Greetings and welcome to the Distribution Solutions Group Second Quarter 2023 Earnings Conference Call. [Operator Instructions] Please note, this conference is being recorded. I will now turn the conference over to your host, Mr. Steven Hooser. You may begin.

Good morning, ladies and gentlemen and welcome to the Distribution Solutions Group second quarter 2023 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.dstributionsolutionsgroup.com. Please note that statements made 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 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 reconciliations to the nearest GAAP measures can be found at the end of the earnings release. The earnings press release issued earlier today was also posted on the Investor Relations section of the 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 also being webcast on the Internet via the Distribution Solutions Group Investor Relations page on the company's website. A replay of the teleconference will be available through August 17, 2023. I will now turn the call over to Bryan King, DSG's Chairman and Chief Executive Officer. Bryan?

Thanks, Steven and thank you all for joining to review our second quarter results. Joining me for today's call is Ron Knutson, DSG's Executive Vice President and Chief Financial Officer. Distribution Solutions Group delivered strong 2023 first half results, anchored by our industry leadership positions, our broad portfolio of products, value-added services and mission-critical solutions and the benefits we are starting to unlock with our significantly improved scale, coupled with our talented team's relentless focus on execution. Starting on Slide 4 of the second quarter earnings presentation. We again delivered strong quarterly sales up almost 18% in the second quarter which included organic growth of 5%. Second quarter adjusted earnings per share were -- was $0.52, up over 40% from the comparable prior year earnings per share. We also generated adjusted EBITDA in excess of $40 million or a margin of 10.6% in the quarter. This quarter represents the fifth consecutive year-over-year quarterly EBITDA margin expansion. We are extremely pleased with how the teams have executed, especially in a dynamic operating environment with a lot of initiatives that are requiring investment of internal and external resources in the first half of 2023 to accelerate unlocking future value to the shareholders. Later, we will provide more commentary on important sales and cost initiatives we are currently working on, along with our discussion of the operating unit performance for the second quarter. We are excited that DSG has successfully established itself as a leader in the end markets we serve. We are positioned well to leverage our high-touch service delivery model and deepen customer relationships with our increasing breadth of value-added products and services. We are thrilled to have closed on the Hisco acquisition on June 8 and are successfully integrating processes and the team to create a unified and streamlined single…

Thank you, Bryan and good morning, everyone. Turning to Slide 7. We're excited this morning to share with you our strong second quarter results of Distribution Solutions Group. Let me summarize Q2 results. On a combined basis, we reported strong top line and bottom-line results over a year ago. As Bryan mentioned, we reported total sales growth of 17.6% with organic sales growing 4.8% through both price and volume expansion. The second quarter results reflect continued growth in margin dollars. GAAP reported income improved threefold with Q2 adjusted EBITDA exceeding $40 million, a first since bringing DSG together over a year ago. Our positive momentum and movement in cash flows generated from operations continued with our focus on working capital improvements. I'll now walk through some of the specific numbers on a combined basis, of which most of this is on Page 7 of our presentation. First, consolidated revenue for the second quarter was $378 million, revenue increased 17.6% or $56.7 million over the second quarter of 2022, driven by organic growth plus approximately $43.4 million coming from acquisitions, of which $28 million was from Hisco. Second, reported GAAP operating income was $13.8 million compared to $4.1 million a year ago quarter. On an adjusted basis, excluding merger-related costs, acquisition costs, stock-based compensation, severance and other nonrecurring items, adjusted EBITDA improved by nearly 27% or $8.5 million to $40.1 million or 10.6% of revenues. While the percentage is down slightly from Q1, approximately 40 bps of the decline was related to including the initial 3 weeks of Hisco which we did anticipate. And third, we reported GAAP diluted earnings per share of $0.14 for the quarter compared to a loss of $0.23 a year ago. On an adjusted basis, diluted EPS was $0.52 for the quarter versus $0.36 for a…

Thank you, Ron. Let's turn to Slide 12. We believe it is important, especially as U.S. and global markets evolve and change quickly to discuss with investors our approach to capital deployment. DSG's allocation of capital is focused on a disciplined balance between investing in growth, both in our core businesses as well as in strategic acquisitions that fit our model with a prudent approach to working capital intensity, leverage and occasionally through opportunistic share buybacks. Our goal is to continue to scale the DSG platform into an even more enduring well-positioned specialty distributor with key differentiators that uniquely benefit from utilizing our high-touch, value-added distribution solutions, services and customizable capabilities that customers clearly recognize and celebrate. Since we have built this business as an asset-light structure, we have planned for organic and inorganic growth through deliberate working capital investments as well as strategic acquisitions that are aligned with our commitment to accelerating shareholder value. Our targeted leverage will continue to be in the 3% to 4% range. And at the end of the second quarter, just 3 weeks post-closing of Hisco our leverage is 3.1x. At the end of the quarter, we had approximately $476 million of net working capital with accelerating cash flow. Our investment in working capital over the last year facilitated our focus to drive organic growth that drives accelerating profitability for our shareholders. Finally, we continue to seek the highest return on invested capital opportunities with an obsessive commitment to build incremental shareholder value for the benefit of all of us. We understand and appreciate why there continues to be interest in DSG from investors. It is easy to see the long-term compounding effects of owning a leading specialty distribution company with the scale and breadth of our products and solutions. Turning to Slide 13.…

[Operator Instructions] Your first question is coming from Kevin Steinke of Barrington Research.

I wanted to start off by asking about the organic growth and the breakdown of price versus volume is kind of roughly half and price and half volume the way to think about that 5% organic growth in the second quarter? Or if not, can you give me the breakdown there?

Yes, Kevin, this is Ron. I can jump in on that one. So it varied a little bit by each of the 3 individual companies. If you look at Lawson's organic growth of 11%, about 2.5 points of that was volume and the rest being price, Gexpro services of the 8.5% organic growth kind of split 50-50, a little bit north of 4% on price and it's same on volume. And then on the test equity side, organic, we mentioned that they were down about 7%. About 2% of that was price and down the offset to that was lower volume. So all in, if you kind of take the weighted average between the 3 operating companies, kind of flattish, maybe up just slightly in volume and then with price being the remainder of that. So hopefully, that breakdown by company is more specific than maybe what you asked but hopefully, that answers your question.

Well, that's great. Yes. No, that's perfect. And I know you touched on that in some of the segment discussion as well. But okay, great. So I think you mentioned in your prepared comments that business activity has remained solid in July. Should we think about similar type volume trends on the organic side continue into July? And have we largely lapped the benefit of the price increases that you've been implementing?

Yes. I'll jump in on that one as well. So I would say that we'll start lapping some of the increases that we put in place more so in the second half of the year, in particular on the Lawson business, more of that -- of those changes took place in the second half of 2022. So we're -- I would say we're in the early stages of starting to lap some of those. And I think the pricing piece for test and Gexpro was probably a little bit more dynamic throughout 2022. So I think that's probably a little bit more consistent. But on the Lawson side, we're probably lapping some tougher numbers in the second half of the year. And as we think about just overall what we've seen so far here in the month of July, flattish to kind of where we were in the second quarter, flattish to down just a little bit. We continue to see a little bit of softening yet within some of the end markets. But again, it kind of varies a little bit by operating company as to where we're seeing that. And there's -- you end up with some kind of some strange dynamics based upon how the calendars fall. So that impacts our average daily sales, especially Gexpro services which has basically a 5-week July. Typically, we see a little bit of compression in the average daily sales number. So but kind of flattish as I think about where we're at today versus the reported numbers in Q2 on a consolidated basis.

Ron, I just -- I'd love to give him a little more detail on -- so the lapping, Lawson, Ron, why don't you give him more specifics on where we did on loss and we had specific spots where we did take pricing actions last year. And they weren't in July last year. So it was later in the year. So to specifically answer your question, July did have both as it related to loss and had both the benefit of some volumes and had some benefit of pricing. We're going to see -- I think it was September. Was it late August or September that we had a specific price action initiative in Lawson.

It was just.

So that way you've got specifically some support from us in terms of actually kind of where those skating spots were. We had a lot less ability last year to on the longer cycle pieces of Gexpro services to be able to take price action on those contracts until later. So to kind of give context around Gexpro services, we were -- it was later in the course of the year. And in some cases, it was really rolling through those contracts as they reset through the inflationary pressures that we had last year that we started to get the benefit of some pricing actions there. And then as we moved into this year, it became a little bit more dynamic on price action. So it was less of on a single day, a point of price action taken. I started to kind of become more dynamically blended into what we were seeing in those particular SKUs on the sourcing side. And so what it becomes less clean, if you will, to be able to kind of point to specific points in time as we move back into 2023. And so that's -- I'm hopeful that, that gives you some context. On the sales side, the softening that we saw on test equity, I think that the context there that I would offer is, first of all, we're really glad that we've bought Hisco because Hisco offers what longer term we want out of that business unit which is to have a lot more MRO and OEM kind of repeat activities as opposed to test equity itself, the legacy business that we've enjoyed for the last number of years did have 2/3 of its revenue of the legacy business was tied towards test and measurement equipment or bench sales and…

I'm just wondering how we should think about adjusted EBITDA margins. As we look to the second half and beyond, I think you mentioned, Ron, that 40 basis points sequentially of the margin versus the first quarter, the 40-basis point headwind just from inclusion of Hisco and he also talked about plans to improve Hisco margins. I mean we started to run in some tougher comps, I guess, in the second half year year-over-year. Should we think about just layering in Hisco being largely offset by organic margin expansion? Or how quickly can you start to improve the Hisco margins? Just any color on margin direction would be helpful.

Yes, I can start. Sure, Bryan. Yes, I'll start with that. So yes, you're -- Kevin, you're spot on the Hisco impact on the sequential margins from Q1 to Q2. And we did anticipate that when we announced the Hisco transaction, we knew that it would bring down the overall margin on a shorter-term basis. But clearly, our expectation is that when we work through the integration process which we were well underway as we sit today, that those margins will -- that they'll really come up to the margin profile of overall DSG. So the interesting part in the second quarter was they were only in for 3 weeks, right? So we have to think about bringing them in for the full quarter here in Q3 and Q4. So whether or not it's going to be entirely offset by margin expansion from the other entities is a bit of a tough question to answer without giving specific guidance here over the last 6 months of the year. What I would say is that we have very specific objectives around and action items around the integration of Hisco. We did comment on some of the cost actions that test equity has already taken around that to how that will help right away here starting in the third quarter. And Gexpro Services just continues to deliver. When we start thinking about even their end market cycling a bit, they have a great ability to be able to focus on those end markets where they can pick up growth. And we saw -- and we continue to see incremental margin expansion there on the organic basis as well as on the Lawson side. So -- it -- so hopefully, that helps without giving you -- without giving you a specific percentage that we're going after here in Q3 and Q4 but that might give you a little bit of context just in terms of some of the actions we're taking.

Yes, Ron, let me -- I'm going to dovetail onto that and just kind of as it relates to Hisco. There -- one thing I want to flag is that we've got an earn-out element to the Hisco transaction that's at the end of this quarter or if it is October, I guess, Ron, is that right?

Yes, October.

October. So there are elements to making sure that they are able to have clean numbers for that opportunity which include -- really was set around some real growth in profitability as well as their targets. And right now, we would expect that, that will be a tough reach for them to hit. But we -- and we've got a great relationship with that management team. So we want to make sure that we give them every opportunity to kind of get through October with their stewardship of kind of the margin profile there. So it's easier for us to take those actions that we took in the month of June looking forward to how the businesses are getting integrated on the test equity side itself. And so that's why when we call out the $4 million of actions that we took on the test equity side and we didn't call out actions that we've played that the management team of Hisco is has looked at as the 2 businesses come together, we wanted to make sure that we wanted them to have every opportunity and we would love for them to hit the earnout. There are gross margin initiatives that are across that total vertical now that we will see during the third and fourth quarter, some as it relates to the test equity side and more opportunity going forward as it relates to the Hisco side. There are -- when we think about longer-term structural margin opportunities for the whole business and when we speak about how Hisco allows the whole business to have a structurally higher margin, there's 2 real levers there. One is the fact that Hisco with test equity allows test equity and Hisco together to get to a higher structural margin than where test…

Your next question is coming from Ken Newman of KeyBanc Capital Markets.

So Ron, you gave some pretty good answers, very, very detailed answers here for a lot of my questions I was going to ask. So, maybe I'll just ask one here on [ph].

Ken, its 30 years of being asking the questions that you're asking. Yes, given that I've been on the other side of these calls for so many years, it's hard for me to resist, not trying to offer some color that I'll probably get in trouble with my team afterwards.

Well, for my question, we are hearing more this earnings season about customers revising orders as lead times are improving, especially in some of these electrical components that maybe you guys touch a bit with tax equity and Gexpro. Curious if you're seeing that today? And how do you view that impacting demand at all in coming quarters?

Ron, well, there's 2 ways to answer that question. One is to specifically talk about how lead times have influenced our own purchases and then also some of the actions that we took a year ago were 18 months ago -- or I guess, 15 months ago when we were concerned about lead times. And so over the last 2 years, we certainly increased the working capital intensity in our businesses across the business, across our verticals and we've got the benefit today of being able to take a more take a posture on our working capital investment that should allow us, specifically in opportunities that we've identified to lean up our working capital investment over the next 3 to 6 months, maybe 9 months to kind of get through it or so. So we -- that's where I called out free cash flow. We had good free cash flow conversion in this last quarter. I think that we'll have better at some point in time over the next 6 to 9 months. We've got initiatives to really go back and look at where we took some actions on inventory stocking levels because we were worried about strong inflationary pressure as well as lead times and freight costs. And there's a lot of money that we've tied up in working capital that we think we might be able to release over the next 6 to 9 months. That's one part of it. That also is it related to Gexpro services specifically had an impact. It's kind of the old game of telephone or the kind of where one person tells you and the story kind of gets amplified and it gets to the next person or maybe it's kind of fishing stories, if you will. But the challenge has been that our customers have re-laid with a lot of anxiety production levels that then got narrated back to and through purchasing. And now that there's less of a concern from their end, we're getting to the heart of exactly what their production levels are and it's allowing us to be more exacting in our -- because there's less anxiety on there and that we're going to not have adequate inventory to support their OEM needs. And specifically, the risk associated with a bunch of our customers of us paying out for -- out of stock on a small piece good that would slow down a major manufacturing line. There's just not that level of flexibility on our side and so we understand why they popped some of their forecasting to us.

And Bryan, clarify my question here. I'm more concerned about your -- of the demand that you're seeing, are customers pulling back on orders because it used to take, call it, 3 months for product widget and now it takes back to normal 3 weeks. And so they don't have to order out as far. Are you seeing that today?

Yes, that's been something that we've talked about over the last 6 months and I think I even alluded to it on the last call was whether or not we were going to see some destocking at our customer level that would have some influence on our own order levels that we were seeing. And I think that some of that's going, is absolutely taking place. If it was happening, we were seeing it happen some in the last quarter because we're not seeing right now an acceleration in it. But I had said this and I think certainly, I said it to some of the investors but I think I said it in the last quarter's earnings call that I been calling out for 3 to 6 months for our team to be anticipating that we were going to see some destocking at the customer level because they are concerns about lead times and availability were so peaked a year ago that they stocked deeper themselves. And so we're saying on the public side, we're seeing some of our customers look like they're working inventory levels down on working capital. And we think some of that's been playing out as a kind of a bit of a dampener on our own performance over the last 3 months or maybe even longer. But we aren't seeing a steepening of that yet this quarter because we didn't see any more of that happening, we don't think during the month of July. Any more is more than what we saw in the second quarter. But yes, we have had a lot of internal conversations about how much of that was taking place and so I think it's a very fair call out on your part. Ron is any more color on that? You may have some more specific areas where we're seeing it or where we might have seen it.

Yes. The only piece I would add to that, Bryan, is on the Lawson side, Ken, we're a short-cycle business. So it's a little difficult for our customers to build up. They really don't have to have a buildup of stock. And so we just -- I mean, we turned quickly with our customers. So probably a less impact of that on the Lawson side of the business. Generally, for Gexpro Services, long-term agreements that we have with customers on the Gexpro Services side. And so I agree with Bryan, there's certainly not any further pullback than probably what we just see as part of the normal process and Gexpro Services is so well connected to the production cycle that we probably saw a little bit of a bump probably last year. But again, it's not a huge movement, I would call it, dramatically impacting our results from quarter-to-quarter.

And Ron, I would even just kind of thinking about what I said and reflecting on it and hearing you say it sometimes so helpful. Gexpro Services has got those long-term contracts and we are required to hold that inventory. So if anything, that inventory has been on our balance sheet. And now what's happening is because they're pulling it as they need it. And so they aren't carrying any real buffer on their end, we're carrying the buffer on our end. And that's where I'm talking about us being able to work our own inventory levels down that we've been carrying for our customers as their anxiousness has kind of buffered a little bit. So that should actually translate back into cash for us. On test equity, there are some shelf-life elements there on some of the products that they order from us. And so we have not seen it specifically in our conversations on test equity be something that we've been concerned about. I continue to be concerned about it. It's a question I'm asking consistently but the answer I've gotten back on the test side has been that we are -- have not been seeing that. So those are those two. And then the short cycle side of Lawson, I think Ron answered very well. So I wouldn't offer any more color there.

We appear to have no further questions in the queue. I'm now going to hand back over to Bryan for any closing remarks.

Thank you. Appreciate it, operator. We appreciate everybody participating today and your support on what we're doing with test -- with -- across DSG. The businesses are coming together very nicely. As we alluded to earlier and I think it's important to process. We've got a lot of moving parts. We made some decisions that we wanted to invest in the business and we called out some of those investments during the second quarter and we're very pleased with how those are impacting where we think we're headed with the business from a structural margin and from a long-term value for the shareholders going forward. We look forward to talking in a lot more detail and having more of a forum discussion this -- at the end of September on our Investor Day and we would encourage any investors or any analysts that are interested in DSG to come to Foot Worth and participate with us in that day. Thank you very much and we appreciate your time. Have a good balance of the summer.

Thank you, everybody. This does conclude today's conference. You may disconnect your lines at this time and have a wonderful day. Thank you for your participation.