Good morning, everyone, and welcome to the Distribution Solutions Group Second Quarter 2022 Earnings Call. As a reminder, this conference call is being recorded. Now I'd like to turn the call over to Sandy Martin, Three Part Advisors, to provide instructions to read the Safe Harbor statement. Please go ahead.

Good morning, ladies and gentlemen, and welcome to the Distribution Solutions Group Second Quarter 2022 Earnings Call. In conjunction with today's call, we have provided a Q2 earnings presentation that has been posted on the company's IR website at investor.distributionsolutionsgroup.com. Joining me on the prepared remarks for today's call will be Bryan King, DSG's Chief Executive Officer and Chairman; and Ron Knutson, DSG's Executive Vice President and Chief Financial Officer. During the call, they will be providing an update on the business from an operational and financial perspective. Additionally, Brad Wallace, LKCM-Headwater Partner and DSG Advisor as well as operating company CEOs, Cesar Lanuza, Russ Frazee and Bob Connors will join the call 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 company's views as of today. The company anticipates that future developments may cause those views to change. Please consider the information presented in that light. The company may, at some point, elect to update the forward-looking statements made today, but disclaims any obligation to do so. Management will also refer to non-GAAP measures, including adjusted EBITDA, adjusted operating income and adjusted diluted EPS. Reconciliations to the nearest GAAP measures can be found at the end of our earnings release. 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 the current report on Form 8-K filed with the SEC. This call is being audio webcast on the Internet via the Distribution Solutions Group Investor Relations page on the company's website. A replay of this teleconference will be available through August 23, 2022. I will now turn the call over to Bryan King. Bryan?

Thank you, Sandy, and good morning, everyone. I'm excited to share with you our results of the combined Distribution Solutions Group organization. As Sandy mentioned, please refer to the slide deck that we have provided on our website to follow along with our commentary today. As you'll recall, we completed the merger effective April 1, 2022, by strategically bringing together 3 high-touch value-added specialty distribution companies. First, I'd like to quickly summarize each of the operating companies under Distribution Solutions Group for any of our new listeners. Lawson Products is a leader in the MRO distribution of Class C parts, offering vendor-managed inventory services through its over 1,000 sales reps. Gexpro Services is a provider of supply chain solutions of largely C parts, specializing and developing and implementing VMI and kitting programs to high-specification manufacturing customers. TestEquity is a leading distributor of specialized Test & Measurement Equipment and solutions, Electronic Production supplies and customized toolkits from leading manufacturing partners. In a moment, Ron will cover the financial details for the quarter, but let me start by pointing out a few of the highlights from the second quarter and also comment on some operational initiatives within each of the companies. For the combined companies', sales grew 34% to $321 million from both acquisitions and organic growth. Organic sales grew nearly 12% versus a year ago quarter. On an apples-to-apples basis, this organic growth demonstrates the strength of the core businesses before taking into consideration our acquisition revenues. We reported solid organic growth across all three of the operating companies or segments. We generated almost $32 million of adjusted EBITDA for the quarter, which translates to 9.9% of sales. We are encouraged by these results as all three operating companies are performing at or above their expectations. While DSC does not provide…

Thank you, Bryan, and good morning, everyone. We're excited this morning to share with you the second quarter results of Distribution Solutions Group. While this represents our second quarter results, it is our initial quarter of presenting consolidated financial results of the three operating companies, Lawson Products, Gexpro services and TestEquity. Given that this is the initial reporting quarter of the combined company, let me comment on the required GAAP accounting presentation before we discuss our results. Please turn to Page three of the second quarter 2022 financial results presentation that we posted on our IR website of DSG. As you may recall, and that was disclosed in the proxy filed earlier this year, the combination of the three operating companies is required to be treated under GAAP as a reverse merger. Given the common ownership control of Gexpro Services and TestEquity by LKCM on a combined basis, they were deemed to be the accounting acquirer org of Lawson Products. A few items to keep in mind as we review the second quarter results. The second quarter 2022 results include all three companies for the full quarter. The comparative GAAP information for 2021 only include Gexpro Services and TestEquity as the predecessor company of the accounting acquirer org. The year-to-date GAAP information for 2022 includes Gexpro Services and TestEquity for the first 6 months. And given the merger date of April 1, only includes Lawson Products from April 1 through June 30. For ease of comparing the results, the slides that we will be utilizing for the conversation this morning are adjusted for the premerger activity of Lawson Products. Now turning to Slide five. Let me summarize the second quarter results. On a combined basis, we reported strong top line and bottom line results across the three principal operating companies.…

Thank you, Ron. I'll direct you to Page 12. This page really speaks for itself, and I would echo Ron's comment that we have gotten off to a great start in our initial quarter of our combined companies. Second quarter results demonstrated our ability to report strong growth, both by acquisition and organically and to drive substantial adjusted EBITDA. We remain confident about the opportunities to scale the business and believe that while supply chain stabilize, customers are going to continue to look for ways to streamline their businesses and leverage their operating results. Our businesses through Lawson Products, Gexpro Services and TestEquity are well positioned to partner with those customers to accomplish their goals. We're expanding wallet share and partnering with our customers to support them with comprehensive supply chain solutions. With that, I would like to open up the line for questions. Operator?

Certainly Your first question is coming from Kevin Steinke from Barrington Research. Your line is live.

Good morning. I wanted to ask about you mentioned progress on cross-selling among the operating companies. When we think about cross-selling, and you have conversations with your customers about maybe bringing services of one of the operating companies into them that they had been using before. Are you -- is that something typically they haven't been outsourcing before when you're able to cross-sell? Or are you displacing a competitor? I'm just wondering how that dynamic typically were surface as kind of all different situations, I assume, maybe depending on the customer.

Yes. This is a great one to let Bob tee up on, as he and Cesar have been working closely on those two businesses, collaborating on some customers. So Bob, why don't you hit it?

Thank you, Bryan. It's actually a great question. And I can tell you, for Gexpro Services, we're there at the blue-chip OEMs every day, managing their production line, bringing our value-added services, BMI, supermarkets, Kanban systems. And I've been doing this over 30 years and customers continue to come to myself and Ray Herzog, who's our Chief Commercial Officer, asking us to expand the service capabilities and include MRO. For us to do that independently, it would be a significant investment, not just in terms of trade working capital, brick-and-mortar and subject matter expertise. So it's just natural for us to tap Lawson, who has best-in-class VMI capabilities to supplement our service offering. And what's surprising to us is we did expect customers to be well received in terms of seeing the total platform. But what shocked us is how many quick conversions we got right off the bat. And now we're literally going through the top 100 accounts and looking at the opportunities with Lawson and Gexpro Services as well as TestEquity to pull the full complete platform together. Customers, mostly what they're looking for. It's not just supplier rationalization, but they're looking for a total cost of ownership improvement. So when you can bring packages together of production line services and MRO as well as Test & Equipment, which their strength is on test and R&D, you basically put together a package service offering of products and services that can really enhance the value proposition, not just of the business but the TCO to the customer.

All right. Great. That's a lot of helpful color. I guess I didn't get on immediately at beginning of the call, but I don't know it doesn't seem like it, but have you seen anything indicating that economic uncertainty or economic slowdown is impacting any of your businesses at this point?

Good morning Kevin, it's Ron Knutson. So I'll comment on this, and then certainly, the other three CEOs can jump in as well. And I would say really across the businesses, we've really not seen a slowdown in terms of unit volume being shipped out of the service centers and the distribution centers. So it's interesting as we look at our internal metrics, we're not seeing really much indication of a slowdown currently. In fact, even the increase in the back -- the customer backlog that we referenced on the prepared remarks for TestEquity is an indicator that there's still strong customer demand that is out there. So we're not seeing anything here on the surface that would indicate a slowdown, but certainly are conscious of commentary that's out there, and we're keeping close tabs on it. But as we sit here today, we've not seen anything indicating a slowdown for us.

All right. Understood. When we think about inflation and you talked about this with regard to Lawson Products, your price increases are being realized there to offset inflation. Where do you stand, I guess, not only within Lawson, but across all of your operating segments in terms of your ability to keep pace with inflation or your -- that it might be necessary to implement more price increases going forward?

Yes, Kevin, this is Ron again. So really, all three companies have been able to pass along price increases really to offset some of the supplier cost increases as long -- as well as the freight and the labor piece of it. On an organic basis, we grew nearly 12% on a combined basis for all three companies combined. And if we look at that on a combined basis as well across all three companies, about 7% of that 12% is price related. So have been able to pass the price increases along. And generally, I would say that, that they're being accepted by the customers. It's not always an easy task to get the customer to accept the increases. But for the most part, I would say across the three businesses, our end customers have been understanding and open to those increases, realizing that we're effectively passing along the cost that we're seeing on our side.

All right. That's good to hear. So what -- when we think about margin expansion, can you just talk a little bit more about the factors that drove margin expansion, adjusted EBITDA margin expansion year-over-year, I guess, in terms of the adjusted results, including Lawson last year, and just your confidence or what gives you confidence that you're going to exit the year at that 10% plus margin?

Yes. I'll take that one, Kevin. And so as both Bryan and I mentioned in our prepared remarks, we ended the quarter at 9.9% and if you look at where we were a year ago, really, really nice expansion as well as the first quarter expansion as well. So I would say there's a few items that are driving that confidence, and one is kind of goes back to your earlier question around some of the sales opportunities across all three organizations working that gives us a lot of confidence that the teams are working really well together to identify those opportunities. And as Bob mentioned, we've got the top 100 accounts already identified in terms of trying to expand those relationships. So that certainly is a piece of it. The fact that we're seeing strong demand just from a unit perspective, gives us some additional confidence as well. And then we are looking at -- and we didn't bring the three companies together from a cost perspective, that wasn't the strategy. However, there certainly are costs that we can take out across the platform on a combined basis that we're focusing in on as well. So I would say those couple of areas being the revenue synergies and the cost from a combined basis. And then as Bryan commented on, a lot of this is going out within the individual operating companies. And we're seeing that margin expansion take place on an individual company basis as well and then factoring in the additional sales and cost opportunities is really, in my mind, what's building our confidence as we move throughout the rest of 2022 and into 2023.

I would also add there, Kevin. I'd also add that we're still in the early stages of integrating the acquisitions that TestEquity and Gexpro have folded into their business units. And there's -- while we didn't make -- we didn't bring the three companies together to try and leverage too much of the costs in any way that would disrupt the relationship with the customers. We have just come out of a summit in Chicago where all the significant amount of the leadership teams and functional team leaders of each of the three companies were together with our operations team that works just with our portfolio companies and then our investment team. And they came out of that with a lot of very specific objectives that they are going to focus on trying to work through a lot of energy, a lot of enthusiasm, but also a lot of opportunities for efficiency gains as well as selling -- cross-selling opportunities, going back to your earlier question. And then when you drill down into the acquisitions that we've made inside of Gexpro and TestEquity recently, there's opportunities that we're still working through to capture synergy there.

All right. Great. And lastly, I just want to ask about the acquisition pipeline. You mentioned it remains strong. Can you just give us, I guess, any more flavor on the types of opportunities you're seeing in terms of size? Is it across all 3 of your operating companies? And what valuations look like right now?

This is a great opportunity. We have a great team, Kevin, and we were able to bring back Matt Boyce, who helped us significantly on industrial distribution group, if you remember that one. When we bought it back in '08 and more than quintupled the EBITDA there. Matt had been over at Carlisle, the public company, leading acquisitions. He worked there before we recruited him for IDG and then went back there after we sold IDG to Sonepar. And he's working closely with Brad Wallace and our team who's really leading a lot of the operational dialogues with the management teams as well as the conversations from our team with the M&A effort inside of the business. There's three M&A professionals that are a team now inside of DSG. One of them had worked with us years ago and then moved over to work with Bob and has been leading the efforts there. And then we brought in Matt to kind of lead the whole effort and then he brought in a colleague. And so Brad, if you've got any color there, why don't you fill in detail for Kevin?

Yes, Kevin, I would say that it's pretty spread out. I would say it's a robust pipeline now. We've got activity going on across all three of the platforms. And I'd say valuations are pretty much in line with where we've been seeing them. We're targeting seven potentially up to 8 times on the acquisition multiples. And we've historically cheapen those back a couple of multiple turns after realizing some of the cost savings that Bryan alluded to earlier. And so market conditions now are obviously a little bit different than they were six months ago. We're happy with the acquisitions that we have done. Bob and Cesar and Russ, they're all working on both combining -- integrating the businesses that they've acquired as well as working diligently on continuing to fill that pipeline. But I would say it is a robust pipeline now that we're excited about and super excited about having really a dedicated team out focused on M&A.

Brad, just to add to that. Kevin, we -- the way that we kind of think about EBITDA multiples, historically for the size of acquisitions that we're focused on is a 6% to 8% range with the 7 being the mode. But -- and I -- we think that there may be opportunities to see that environment -- in the current environment to see opportunities that may be towards the lower end of that range versus the higher end. But the better quality businesses or the ones that are more strategically appropriate for what we're trying to accomplish with the platform may require us to cheapen them back, meaning kind of if they cost us 8 times, we would expect to bring them down, as Brad said. I'm not convinced yet that there isn't the firepower that a number of the large private equity firms have out there and the distribution platforms that they've built. While each of these acquisitions we're working on are largely directly sourced, I'm not sure that the sellers are ready to take a lower multiple. And the end market on the industrial side, at least what we're seeing, the end markets that we're playing in other than renewables, which we're about to get a shot in the arm on in government, which we think is also going to improve, we're still seeing really robust demand. So business performance on the businesses that we're looking at is largely consistent with pre-COVID years.

Okay. That's really helpful color. And just I'll sneak in one last one here. You mentioned there renewables, in the presentation, you mentioned that it's kind of like an isolated area where there's some headwinds. What's going on there? And are you -- I guess you're referring to the spending package working its way through Congress. That could be a shot in the arm. Is that the way you're thinking about it?

Bob can't wait to talk about renewables. So Bob, why don't you...

So a couple of things. One, we're really excited about the inflation reduction and the investment forthcoming for wind, solar as well as electric vehicle. So for us, we saw the Senate vote, that's positive. It's going through the House next. So we think that, as Bryan said, it's going to be a good shot in the arm and renewables down for services 28% and it's one of our largest and most profitable businesses. So to see a 10-year commitment going forward, that gives us a lot of confidence that the business will continue to sustain and improve. And I'll also go back to the technology segment with the CHIPS and Science Act, $50 billion investment, that's, again, strong tailwinds for the business going forward.

Well thanks for all the insight. That’s all I had. Thanks for taking the questions, appreciate it.

Thanks Kevin.

Thank you. Your next question is coming from Ben Newman from KeyBanc Capital. Your line is live.

Good morning there. Yes, it’s Ken Newman from KeyBanc.

Hey Ken.

Good morning. Just for my first question, I'm curious if you could provide a little color just on order trends through August for each of the business segments. Really, I'm sure for the revenue cadence for some of these businesses from a seasonality perspective, just since we don't have the prior year quarter restatements. So any sense on how we should think about the typical seasonality for each of the -- as we move from 2Q to 3Q and then into the last quarter as well?

Yes. Ken, I'll take this. This is Ron Knutson. So typically, what we would see is that generally across really all three of the business is that the second and third quarter are generally stronger quarters. And quite honestly, some of it just comes down to a number of selling days. When we look at the calendar here for 2022, we have 64 selling days in the second quarter, 63 and -- I'm sorry, 64 in Q3 and 60 days in Q4. So we'll naturally see a little bit of a slowdown as we enter into the fourth quarter just based upon the selling days. But I think that the second quarter results that we posted is a really good indication of how strong the quarter was. When we look at how the third quarter has started and we don't provide formal guidance, as you're aware. But I would say that what we've seen so far, the first, call it, five weeks into the quarter is that really a consistent mode in terms of what we saw in the second quarter as well. So nice increases over a year ago. And I would say really in the same, call it, kind of in the same range, maybe even a little bit greater than what we saw here in the second quarter from what we posted. So the trends that we saw have continued so far here early in the quarter.

Understood. And then just on price, it sounds like 10% price in Lawson Products seems like a really good solid improvement I think 7% consolidated. When I think about that in the context of the orders that you're taking, do you think price contributions here have likely peaked in the second quarter or that ramps further in coming quarters?

Yes. It -- what we've seen is that the cost increases from many of our suppliers have not slowed down dramatically from what we saw in the second quarter. So we're continuing -- all three companies are monitoring margins very closely and in monitoring those increases from our supplier base. So it's a little tough to forecast this out. But we're not seeing any great slowdown, I would say, and we'll stay on top of it from an individual company perspective. So I suspect that we'll continue to see price actions as we move throughout the rest of 2022.

Right. In terms of the TestEquity backlog, I understand that supply chain remains pretty challenging here. But just any sense or color if there was some delivery slippage that impacted revenues in that segment this quarter? And then if so, maybe give us a little bit more color how much of the backlog increases a push out versus order growth?

Russ, you want to talk about that?

Yes, thanks. I can take that one. We've seen a continuous slippage in the orders coming from our suppliers over the past couple of years since COVID started with the chip shortage. We haven't seen it increase. It's been maintaining about the same. We get lumpy deliveries from our suppliers, and we can turn that very quickly when we get it back in. I don't see that changing much over the next 12 months, but I don't see it increasing. Our suppliers are working toward allocating their chips in the proper way to help fill the backlog. Our backlog is at its peak right now than it's ever been, but we're comfortable that we'll be working through that over the next 12 to 24 months.

Yes. When I think about the chip shortages within that segment, I mean maybe -- how should I think about the types of chips that are going into some of the -- and equipment product. Is it more of the trailing edge chips, the older chips versus sort of the new leading-edge chips that are kind of being built for the newer processes?

It's a mix. There's a lot of the older chips there's still quite a backlog for. The newer chips, since they're not going into production as quickly as they normally would, so it's a combination of both.

Okay. And just one more for me. Just I didn't hear a mention of cash flow or cash generation in the quarter. Maybe just help us understand where that ended? And how do we think about or if there's been a change to the outlook for cash generation and working capital build into the back half?

Yes. Ken, this is Ron...

Go ahead, Ron.

Yes, I can start, Bryan. I can jump in on that. So for the first -- well, I say for the first quarter, for our initial quarter on a combined basis, our cash flow or I would say, even our debt level was pretty well flat with where we opened the transaction as of April 1. However, keep in mind that this first -- or this initial quarter had quite a few, what I'll call one-off items in terms of some of the merger-related costs still coming through. And we did enter into the merger transaction with, I would say, probably higher payables than what we would normally run at. So those clear through here in the quarter as well. Certainly, as we get into the second and third -- I'm sorry, into the third and fourth quarters, we anticipate that, that cash flow generation will be back to the normalized levels. But this first quarter was, I would say, really impacted by some of these one-off items and letting the trade payables clear through. So again, we're -- we manage working capital very tightly within all the individual operating companies. We have a comprehensive process we go through around managing CapEx as well. So we're comfortable that we'll be back to our normalized levels here in the latter half of the year.

Can you just remind me what is -- I mean, how would you define normalized cash flow generation for the consolidated businesses? Is it -- I mean, is it fair to think that free cash could be 100% of net income or in excess of that in the out year if things start to normalize here from a supply chain perspective?

Yes. What I -- yes, let me answer that. A couple of data points. So we -- from a CapEx perspective, we would anticipate on an annual basis that will be in the kind of $15 million to $20 million range on CapEx this year. And then the other piece that I'll comment on is really just the working capital needs in terms of the expansion of the business in terms of organic sales. So historically, if you look back -- and there's certainly some opportunities here. But historically, if you look back, all 3 companies on a combined basis, would operate at about 20% working capital as a percent of sales. So you can probably kind of do the math on that in terms of what that means in terms of free cash flow on a go-forward basis. But those are probably the two largest pieces of uses of cash. And then we have the funding or the service of the debt as well in terms of interest in the principal payments.

Alright. Thanks for the color.

Thank you. Your next question is coming from Brad Hathaway from Far View. Your line is live.

Hi, everyone. Congrats on an incredible quarter. I mean both the growth and the profitability is really great. Most -- I guess it was positive to hear the commentary on kind of the confidence on the EBITDA for this year. I guess I'm curious, based on kind of what you're seeing from the summit and all the kind of discussion among the teams, I mean, how do you feel about the EBITDA progression as we look into the midterm and kind of that path towards the teams that you talked about previously? I mean how has your confidence changed on that?

Well, first of all, it was nice just to get through the first one, right? I mean it's been over a year of really 15, 16 months of since we made the proposal in May or in May 2021. And so to get 1 under the belt, to get out of the gate more than straight and to feel really good about how everyone is working together and the opportunities that we're continuing to uncover which are larger than the opportunities that we underwrote to when we first thought about bringing the businesses together, both in terms of how they could work collaboratively on cross-selling some of the abilities to leverage the platform to be more efficient. And then obviously, how we are thinking about using the free cash flow and the scale benefits to continue to add acquisition revenue and thoughtfully the right strategic acquisitions for kind of bringing together a better business, and not just to grow EBITDA. So I think as we're looking at it, that this is -- the progression is going to be up into the right in terms of operating margins, EBITDA margins over the next several years. And I think we're feeling -- the other thing that's nice, Brad, is that each of the 3 teams have done a great job managing the inflationary pressures on inventory or purchasing and passing that through to the kind of -- in order to sustain their margins and actually improve their visibility on margins through their price actions. And so I think that, that's helpful. I mean in an inflationary environment, the last thing you would do is lose ground on that. It's hard to recapture if you don't get after it on day 1. We're still seeing some of that flow through the model, some of the price actions that we've taken. And so I think our confidence is -- and a big part of that comes from the three CEOs that are on here on the phone and how well they and their teams are culturally working well together. So we see a lot of progress in front of us.

Excellent. That's great. That's really helpful. And I guess just -- I mean, it seems like all three teams are operating great. So thank you all for all that effort. And I guess just 1 other small question on the M&A pipeline. If memory serves, there was a Gexpro deal that was kind of somewhat in the proxy, something that's kind of at least in process. Is there any update you can provide on that one?

Brad, you or Bob want to talk about where we are on that company?

Yes. So, Brad, this is Brad Wallace speaking here. I would say it is still in process. I think that M&A -- certain transactions take a life of their own, and this would qualify as that. We are in the later innings than we were before, but we're not yet to the ninth inning. So it is still on the hook and still in process.

Got it. And has TestEquity completed all the transactions from the proxy? The ones that they've got, is that -- are those all done?

Yes, they have.

Got it. Okay. So it's just this 1 Gexpro 1 for the proxy that's not in there yet.

Referencing back to the proxy that is correct. But there -- as I mentioned earlier, there's others that we are working that are in the pipeline that were not included in the proxy as they weren't as far along as those that were in the proxy.

No, 100%. I understand the pipeline is very different. I was just curious about the one specifically noted in that. Great. Well, I would say that not only have you come out straight but I think you guys have come out with a really great first quarter. So thank you all for the effort and look forward to the development here.

Brad, thank you. We appreciate your engagement.

Thanks, Bryan.

Thank you. That concludes our Q&A session. I will now hand the conference back to Bryan King for closing remarks. Please go ahead.

Well, thank you. Thank you, everyone for listening today. We appreciate the support of the investors that have been with us along this journey, and we welcome those that are new to our -- new to our business. And we're really proud of the management teams of these three business units and how they've continued to work together and collaborate and a lot of work that Ron and his team has done in order to work through the challenges of effectively a double reverse merger and one of a more complicated accounting -- GAAP accounting exercises that we've been involved in. Lots of hard effort, hard work over the last six months, nine months to get to where we are today. We're enthusiastic about what we're seeing in the marketplace right now, over the last couple of months for the businesses, and the way that the teams are working together to be able to unlock more value for the shareholders. The business is going to present at the Midwest IDEAS Conference in Chicago on August -- which is held on August 24 and 25. We welcome anyone that is going to be there to meet with us in person. And then obviously, if anyone has any questions as follow-ups or would like to have a call with us, please reach out to Three Parts Advisors or to Ron, and let's get on the calendar and have a conversation. Thank you for your interest, and have a great rest of the summer and hope to see you soon.

Thank you, ladies and gentlemen. This concludes today's event. You may disconnect at this time, and have a wonderful day. Thank you for your participation.