, which we highlighted and occurred for the first time in the second quarter and continues to move into Fiscal Year 2024. What this indicates is that we are continuing to give bookings, and as we mentioned earlier, we are likely in the front end of a good cycle on the energy-related project work that we look forward to as we move through '23 and into '24.

As we maintain growth, our main focus within IPS will be managing the demand levels we have; finding opportunities in all markets, such as energy, biofuels, food and beverage, water and wastewater; and pricing appropriately given the supply chain dynamics and ebbs and flows of inflation.

Supply Chain Services experienced a decline year-over-year, primarily due to some facility foreclosures with our customers as well as streamlining and the efficiencies we brought to our new diversified chemical customer that we added last year. This happens as part of our value proposition, but we do not anticipate any further material saving impact on DXP.

As we move into Q4, we will look for new customer additions as well as continuing to manage procuring products and managing inflation. Both year-over-year and sequential growth will flatten out until we start ramping new customers.

That said, demand for SCS services is increasing because of the proven technology and efficiency they perform for all their industrial customers. But the sales cycle can be protracted, and we will look to our SCS leaders to add new customers as we move into 2024.

DXP's overall gross profit margins for the third quarter were 29.9%, a 113-basis point improvement over '22 and down 85 basis points sequentially. Overall, I'm pleased with our gross margins and our steady improvement over the last 7 quarters.

SG&A for the third quarter increased $4.6 million versus Q3 of '22, but SG&A as a percent of sales declined, going from 22% in Q3 of '22 to 21.4% in Q3 of '23. SG&A continues to reflect our investment in our people and organization. And as always, it is my privilege to share DXP's financial results on behalf of these DXP people.

DXP's overall operating income was 8.6%, or $35.9 million, which included corporate expense and amortization. This reflects a 170-basis point improvement in margins over Q3 of '22. That being said, we still feel there is opportunity in operations to be more efficient.

Service Centers operating income margins were 14.1%, and IPS operating income margins were 18.9%, and Supply Chain Services operating income margin was 8.5%.

Overall, DXP produced adjusted EBITDA of $44 million, versus $34.3 million in '22. This turned into a year-over-year increase of $9.7 million, or 28.3%. Adjusted EBITDA as a percent of sales was 10.5%, up 164 basis points versus Q3 of '22 and essentially flat with Q2 of '23.

I am pleased by our performance in the third quarter. We still have substantial work to do to achieve our goals, but I am confident that the team will continue to execute. We are growing sales in excess of market and expect that in the near future we expect to drive strong SG&A leverage, manage working capital and generate free cash flow. If organic growth slows, then free cash flow will grow, and we will take advantage of the economy to grow profitably through acquisitions.

We have grown sales on a compounded annual growth rate of over 23% since COVID, and we have achieved new highs in both sales and profitability. And I would like to thank our stakeholders and especially our DXP people.

With that, I will now turn it back over to Kent to review the financials in more detail.

Kent Yee

Thank you, David, and thank you to everyone for joining us for our review of our third quarter 2023 financial results.

Q3 was a great quarter for DXP, and our results are in line with our expectations and reflect the positioning we were anticipating as we prepare to go into Fiscal 2024. This quarter reflects our third quarter of 10%-plus adjusted EBITDA margins, strong free cash flow generation and meaningful diluted EPS growth. We are excited to report these results, and we look forward to successfully closing out 2023 and starting Fiscal 2024.

Specifically, Q3 financial performance reflects our ability to continue to successfully navigate through the market and create value for all our stakeholders. As it pertains to our third quarter, Q3 highlights are as follows: strong year-over-year organic sales growth; lessening impacts from inflation and price increases compared to a year ago; continued gross margin strength and stability; continued year-over-year and sequential growth in the IPS energy-related backlog; consistent operating leverage leading to sustained adjusted EBITDA margins; more notably, our third quarter of 10%-plus adjusted EBITDA margins; and significant capital returned to our shareholders through our share repurchase program.

Total sales for the third quarter increased 8.3% year-over-year to $419.2 million. Acquisitions that have been with DXP for less than a year contributed $3.9 million in sales during the quarter.

Average daily sales for the third quarter were $6.7 million per day, or essentially flat to Q2, and were up 10% versus Q3 2022. Adjusting for acquisitions, average daily sales were $6.6 million per day for the third quarter. That said, average daily sales trends during the quarter went from $6.58 million per day in July to $7.1 million per day in September, reflecting a typical quarter-end push as we closed out the third quarter, and an uptick from the Q2 '23 month of June versus September, or $6.9 million per day versus $7.1 million per day.

In terms of our business segments, Service Centers grew 13.2% year-over-year. This was followed by Innovative Pumping Solutions declining 0.1%, or essentially flat year-over-year, and Supply Chain Services declining 3.5% year-over-year.

In terms of our service centers, regions within our Service Centers business segment which experienced notable sales growth year-over-year include the North Rockies, North Central, Alaska and Texas Gulf Coast. Key products in end markets that continued to drive sales performance include air compressors, rotating equipment and chemical, general industrial, food and beverage, transportation and energy.

Supply Chain Services performance continues to reflect the impact of the addition of a large diversified chemical customer that we added in Q2 of last year and has fully ramped as of Q2 of this year. That said, Supply Chain Services experienced a decline year-over-year, primarily due to some facility closures with existing customers as well as the streamlining and efficiencies we brought to our new diversified chemical customer that we added last year.

As David mentioned, this happens as a part of our value proposition; meaning, we anticipate reducing a customer's absolute spending volume by improving their purchase behaviors and inefficiencies. This customer contributed $16.1 million in sales during the quarter versus $16.5 million a year ago.

As we move into Q4, we will look for new customer additions as well as continuing to manage procuring products and managing inflation, but both year-over-year and sequential growth will flatten out until we start ramping new customers.

In terms of Innovative Pumping Solutions, we continue to experience increases in the energy-related backlog. Our Q3 energy-related average backlog grew 7.9% over our Q2 average backlog, which continues to be a notable uptick compared to Q1 of this year and continues to be ahead of our 2015, 2016 and 2017 average backlog. The conclusion continues to remain that we are trending meaningfully above 2016 and 2017 sales levels and we are moving towards 2015 levels based upon where our backlog stands today.

We have been experiencing strong organic sales growth within IPS, as we mentioned in the first half of 2023. We expect that to continue throughout 2023 and into 2024. Additionally, we are also continuing to find opportunities in other markets.

In terms of our DXP water backlog, we experienced a sequential increase of 28.2%.

Turning to our gross margins. DXP's total gross margins were 29.95%, a 133-basis point improvement over Q3 2022. This improvement was driven by strength in our IPS business segment, showing the greatest improvement with margins improving 430 basis points on a year-over-year comparative basis. This was followed by a 49-basis point improvement from Service Centers.

That said, from a segment mix sales contribution, Service Centers contributed 70.2%; Supply Chain Services, 15.7%; and Innovative Pumping Solutions was 14.1%. Compared to last year, SCS' mix contribution was higher, at 17.6%, which impacted margins in Q3 of 2022.

In terms of operating income, combined, all 3 business segments increased 139 basis points in year-over-year business segment operating income margins, or $9.8 million, versus Q3 2022. This was driven by improvements in operating income margins across all 3 business segments. IPS operating income margins improved 651 basis points, driven by the addition of water and wastewater acquisitions and overall improvement within the energy-related IPS business. Service Center operating income margins improved 34 basis points on a Q3 comparative basis in year-over-year operating income margins. Supply Chain Services operating income margins improved [67.6] basis points on a year-over-year comparative basis. The improvement in Service Centers reflects the impact of acquisitions at a higher relative operating income margin.

Total DXP operating income increased 170 basis points versus Q3 2022 to $35.9 million.

Our SG&A for the quarter increased $4.6 million from Q3 2022 to $89.7 million. The increase reflects the growth in the business and associated incentive compensation as well as DXP investing in its people through merit and pay raises that we continue to experience. SG&A as a percentage of sales decreased 57 basis points year-over-year to 21.4% of sales. We still anticipate that DXP will benefit from the leverage inherent in the business despite increased operating dollars supporting our growth, cost inflation and the impacts of acquisitions.

Turning to EBITDA. Q3 2023 adjusted EBITDA was $44 million. Adjusted EBITDA margins were 10.5%. This is our third quarter of sequential adjusted EBITDA margins in excess of 10%, and we will look for this to continue.

Year-over-year adjusted EBITDA margins increased 164 basis points, or $9.7 million. This reflects the fixed-cost SG&A leverage we experience as we grow sales. This translated into 3.4x operating leverage during the quarter.

In terms of EPS, our net income for Q3 was $16.2 million. Our earnings per diluted share for Q3 '23 was $0.93 per share, versus $0.71 per share last year.

Of note, we returned $22.6 million to shareholders through our share repurchases during Q3.

Turning to the balance sheet and cash flow. In terms of working capital, our working capital increased $10.4 million from December and decreased $11.9 million from June to $287.5 million. As a percentage of sales, this amounted to 17.1% of last-12-month sales.

At this point, we have moved in line with our historical averages or range in terms of investing in working capital, and we have moved off our Q3 2022 high of 19.9% of last-12-month sales, as we have onboarded some of our recent acquisitions for a full 12 months. We do anticipate further acquisitions. So as we move into Fiscal 2024, this could move upwards, albeit we are focused on managing working capital as efficiently as possible as we scale and grow.

In terms of cash, we had $27.2 million in cash on the balance sheet as of September 30. This is a decrease of $18.9 million compared to the end of Q4 2022 and an increase of $11.6 million since June. This reflects the strong cash flow generation we experienced during the quarter, which we will touch upon later on in my comments.

In terms of CapEx, CapEx in the third quarter was $1.5 million, or a decrease of $327,000 compared to Q2 '23. We still are ahead of our Fiscal Year 2022 levels.

We've continued to reinvest in some of our facilities and equipment on behalf of our employees. As we move forward, we will continue to invest in the business as we focus on growth.

Turning to free cash flow. Free cash flow through Q3 was a positive $56.7 million, which reflects free cash flow produced of $38.3 million during the third quarter. This was driven by an $11.9 million reduction in working capital, along with our sustained earnings through the quarter. Specifically, we lessened the impact from investments and project work, along with a small increase in payable days.

That said, while we continue to make improvements in our free cash flow when we are growing, DXP makes significant investments in inventory and project work throughout the year, and we have experienced significant step-ups since Q4 of last year.

Return on invested capital, or ROIC, at the end of the third quarter was 34% and continues to be above our cost of capital, as reflected in our improved profitability levels.

As of September 30, our fixed-charge coverage ratio was 2.67:1, and our secured leverage ratio was
(technical difficulty)

Operator

Ladies and gentlemen, this is the Operator. Please stand by. We are experiencing technical difficulties. One moment, please.

Okay. You may now begin.

Kent Yee

I understand we got temporarily disconnected. So I'll turn back a few paces to when we started discussing our balance sheet.

Turning to the balance sheet and cash flow. In terms of working capital, our working capital increased $10.4 million from December and decreased $11.9 million from June to $287.5 million. As a percentage of sales, this amounted to 17.1% of last-12-month sales.

At this point, we have moved in line with our historical averages or ranges in terms of investing in working capital, and we have moved off our Q3 2022 high of 19.9% of last-12-month sales, as we have onboarded some of our recent acquisitions for a full 12 months. We do anticipate further acquisitions. So as we move into Fiscal 2024, this could move upwards, albeit we are focused on managing working capital as efficiently as possible as we scale and grow.

In terms of cash, we had $27.2 million in cash on the balance sheet as of September 30. This is a decrease of $18.9 million compared to the end of Q4 2022 and an increase of $11.6 million since June. This reflects the strong cash flow generation we experienced during the quarter, which we will touch upon later on in my comments.

In terms of CapEx, CapEx in the third quarter was $1.5 million, or a decrease of $327,000 compared to Q2 '23. We still are ahead of our Fiscal 2022 levels.

In terms of liquidity, as of the quarter we were undrawn on our ABL, with $2.9 million in letters of credit outstanding, with $132.1 million of availability and liquidity of $159.3 million, including the $27.2 million in cash.

Subsequent to the quarter, we announced that we refinanced and repriced our Term Loan B, which now has a maturity of October 2030. We successfully repriced the new Term Loan B, reducing our borrowing costs by 50 basis points to SOFR plus 475, versus SOFR plus 525, while also raising an incremental $125 million in capital to support our acquisition program over the next 6 to 9 months.

In terms of go-forward financial statement impacts, in the fourth quarter we will write off an estimated $12.4 million in unamortized debt issuance costs and capitalize a new estimated $12 million to $13 million of financing costs. Pro forma interest is expected to be in the range of $16 million to $17 million per quarter.

In terms of acquisitions, we closed on 1 acquisition after the quarter, Alliance Pump & Mechanical Service, and we are excited to have them, and they will start reporting with us for the fourth quarter of 2023.

DXP's acquisition pipeline continues to grow, and the market continues to present compelling opportunities. Looking forward, we expect this to continue through 2023 and 2024, and we look forward to closing a minimum of 4 to 5 acquisitions by the end of the first quarter of 2024.

In terms of capital allocation, we repurchased $22.6 million in the quarter and year-to-date $56.2 million, or a total of 618,000 shares in Q3 and 1.7 million shares year-to-date of DXP stock.

In summary, we are pleased with our third quarter performance, and we look forward to finishing 2023 strong as we position ourselves for 2024.

Now I will turn the call over for questions.

Question and Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Tommy Moll, from Stephens, Inc.

Thomas Allen Moll

David, you used the word "constructive" to describe your end markets, and I wondered if we could unpack that a little bit. And I'm specifically talking about ex-oil and gas. So more on the industrial side. How would you characterize that environment today just based on any anecdotes you can share? And how does it feel like it may have changed over the last quarter?

David R. Little

Tommy, thanks for your question. And that's a good question. I think best described is that we have an unusual amount of companies that are doing well, and we have an unusual amount of companies that aren't doing well. I think you have people that are being affected by higher interest rates. I think we have people that aren't being affected by that. And then, of course, the consumer ultimately is probably the driver of all of that.

And so it's interesting that it seems to all be balancing out. Whether aerospace is up, and you exed oil and gas, but actually that's kind of been down through most of this year. And of course, we think that's going to get better. But other industrial, the PMI index is saying we're in contraction, and yet my Metal Working group has been relatively flat most of the year, maybe ever so slightly down. And then when I say up and down, I'm really not talking about it being drastically up and down. I'm just talking about it being up a little bit and down a little bit.

So we don't -- we're not -- there's no panicking going on over here. We have some very strong growth initiatives for to be very specific, and they are producing good results. Because they're new in nature, they don't move the needle a whole bunch. We do an extra $1 million here and an extra $2 million here and $3 million here. But that's not offsetting that we have some customer that his business is down 10%, so he comes down.

So it's really hard. It's really why we're not overly positive or negative. I think we're not taking a positive or negative stand on anything, and we're just dealing with what hand we're dealt with. And I think we're trying to grow the business. And I think I'm pretty proud of our DXP people for -- our goal is always 10%, 10% and 10%. 10% organic growth, and we've exceeded that. And then 10% EBITDA margins, and we've exceeded that.

We're picking acquisitions that have high EBITDA margins. That's kind of the goal. We're trying to pick acquisitions that actually are small in nature, typically, but they have some record of growth. There's a lot of opportunities. I'm not paying 10x for some company that for the last 5 years has had flat growth.

And then we're going to generate a lot of cash flow. So that's a good thing.

So I don't know, I'm answering a lot of questions, and I'm -- but back to your point of how about looking at each individual market, we could go through that, but it's just going to be 10 up and just slightly up and 10 down, slightly down. And so it's kind of an interesting economy out there.

Thomas Allen Moll

Well, if you roll it all together and you look at the $419 million you just reported for the third quarter, what's your best guess on fourth quarter? Above that level, below that level, about the same?

Kent Yee

Tommy, I'll jump in here a little bit. One thing, just to tag on to David's just comments about the end markets, is sequentially $419 million, I think from your estimate may be considered down. I think the 1 thing we missed there is we had 63 business days in Q3, versus 64 in Q2. So if I adjust for our sales per business day, we're essentially flat to Q2, which was in line, I think, with directional comments, once again we typically don't give guidance, but directional comments around our Q2 commentary.

That said, to pull that forward, I think in Q4 what we see is there's 61 business days. So you even go down an additional 2. So our sales per business day continues to perform. As I outlined, kind of the trend was, through the quarter, $6.6 million in July, $6.3 million in August, September was $7.1 million, October $6.4 million. So if you take a blended average and do that by 61 days, you can get to kind of our macro or directional comments on where we think the business will perform in Q4. And some of that's just once again a function of the number of business days. You go into the holiday season, et cetera. Some other things going in there.

That said, we did have an acquisition in the quarter that on a full year basis is roughly around $2 million in sales. So once again, people can do the math of incorporating that.

And so those would be our thoughts about how to think about kind of going forward. I don't think we see -- to David's comments, we have a balanced mix of end markets. The consumer-facing ones would probably, would be the way I'd summarize it, tends to probably see the ones that you have those slightly downs. And then in terms of our hardcore true industrial markets, to David's point, you have some that are up or down that are offsetting, that are having lessening impacts from inflation. And so net, the business is still growing year-over-year.

Thomas Allen Moll

Kent, all the detail was helpful. And just to make sure I'm following correctly, your 63 business days in the third quarter steps down to 61 in the fourth quarter. And I think what I heard you say is if we calculate that daily sales rate for the third quarter across the average of the third quarter, there's no reason that shouldn't look meaningfully different in the fourth quarter. Did I hear that correctly?

Kent Yee

That's directionally correct. Once again, we had an acquisition, without being too specific. But yes. I mean, that's how one of the KPIs here at DXP that we monitor, that we always talk about, obviously, on the earnings calls, is very simplistically at a very high level sales per business today.

Thomas Allen Moll

Okay. And then on the margin side, third quarter in a row hitting that double-digit target. And I think I heard you all say you don't see any reason that shouldn't continue. So I would just ask a more open-ended question. I mean, first of all, make sure I heard that correctly. And second of all, just talk to what's supporting some of that double-digit margin performance and where do you think you head medium term.

Kent Yee

I mean, at the high level, what starts off really supporting that is our gross margins. If you look at our gross margins over the past 1.5 years, 2 years, we've taken a step up by about 100 to 200 basis points, call it, on average. So that 29% to 30% gross profit range is the biggest driver.

And then as is inherent in distribution, you get SG&A leverage. And so if you're managing costs correctly, which we work pretty hard on, if you get to 30%, and then you've got the 20% SG&A, which has been one of David's long-term goals, you get to the 10%. And so we've been able to do that.

Part of that is driven by mix. Once again, our water/wastewater acquisitions tend to perform at a higher level of gross margin. So does our air compressors. And then our base business, we're always pushing our heritage, if you will, DXP business to perform in line with those businesses and get to that 30%. And we surely have some that do that and more.

So those are the levers at a high level, and we've been experiencing that quarter-over-quarter.

Thomas Allen Moll

All right. Kent, on interest expense, I just want to make sure I heard everything you said correctly, and there's a couple of layers here. So maybe we'll start with the easier one. I think what I heard you say is, forgetting about Q4 for a minute, where there's some noise, but that post the refinancing on today's SOFR, it's about a $16 million to $17 million a quarter expense line. Did I interpret that correctly?

Kent Yee

Yes, yes. It's a floating rate, right? So it's a little bit of a moving target, Tommy, but that's correct. If you just kind of, with everything you know today, pro forma it, right at about $16 million to $17 million in interest expense a quarter for the new incremental $125 million.

Thomas Allen Moll

Okay. And then 4Q, which will be a little bit trickier, there was a $12.4 million item and a $12 million to $13 million item. Can we just go back over those again?

Kent Yee

Yes. Essentially, you have -- you already, for lack of better words, expense and pay for it, but due to the accounting you have unamortized debt issuance costs that you write off as part of a new facility and a new transaction. So we'll write that off and flush that through the P&L, if you will, in Q4, and then we'll capitalize a new $12 million to $13 million worth of debt issuance costs associated with the new facility, or the new $550 million raised here just recently.

So that's essentially what will go on. The P&L impacts, once again, that people will see is just the write-off of the debt issuance costs, and then you'll start to see, obviously, the new pro forma interest kick in, in Q4. So those are the 2 things you'll really see in the P&L.

Thomas Allen Moll

Okay. And if you think about the consolidated interest expense line for Q4, what does it all add up to?

Kent Yee

Well, once again, also the missing piece, which once again, as we do in today's environment, we are managing cash. Meaning, hey, we do get some interest income on our cash that offsets that $16 million to $17 million, but that's -- there's a daily movement there a little bit. So net, you could get down to $15.5 million at the lower end of that forecast of interest expense, is what I would tell you just in terms of what's rolling through the P&L.

Thomas Allen Moll

And that's for Q4 or for the run rate?

Kent Yee

For Q4. Once again, the facility also amortizes. If you go past Q4, Tommy, 1% per year in terms of principal reduction. So you're effectively lowering that ultimate interest over time. Not to get into the details of that math here on the phone. But I think in Q4, what you would expect to see is the $16 million to $17 million in interest expense. And then as you go forward, every quarter, the combination of debt amortization of the 1% per year, or 0.25% every quarter, plus kind of some interest income associated with the cash on the balance sheet will offset that. And so it will peak probably in Q4, Q1, and then it will just lessen as we go out.

Thomas Allen Moll

Okay. Let's see. On a couple of strategic items for you guys. M&A, I think I heard maybe 4 to 5 more deals you've got soft circled for Q4, Q1. What can you tell us about that pipeline, particularly in terms of just size of the deals you're considering at this point and what seller expectations look like in this rate and economic environment?

Kent Yee

So we actually have letters of intent in place. So we're just actively working through due diligence on those, and that's why we said a minimum of 4 to 5 by the end of Q1. The timing, once again, the calendar is a little bit tough at this time of the year. You have holidays and different things. So we're kind of working through that, being sure we're being prudent from a due diligence standpoint. But we're anticipating potentially some here as we close out the year. And obviously, if we don't hit that timeline, we'll close them out in the first quarter. So just to give you some color there.

Just in terms of kind of overall expectations from a valuation standpoint, I mean, hey, we still continue to find good deals at good multiples. I mean, our average purchase multiple has always been 7x or less. And so we're still finding those opportunities out there in the marketplace.

The themes in terms of the types of acquisitions, water/wastewater continues to be a big theme. We do have some just industrial kind of, I'll call it, rotating equipment product in our repair and services. And so those are also one of our themes. That's what Alliance Pumping & Mechanical was closer to and did add some water/wastewater things there, but also just some general rotating equipment repair type stuff. So those are the themes we're seeing. And so we're kind of excited to work through those, and we'll be excited to kind of report those when we get those closed.

Thomas Allen Moll

Last question for me, on oil and gas. There have been some large transactions announced for some of the players in that industry to consolidate. And I just wonder from a strategic perspective, is there anything that that signals, positive or negative, to you for your business in that end market?

David R. Little

Well, I think it's potentially negative. I think these big companies had their own budgets, their own people doing projects. We participate in those projects. And when you put the 2 of them together, assuming if they're doing it and they're just going to move forward with the same total budget, then that would be great. If they do it and they're wanting to consolidate and try to become more efficient, well, then I think those budgets could possibly be cut. And so therefore, there's going to be good activity, and of course it's all about how much of -- we don't get 100% of anybody's budget.

So still, we don't feel like that IPS, our Innovative Pumping Solutions group, is pretty positive about a combination of alternative type fuels that are more environmentally friendly and the traditional stuff, and both of those things are happening as we speak. And so in some ways, they feel like things are continuing to improve for them, and I feel that way. But specific to the mergers you're talking about, they take some budget out of play.

Operator

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