21
|
| | | | | | | | | | | | | | | |
| (Dollars in thousands) |
| Three Months Ended September 30, | | Nine Months Ended September 30, |
| 2017 | | 2016 | | 2017 | | 2016 |
Net sales | | | | | | | |
Actual | $ | 75,651 |
| | $ | 70,199 |
| | $ | 225,274 |
| | $ | 209,258 |
|
Pro forma | 75,651 |
| | 70,978 |
| | 225,274 |
| | 212,738 |
|
| | | | | | | |
Net income | | | | | | | |
Actual | $ | 1,321 |
| | $ | 1,825 |
| | $ | 9,451 |
| | $ | 3,014 |
|
Pro forma | 1,321 |
| | 2,048 |
| | 9,451 |
| | 3,662 |
|
Property, Plant and Equipment, net
The pro forma disclosuresComponents of property, plant and equipment were as follows:
| | | | | | | | | | | |
| |
(in thousands) | September 30, 2023 | | December 31, 2022 |
Land | $ | 16,753 | | | $ | 9,578 | |
Buildings and improvements | 50,009 | | | 27,199 | |
Machinery and equipment | 48,235 | | | 26,948 | |
Capitalized software | 9,140 | | | 7,889 | |
Furniture and fixtures | 10,707 | | | 6,346 | |
Vehicles | 1,703 | | | 1,713 | |
Construction in progress(1) | 3,804 | | | 3,140 | |
Total | 140,351 | | | 82,813 | |
Accumulated depreciation and amortization | (28,402) | | | (18,418) | |
Property, plant and equipment, net | $ | 111,949 | | | $ | 64,395 | |
(1)Construction in progress primarily related to upgrades to certain of the Company's information technology systems that we expect to place in service in the table above include adjustmentsnext 12 months.
Depreciation expense for amortizationproperty, plant and equipment was $3.5 million and $1.1 million for the third quarter of intangible assets2023 and acquisition costs to reflect results that are more representative of the combined results of the transactions as if the Mattic, F.B Feeney2022, respectively, and Perfect Product acquisitions closed on January 1, 2015 rather than on the actual acquisition dates. This pro forma information utilizes certain estimates, is presented for illustrative purposes only$9.5 million and is not intended to be indicative of the actual results of operation. In addition, future results may vary significantly from the results reflected in the pro forma information. The unaudited pro forma financial information does not reflect the impact of future positive or negative events that may occur after the acquisition, such as anticipated cost savings from operating synergies.
Goodwill activity$4.0 million for the first nine months of 20172023 and 2016 is2022, respectively. Amortization expense for capitalized software was $0.5 million and $0.0 million for the third quarter of 2023 and 2022, respectively, and $2.0 million and $1.0 million for the first nine months of 2023 and 2022, respectively.
Rental Equipment, net
Rental equipment, net consisted of the following:
| | | | | | | | | | | |
| |
(in thousands) | September 30, 2023 | | December 31, 2022 |
Rental equipment | $ | 63,310 | | | $ | 63,184 | |
Accumulated depreciation | (36,990) | | | (36,045) | |
Rental equipment, net | $ | 26,320 | | | $ | 27,139 | |
Depreciation expense included in cost of sales for rental equipment was $1.7 million and $2.3 million for the table below:third quarter of 2023 and 2022, respectively and $5.9 million and $5.4 million for the first nine months of 2023 and 2022, respectively. Refer to Note 4 – Revenue Recognitionfor a discussion on the Company's activities as lessor.
|
| | | | | | | |
| (Dollars in thousands) |
| Nine Months Ended September 30, |
| 2017 | | 2016 |
Beginning balance | $ | 5,520 |
| | $ | 319 |
|
Acquisition | (73 | ) | | 2,442 |
|
Impact of foreign exchange | 342 |
| | 12 |
|
Ending balance | $ | 5,789 |
| | $ | 2,773 |
|
Accrued Expenses and Other Current Liabilities
The reduction in acquisition activityAccrued expenses and other current liabilities consisted of $0.1 million in 2017 resulted from a non-cash adjustment to the estimated purchase price allocation to inventory originally recorded in 2016.following:
| | | | | | | | | | | |
(in thousands) | September 30, 2023 | | December 31, 2022 |
Accrued compensation | $ | 27,532 | | | $ | 24,094 | |
Deferred acquisition payments and accrued earnout liabilities | 16,461 | | | 1,383 | |
Accrued severance and acquisition related retention bonus | 12,648 | | | 927 | |
| | | |
Accrued and withheld taxes, other than income taxes | 8,758 | | | 4,885 | |
Accrued stock-based compensation | 5,055 | | | 3,340 | |
Accrued customer rebates | 4,710 | | | 5,053 | |
Accrued interest | 3,592 | | | 1,775 | |
Accrued health benefits | 1,743 | | | 1,306 | |
Deferred revenue | 1,136 | | | 2,313 | |
Accrued income taxes | 734 | | | 731 | |
Other | 14,822 | | | 16,870 | |
Total accrued expenses and other current liabilities | $ | 97,191 | | | $ | 62,677 | |
Other Liabilities
Other liabilities consisted of the following:
| | | | | | | | | | | |
(in thousands) | September 30, 2023 | | December 31, 2022 |
Security bonus plan | $ | 9,109 | | | $ | 9,651 | |
Deferred compensation | 10,854 | | | 9,962 | |
Other | 4,658 | | | 4,036 | |
Total other liabilities | $ | 24,621 | | | $ | 23,649 | |
Note 6 — Loan Agreement– Goodwill and Intangible Assets
In 2012,Goodwill
Changes in the Company entered into a Loancarrying amount of goodwill by segment were as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | |
(in thousands) | | Lawson | | TestEquity | | Gexpro Services | | All Other | | Total |
Balance at December 31, 2022 | | $ | 155,773 | | | $ | 114,104 | | | $ | 55,421 | | | $ | 22,750 | | | $ | 348,048 | |
Acquisitions(1) | | — | | | 49,941 | | | — | | | — | | | 49,941 | |
Impact of foreign exchange rates | | (11) | | | — | | | (174) | | | (42) | | | (227) | |
Balance at September 30, 2023 | | $ | 155,762 | | | $ | 164,045 | | | $ | 55,247 | | | $ | 22,708 | | | $ | 397,762 | |
| | | | | | | | | | |
(1)Refer to Note 3 – Business Acquisitions for information related to measurement period adjustments.
Intangible Assets
The gross carrying amount and Security Agreement (“Loan Agreement”). The Loan Agreementaccumulated amortization for definite-lived intangible assets were as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| |
| September 30, 2023 | | December 31, 2022 |
(in thousands) | Gross Carrying Amount | | Accumulated Amortization | | Net Carrying Value | | Gross Carrying Amount | | Accumulated Amortization | | Net Carrying Value |
Trade names | $ | 117,780 | | | $ | (26,498) | | | $ | 91,282 | | | $ | 92,286 | | | $ | (17,401) | | | $ | 74,885 | |
Customer relationships | 234,346 | | | (64,276) | | | 170,070 | | | 192,934 | | | (44,481) | | | 148,453 | |
Other (1) | 7,974 | | | (4,007) | | | 3,967 | | | 7,961 | | | (3,305) | | | 4,656 | |
Total | $ | 360,100 | | | $ | (94,781) | | | $ | 265,319 | | | $ | 293,181 | | | $ | (65,187) | | | $ | 227,994 | |
(1) Other primarily consists of a $40.0non-compete agreements.
Amortization expense for definite-lived intangible assets was $11.3 million revolving line of credit facility, which includes a $10.0and $29.9 million sub-facility for letters of credit. Certain termsthe three and nine months ended September 30, 2023, respectively, and $5.6 million and $20.9 million for the three and nine months ended September 30, 2022, respectively. Amortization expense related to intangible assets was recorded in Selling, general and administrative expenses.
The estimated aggregate amortization expense for the remaining year 2023 and each of the original Loan Agreement have been revisednext five years are as follows:
| | | | | | | | |
(in thousands) | | Amortization |
Remaining 2023 | | $ | 8,952 | |
2024 | | 42,856 | |
2025 | | 39,191 | |
2026 | | 36,217 | |
2027 | | 31,409 | |
2028 | | 27,537 | |
Thereafter | | 79,157 | |
Total | | $ | 265,319 | |
Note 7 – Leases
Activities as Lessee
The Company leases property used for warehousing, distribution centers, office space, branch locations, equipment and vehicles. The expenses generated by subsequent amendments.leasing activity for the three and nine months ended September 30, 2023 and 2022 were as follows (in thousands):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | |
| | | | Three Months Ended September 30, | | Nine Months Ended September 30, |
Lease Type | | Classification | | 2023 | | 2022 | | 2023 | | 2022 |
Operating Lease Expense (1) | | Operating expenses | | $ | 5,850 | | | $ | 4,519 | | | $ | 14,980 | | | $ | 10,581 | |
Financing Lease Amortization | | Operating expenses | | 133 | | | 207 | | | 393 | | | 471 | |
Financing Lease Interest | | Interest expense | | 23 | | | 37 | | | 65 | | | 68 | |
Financing Lease Expense | | | | 156 | | | 244 | | | 458 | | | 539 | |
Net Lease Cost | | | | $ | 6,006 | | | $ | 4,763 | | | $ | 15,438 | | | $ | 11,120 | |
Effective October 3, 2017, the Company entered into a Consent(1) Includes short term lease expense, which is immaterial.
The value of net assets and Ninth Amendment to Loan and Security Agreement that provides the creditor's consent, to the acquisition of all of the issued and outstanding shares of The Bolt Supply House Ltd. ("Bolt Supply House") (see Note 11 - Subsequent Events) and revised the Loan Facility to permit Bolt Supply House to continue its existing line of credit. Additionally, in October, the Company borrowed $16.3 million from its revolving line of credit facilityliabilities related to our operating and finance leases as of September 30, 2023 and December 31, 2022 was as follows (in thousands):
| | | | | | | | | | | | | | |
Lease Type | | September 30, 2023 | | December 31, 2022 |
Total ROU operating lease assets (1) | | $ | 79,791 | | | $ | 46,755 | |
Total ROU financing lease assets (2) | | 1,514 | | | 1,519 | |
Total lease assets | | $ | 81,305 | | | $ | 48,274 | |
| | | | |
Total current operating lease liabilities | | $ | 12,711 | | | $ | 9,480 | |
Total current financing lease liabilities | | 530 | | | 484 | |
Total current lease liabilities | | $ | 13,241 | | | $ | 9,964 | |
| | | | |
Total long term operating lease liabilities | | $ | 69,558 | | | $ | 38,898 | |
Total long term financing lease liabilities | | 795 | | | 930 | |
Total long term lease liabilities | | $ | 70,353 | | | $ | 39,828 | |
(1)Operating lease assets are recorded net of accumulated amortization of $23.2 million as of September 30, 2023 and $14.8 million as of December 31, 2022.
(2)Financing lease assets are recorded net of accumulated amortization as a component of Other assets in the Bolt Supply House acquisition.Unaudited Condensed Consolidated Balance Sheet of $1.3 million as of September 30, 2023 and $0.9 million as of December 31, 2022.
The Loan Agreement,value of lease liabilities related to our operating and finance leases as amended, expires in August 2020. Due to the lock box arrangement and a subjective acceleration clause contained in the Loan Agreement, any outstanding borrowings under the revolving line of credit are classifiedSeptember 30, 2023 was as a current liability.follows (in thousands):
| | | | | | | | | | | | | | | | | | | | |
Maturity Date of Lease Liabilities | | Operating Leases | | Financing Leases | | Total |
Remaining 2023 | | $ | 5,030 | | | $ | 165 | | | $ | 5,195 | |
2024 | | 18,477 | | | 558 | | | 19,035 | |
2025 | | 18,179 | | | 364 | | | 18,543 | |
2026 | | 14,406 | | | 282 | | | 14,688 | |
2027 | | 12,326 | | | 95 | | | 12,421 | |
Thereafter | | 40,120 | | | 5 | | | 40,125 | |
Total lease payments | | 108,538 | | | 1,469 | | | 110,007 | |
Less: Interest | | (26,269) | | | (144) | | | (26,413) | |
Present value of lease liabilities | | $ | 82,269 | | | $ | 1,325 | | | $ | 83,594 | |
Currently, credit available under the Loan Agreement, as amended, is based upon:
| |
a) | 85% of the face amount of the Company’s eligible accounts receivable, generally less than 60 days past due, and |
| |
b) | the lesser of 60% of the lower of cost or market value of the Company’s eligible inventory, generally inventory expected to be sold within 18 months, or $20.0 million. |
The applicableweighted average lease terms and interest rates for borrowings are at the Prime rate or, if the Company elects, the LIBOR rate plus 1.50% to 1.85% based on the Company’s debt to EBITDA ratio. The Loan Agreement is secured by a first priority perfected security interest in substantially all existing assets of the Company. Dividends are restricted to amounts not to exceed $7.0 million annually.
Atleases held as of September 30, 2017, the Company had no borrowings under its revolving line2023 were as follows:
| | | | | | | | | | | | | | |
Lease Type | | Weighted Average Term in Years | | Weighted Average Interest Rate |
Operating Leases | | 6.8 | | 7.8% |
Financing Leases | | 2.8 | | 6.9% |
The cash outflows of credit facility and additional borrowing availability of $36.0 million. The Company paid interest of $0.4 million and $0.5 millionleasing activity for the nine months ended September 30, 20172023 and 2016, respectively.2022 were as follows (in thousands):
| | | | | | | | | | | | | | | | | | | | |
| | | | Nine Months Ended September 30, |
Cash Flow Source | | Classification | | 2023 | | 2022 |
Operating cash flows from operating leases | | Operating activities | | $ | (9,083) | | | $ | (3,330) | |
Operating cash flows from financing leases | | Operating activities | | (186) | | | 37 | |
Financing cash flows from financing leases | | Financing activities | | (358) | | | (457) | |
Refer to Note 4 – Revenue Recognition for a discussion on the Company's activities as lessor.
Note 8 – Earnout Liabilities
Combination with TestEquity and Gexpro Services
On the Merger Date, the Company recorded an earnout derivative liability for the two earnout provisions within the Merger Agreements. The weighted averageCompany estimated the initial fair value of the earnout derivative liability based on an aggregate of 2,324,000 additional shares available to be issued under the two earnout provisions of the Merger Agreements. The aggregate of 2,324,000 shares was comprised of 1,400,000 shares of DSG common stock that were contingently issuable to (or forfeitable by) the TestEquity Equityholder and 924,000 shares of DSG common stock that were contingently issuable to (or forfeitable by) the Gexpro Services Stockholder, in each case as of the Merger Date. The additional 1,076,000 shares that were potentially issuable as of the Merger Date under the earnouts were not recorded as an earnout derivative liability as the acquisition contingency for these shares was determined to have been met at the Merger Date.
The Company's earnout derivative liability was classified as a Level 3 instrument and was measured at fair value on a recurring basis. The fair value of the earnout derivative liability was measured using the Monte Carlo simulation valuation model using a distribution of potential outcomes on a monthly basis for the year ended December 31, 2022. Inputs to that model included the expected time to liquidity, the risk-free interest rate over the term, expected volatility based on representative peer companies and the estimated fair value of the underlying class of common stock. The significant unobservable inputs used in the fair value measurement of the earnout derivative liability were the fair value of the underlying stock at the valuation date and the estimated term of the earnout arrangement periods. Generally, increases (decreases) in the fair value of the underlying stock and estimated term would result in a directionally similar impact to the fair value measurement.
The estimated aggregate fair value of the earnout derivative liability recorded on the April 1, 2022 Merger Date was 3.91%$43.9 million, with an offsetting entry to additional paid-in capital. As of April 29, 2022 and December 31, 2022, 1,400,000 and 924,000 of the 2,324,000 shares, respectively, were reclassified to equity, as the contingencies had been determined to have been met. There was no remaining earnout derivative liability at December 31, 2022. Immediately prior to the reclassifications, the respective shares were remeasured to fair value. For the year ended December 31, 2022, the Company recorded income of $0.3 million as a component of Change in fair value of earnout liabilities in the Unaudited Consolidated Statements of Operations and Comprehensive Income (Loss) due to changes in the fair value of the earnout derivative liability.
On March 20, 2023, all of the 3.4 million shares of DSG common stock available to be issued under the earnout provisions within the Merger Agreements were issued in accordance with the two earnout provisions within the Merger Agreements.
As the remaining additional shares had been reclassified to equity as of December 31, 2022, there was no change in fair value for the first nine months of 2023. For the three and nine months ended September 30, 2022, the Company recorded income of $10.3 million and $4.6 million, respectively, as a component of Change in fair value of earnout liabilities in the Unaudited Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) due to changes in the fair value of the earn-out derivative liability.
Hisco Acquisition
The Hisco Transaction includes a potential earn-out payment of up to $12.6 million, subject to Hisco achieving certain performance targets. The earn-out payment is calculated based on the gross profit of Hisco and its affiliates for the twelve months ending October 31, 2023, subject to certain adjustments and exclusions set forth in the Purchase Agreement. The fair value of the contingent consideration arrangement was classified as a Level 3 instrument and was determined using a probability-based scenario analysis approach. As of June 8, 2023 (the Hisco Transaction date) and September 30, 2023, the fair value of the earn-out was $6.0 million and $0.1 million, respectively, with amounts recorded in Accrued expenses and other current liabilities in the Unaudited Condensed Consolidated Balance Sheet.
Prior to the Hisco Transaction by DSG, Hisco had a preexisting contingent consideration arrangement from an acquisition Hisco made during 2022. DSG assumed this liability with a potential earn-out payment of up to $3.8 million, subject to the achievement of certain EBITDA performance targets for the twelve months ending December 27, 2023, subject to certain adjustments and exclusions set forth in the Purchase Agreement. The fair value of the contingent consideration arrangement was classified as a Level 3 instrument and was determined using a probability-based scenario analysis approach. As of June 8, 2023 (the Hisco acquisition date) and September 30, 2023, the fair value of the earn-out was $1.5 million and $1.5 million, respectively, with amounts recorded in Accrued expenses and other current liabilities in the Unaudited Condensed Consolidated Balance Sheet. There was no change in the fair value of the earn-out liability for the nine months ended September 30, 20172023.
Frontier Acquisition
The consideration for the Frontier acquisition includes a potential earn-out payment of up to $3.0 million based upon the achievement of certain milestones and 3.50%relative thresholds during the earn out measurement period which ends on December 31, 2024, with payments made annually beginning in 2023 and ending in 2025. During the first quarter of 2023, a $1.0 million earn-out payment was made based on the achievement of certain milestones in 2022. The fair value of the contingent consideration arrangement was classified as a Level 3 instrument and was determined using a probability-based scenario analysis approach. As of March 31, 2022 (the Frontier acquisition date), December 31, 2022 and September 30, 2023, the fair value of the earn-out was $0.9 million, $1.7 million and $0.0 million, respectively, with amounts recorded in Accrued expenses and other current liabilities and Other liabilities in the Unaudited Condensed Consolidated Balance Sheet. The Company recorded income of $0.7 million for changes in the fair value of the earn-out liability for the nine months ended September 30, 2016.2023 as a component of Change in fair value of earnout liabilities in the Unaudited Condensed Consolidated Statements of Operations and Comprehensive Income (Loss).
| | | | | | | | | | | | |
| | |
(in thousands) | September 30, 2023 | | December 31, 2022 | |
Senior secured revolving credit facility | $ | — | | | $ | 122,000 | | |
Senior secured term loan | 234,375 | | | 243,750 | | |
Senior secured delayed draw term loan | 48,125 | | | 50,000 | | |
Incremental term loan | 305,000 | | | — | | |
Other revolving line of credit | 2,085 | | | 1,352 | | |
| | | | |
| | | | |
Total debt | 589,585 | | | 417,102 | | |
Less current portion of long-term debt | (32,335) | | | (16,352) | | |
Less deferred financing costs | (6,724) | | | (4,925) | | |
Total long-term debt | $ | 550,526 | | | $ | 395,825 | | |
In addition
Amended and Restated Credit Agreement
On April 1, 2022, DSG and certain of its subsidiaries entered into an Amended and Restated Credit Agreement by and among DSG, certain subsidiaries of DSG as borrowers or guarantors, the lenders party thereto and JPMorgan Chase Bank, N.A., as administrative agent. Pursuant to the Amended and Restated Credit Agreement, the Company's previous credit agreement was amended and restated in its entirety.
On June 8, 2023, the Company and certain of its subsidiaries entered into the First Amendment to Amended and Restated Credit Agreement (the “First Amendment”), which amended the Amended and Restated Credit Agreement, dated as of April 1, 2022 (as amended by the First Amendment, the “2023 Credit Agreement”). The First Amendment provides for a $305 million incremental term loan.
The 2023 Credit Agreement provides for (i) a $200 million senior secured revolving credit facility, with a $25 million letter of credit sub-facility and a $10 million swingline loan sub-facility, (ii) a $250 million senior secured initial term loan facility, (iii) a $305 million incremental term loan, (iv) a $50 million senior secured delayed draw term loan facility and (v) the Company to increase the commitments thereunder from time to time by up to $200 million in the aggregate, subject to, among other customary representations, warrantiesthings, the receipt of additional commitments from existing and/or new lenders and pro forma compliance with the financial covenants in the 2023 Credit Agreement.
On June 8, 2023, in connection with the Hisco Transaction, the Company borrowed the $305 million under the incremental term loan. These borrowings were used, among other things, to partially fund the Hisco Transaction, to repay certain existing indebtedness of Hisco, HISCO Acquisition Subsidiary I, Inc. and HISCOCAN Inc. and their respective subsidiaries and to pay fees and expenses incurred in connection with the Hisco Transaction and the First Amendment. Refer to Note 3 – Business Acquisitions for further details about the Hisco Transaction.
Each of the loans under the 2023 Credit Agreement mature on April 1, 2027. The Company is required to meetrepay principal of approximately $7.6 million each quarter.
Net of outstanding letters of credit, there was $198.3 million of borrowing availability under the revolving credit facility as of September 30, 2023. The weighted average interest rate from January 1, 2023 through September 30, 2023 was 7.4%.
The loans under the 2023 Credit Agreement bear interest, at the Company’s option, at a minimum trailing twelve month EBITDArate equal to fixed charges ratio,(i) the Alternate Base Rate or the Canadian Prime Rate (each as defined in the amended Loan2023 Credit Agreement), plus, in each case, an additional margin ranging from 0.0% to 1.75% per annum, depending on the total net leverage ratio of the Company and its restricted subsidiaries as of the most recent determination date under the 2023 Credit Agreement ifor (ii) the excess borrowing capacity is below $10.0 million. Adjusted Term SOFR Rate or the CDOR Rate (each as defined in the 2023 Credit Agreement), plus, in each case, an additional margin ranging from 1.0% to 2.75% per annum, depending on the total net leverage ratio of the Company and its restricted subsidiaries as of the most recent determination date under the 2023 Credit Agreement.
On April 1, 2022, deferred financing costs of $4.0 million were incurred in connection with the original Amended and Restated Credit Agreement, and on June 8, 2023, deferred financing costs of $3.4 million were incurred in connection with the First Amendment. Deferred financing costs are amortized over the life of the debt instrument and reported as interest expense. As of September 30, 2017,2023, total deferred financing costs net of accumulated amortization were $9.2 million of which $6.7 million are included in Long-term debt, less current portion, net (related to the senior secured term loan, senior secured delayed draw term loan and incremental term loan) and $2.5 million are included in Other assets (related to the senior secured revolving credit facility) in the Unaudited Condensed Consolidated Balance Sheet.
The 2023 Credit Agreement contains various covenants, including financial maintenance covenants requiring the Company to maintain compliance with a consolidated minimum interest coverage ratio and a maximum total net leverage ratio, each determined in accordance with the terms of the 2023 Credit Agreement. The Company was in compliance with all financial covenants set forth in the 2023 Credit Agreement as of September 30, 2023.
Note 10 – Stock-Based Compensation
The Company recorded stock-based compensation expense of $1.0 million and $5.4 million for the three and nine months ended September 30, 2023, respectively, and a benefit of $3.6 million and expense of $0.4 million for the three and nine months ended September 30, 2022, respectively. A portion of the Company's borrowing capacity exceeded $10.0 million. Therefore,stock-based awards are liability-classified. Accordingly, changes in the market value of DSG common stock may result in stock-based compensation expense or benefit in certain periods. A stock-based compensation liability of $5.1 million as of September 30, 2023 and $3.3 million as of December 31, 2022 was included in Accrued expenses and other current liabilities in the Unaudited Condensed Consolidated Balance Sheet.
Impact of Stock Split
The equity compensation plans contain anti-dilution provisions whereby in the event of any change in the capitalization of the Company was(including in the event of a stock split), the number and type of awards underlying outstanding stock-based compensation awards must be adjusted, as appropriate, in order to prevent dilution or enhancement of rights. The impact of these provisions resulted in a modification of all outstanding stock-based compensation awards upon the Stock Split. As the fair value of the awards immediately after the Stock Split did not subjectchange when compared to this financial covenant, however, for informational purposes the fair value of such awards immediately prior to the Stock Split, no incremental compensation costs were recognized as a result of such modifications. In addition, there was no change to the financial covenantvesting conditions or classification of each of the outstanding stock-based compensation awards.
Restricted Stock Awards
For the nine months ended September 30, 2023, the Company issued approximately 53,000 Restricted stock awards ("RSAs") that vest over five years from the grant date with a grant date fair value of $1.2 million. Upon vesting, the vested RSAs are exchanged for an equal number of shares of DSG common stock. The participants have no voting or dividend rights with the RSAs. The RSAs are valued at the closing price of shares of DSG common stock on the date of grant and the expense is provided below:recorded ratably over the vesting period.
Stock Options
For the nine months ended September 30, 2023, the Company issued approximately 1,354,000 stock options to key employees that vest over five years from the grant date. The fair value was determined using a Black-Scholes valuation model with a grant date fair value of $9.6 million.Each stock option can be exchanged for one share of DSG common stock at the stated exercise price. Upon vesting, stock options are recognized as a component of equity. Unrecognized compensation related
to stock options as of September 30, 2023 was $10.0 million, which is expected to be recognized over a weighted-average period of 2.3 years.
Activity related to the Company’s stock options during 2023 was as follows:
| | | | | | | | | | | |
| Number of Stock Options | | Weighted Average Exercise Price |
Outstanding on December 31, 2022 | 576,000 | | | $ | 38.80 | |
| | | |
Granted | 1,353,706 | | | 37.05 | |
| | | |
| | | |
Outstanding on September 30, 2023 | 1,929,706 | | | 37.50 | |
| | | |
Exercisable on September 30, 2023 | 180,800 | | | 29.74 | |
The weighted average fair value assumptions used in the Black-Scholes model for the stock options issued during 2023 were as follows:
|
| | | | |
Quarterly Financial CovenantExpected volatility | | Requirement | | Actual45.2% to 45.5% |
EBITDARisk-free rate of return | 3.6% to fixed charges ratio4.5% |
Expected term (in years) | 6.2 years to 6.5 years |
Expected annual dividend | 1.10 : 1.00 | | 3.20 : 1.00$0 |
The expected volatility was based on the historic volatility of the Company's stock price commensurate with the expected life of the stock options. The risk-free rate of return reflects the interest rate offered for zero coupon treasury bonds over the expected life of the stock options. The expected life represents the period of time that options granted are expected to be outstanding and was calculated using the simplified method allowed by the SEC, which approximates our historical experience. The estimated annual dividend was based on the recent dividend payout trend.
Note 11 – Stockholders' Equity
Stock Split
On August 15, 2023, DSG announced that its Board of Directors approved and declared the Stock Split which entitled each stockholder of record as of the close of business on August 25, 2023 to receive one additional share of DSG common stock for each share of DSG common stock then-held. The additional shares were distributed after the close of trading on August 31, 2023, and shares of DSG common stock began trading at the split-adjusted basis on September 1, 2023. Accordingly, all share and per share amounts presented herein have been retroactively adjusted to reflect the impact of the Stock Split. Stockholders’ equity has been retroactively adjusted, where applicable, to give effect to the Stock Split for all periods presented by reclassifying the par value of the additional shares issued in connection with the Stock Split to Common stock from Capital in excess of par value.
Rights Offering
On May 9, 2023, the Company commenced a Rights Offering to raise gross proceeds of up to approximately $100 million. The Rights Offering provided one transferable subscription right for each share of DSG common stock held by holders of DSG common stock on record as of the close of business on May 1, 2023. Each subscription right entitled the holder to purchase 0.0525 shares of DSG common stock at a subscription price of $22.50 per share. The subscription rights were transferable, but were not listed for trading on any stock exchange or market. In addition, holders of subscription rights who fully exercised their subscription rights were entitled to oversubscribe for additional shares of DSG common stock, subject to proration.
The Rights Offering closed on May 30, 2023 and was fully subscribed (taking into account the exercise of over-subscription rights) and raised approximately $100 million and resulted in the issuance of 4,444,444 shares of DSG common stock, at a purchase price of $22.50 per share. The Company incurred transaction costs related to the issuance of DSG common stock for the Rights Offering of $1.5 million, which were recorded against Capital in excess of par value in the Unaudited Condensed Consolidated Balance Sheet.
DSG used the proceeds from the Rights Offering, in combination with borrowings under the 2023 Credit Agreement, to fund the Hisco Transaction.
Stock Repurchase Program
Under an existing stock repurchase program authorized by the Board of Directors, the Company may repurchase its common stock from time to time in open market transactions, privately negotiated transactions or by other methods. No shares were repurchased during the three and nine months endedSeptember 30, 2023 under the Company's stock repurchase plan. During the third quarter of 2022, the Company repurchased 108,178 shares of Company common stock under the repurchase plan at an average cost of $17.93 per share for a total cost of $1.9 million. The remaining availability for stock repurchases under the program was $7.6 million at September 30, 2023.
Note 7 — Severance Reserve12 – Earnings Per Share
ChangesAs a result of the Stock Split and Mergers discussed in Note 1 – Nature of Operations and Basis of Presentation, all historical per share data, number of shares and numbers of equity awards were retroactively adjusted. The following table provides the Company’s reserve for severance ascomputation of September 30, 2017basic and 2016 were as follows:diluted earnings per share:
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended September 30, | | Nine Months Ended September 30, |
(in thousands, except share and per share data) | 2023 | | 2022 | | 2023 | | 2022 |
| | | | | | | |
Basic income per share: | | | | | | | |
Net income (loss) | $ | (1,568) | | | $ | 16,541 | | | $ | 7,363 | | | $ | 9,289 | |
Basic weighted average shares outstanding | 46,737,443 | | | 38,879,992 | | | 44,216,541 | | | 34,287,628 | |
Basic income (loss) per share of common stock | $ | (0.03) | | | $ | 0.43 | | | $ | 0.17 | | | $ | 0.27 | |
| | | | | | | |
Diluted income per share: | | | | | | | |
Net income (loss) | $ | (1,568) | | | $ | 16,541 | | | $ | 7,363 | | | $ | 9,289 | |
Basic weighted average shares outstanding | 46,737,443 | | | 38,879,992 | | | 44,216,541 | | | 34,287,628 | |
Effect of dilutive securities | — | | | 426,716 | | | 380,878 | | | 626,506 | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
Diluted weighted average shares outstanding | 46,737,443 | | | 39,306,708 | | | 44,597,419 | | | 34,914,134 | |
Diluted income (loss) per share of common stock | $ | (0.03) | | | $ | 0.42 | | | $ | 0.17 | | | $ | 0.27 | |
Anti-dilutive securities excluded from the calculation of diluted income per share | 448,910 | | | 493,914 | | | — | | | 496,000 | |
|
| | | | | | | |
| (Dollars in thousands) |
| Nine Months Ended September 30, |
| 2017 | | 2016 |
Balance at beginning of period | $ | 1,710 |
| | $ | 697 |
|
Charged to earnings | 595 |
| | 714 |
|
Payments | (1,625 | ) | | (950 | ) |
Balance at end of period | $ | 680 |
| | $ | 461 |
|
The remaining severance liabilities outstanding as of September 30, 2017 will be substantially paid by the end of 2017.
Note 8 — Stock-Based Compensation13 – Income Taxes
The Company recorded stock-based compensationincome tax expense of $2.7$1.0 million and, a benefit of $1.3 million(171.3)% effective tax rate for the first nine months of 2017 and 2016, respectively. A portion of stock-based compensation is related to the change in the market value of the Company's common stock.
A summary of stock-based awards activity during the ninethree months ended September 30, 2017 follows:2023. Income tax expense of $8.5 million, a 33.9% effective tax rate was recorded for the three months ended September 30, 2022. The effective tax rate for the three months ended September 30, 2023 was higher than the U.S. statutory rate primarily due to adjustments to uncertain tax positions, a book loss for the current quarter, and other permanent items. The effective tax rate for the three months ended September 30, 2022 was higher than the U.S. statutory rate primarily due to state taxes, transaction costs, and other permanent items.
Stock Performance Rights ("SPRs")
SPRs entitle the recipient to receiveThe Company recorded income tax expense of $3.6 million, a cash payment equal to the excess of the market value of the Company's common stock over the SPR exercise price when the SPRs are surrendered. A liability of $9.0 million, reflecting the estimated fair value of future pay-outs is included as a component of Accrued expenses in the condensed consolidated balance sheets. Activity related to the Company’s SPRs33.1% effective tax rate for the nine months ended September 30, 20172023. Income tax expense of $3.9 million, a 29.6% effective tax rate was as follows:
|
| | | | | | |
| Number of SPRs | | Weighted Average Exercise Price |
Outstanding on December 31, 2016 | 946,701 |
| | $ | 19.60 |
|
Granted | 78,948 |
| | 25.12 |
|
Exercised | (34,095 | ) | | 12.99 |
|
Cancelled | (30,000 | ) | | 36.71 |
|
Outstanding on September 30, 2017 | 961,554 |
| | 19.76 |
|
Restricted Stock Awards ("RSAs")
Each RSA is exchangeable for one share of the Company's common stock at the end of the vesting period. Activity related to the Company’s RSAs for the nine months ended September 30, 2017 was as follows:
|
| | |
| Restricted Stock Awards |
Outstanding on December 31, 2016 | 31,897 |
|
Granted | 83,920 |
|
Exchanged for shares | (31,897 | ) |
Outstanding on September 30, 2017 | 83,920 |
|
Market Stock Units ("MSUs")
MSU's are exchangeable for the Company's common stock at the end of the vesting period. The number of shares of common stock that will be issued upon vesting, ranging from zero to 150% of the underlying MSU, will be determined based upon the trailing sixty-day weighted average closing price of the Company's common stock upon vesting. Activity related to the Company’s MSUs for the nine months ended September 30, 2017 was as follows:
|
| | | | | |
| Number of Market Stock Units | | Maximum Shares Potentially Issuable |
Outstanding on December 31, 2016 | 149,532 |
| | 224,298 |
|
Granted | 98,243 |
| | 147,065 |
|
Outstanding on September 30, 2017 | 247,775 |
| | 371,363 |
|
Note 9 — Income Taxes
At each reporting date, Lawson’s management considers new evidence, both positive and negative, that could impact management’s view with regard to the realization of its deferred tax assets and the reversal of the corresponding valuation allowances. Although the Company has generated pre-tax profits over the past three quarters and has begun to utilize a small portion of its net operating loss carryforwards over the past two years, management feels that additional positive evidence is necessary in order to conclude that it is more likely than not that it will be able to realize its deferred tax assets. We believe that there is a reasonable possibility that within the next twelve months, sufficient evidence may become available to allow us to reach a conclusion that a significant portion of the valuation allowance will no longer be needed. As of September 30, 2017, substantially all deferred tax assets remain subject to a tax valuation allowance.
If the Company continues to demonstrate that it can consistently generate income in future quarters, it may lead to a determination that there is sufficient positive evidence to conclude that it is more likely than not that the company will be able to utilize its deferred tax assets to offset future taxable income. This would lead to the reduction of all or a portion of the valuation allowance resulting in an income tax benefit for the period in which the reduction is recorded. The Company will continue to closely monitor all positive and negative evidence and will re-assess its position on a quarterly basis.
Although the Company is in this full tax valuation allowance position, income tax expenses of $0.8 million and $0.5 million were recorded for the nine months ended September 30, 2017 and 2016, respectively,2022. The effective tax rate for the nine months ended September 30, 2023 was higher than the U.S. statutory rate primarily due to reservesstate taxes, foreign operations, and other permanent items, offset by the release of a reserve for an uncertain tax positions, federal alternative minimumbenefit. The effective tax rate for the nine months ended September 30, 2022 was higher than the U.S. statutory rate primarily due to state taxes, transaction costs, and state taxes.other permanent items.
In 2017, the company increased its deferred tax assets and related valuation allowance by $7.2 million that may arise from future settlement of uncertain tax positions in Canada. There was no impact to the Company's consolidated statements of income and comprehensive income, balance sheets or statements of cash flows, as the company had valuation allowances equal to the value of the deferred tax assets.
The Company and its subsidiaries are subject to U.S. Federalfederal income tax, as well as income tax of multiple state and foreign jurisdictions. As of September 30, 2017,2023, the Company is subject to U.S. Federalfederal income tax examinations for the years 20142019 through 20162021 and income tax examinations from various other jurisdictions for the years 20112016 through 2016.2022.
Earnings from the Company’s foreign subsidiarysubsidiaries are considered to be indefinitely reinvested. A distribution of these non-U.S. earnings in the form of dividends or otherwise wouldmay subject the Company to bothforeign withholding taxes and U.S. Federalfederal and state income taxes, as adjusted for foreign tax credits.
taxes.
Note 14 – Commitments and Contingencies
Merger Litigation
In February 2022, three purported DSG stockholders made demands pursuant to Section 220 of the Delaware General Corporation Law to inspect certain books and records of DSG (collectively, the “Books and Records Demands”). One stated purpose of the Books and Records Demands was to investigate questions of director disinterestedness and independence and the alleged possibility of wrongdoing, mismanagement and/or material non-disclosure related to the Special Committee’s and the DSG Board of Directors’ approval of the Mergers. On March 16, 2022, one of the purported DSG stockholders who previously made a Books and Records Demand filed a lawsuit entitled Robert Garfield v. Lawson Products, Inc., Case No. 2022-0252, in the Court of Chancery of the State of Delaware against DSG (the “Garfield Action”). On March 22, 2022, another of the purported DSG stockholders who previously made a Books and Records Demand filed a lawsuit entitled Jeffrey Edelman v. Lawson Products, Inc., Case No. 2022-0270, in the Court of Chancery of the State of Delaware against DSG (the “Edelman Action”). The Garfield Action and the Edelman Action, which were consolidated and re-captioned as Lawson Products, Inc. Section 220 Litigation, Case No. 2022-0270, are collectively referred to as the “Books and Records Actions.” The Books and Records Actions sought to compel inspection of certain books and records of DSG to investigate questions of director disinterestedness and independence and the alleged possibility of wrongdoing, mismanagement and/or material non-disclosure related to the Special Committee’s and the DSG Board of Directors’ approval of the Mergers. Following briefing, the Delaware Court of Chancery held a trial on July 14, 2022 to adjudicate the Books and Records Actions. At the conclusion of the trial, the Court ruled orally that the stockholders’ demands would be granted only in one respect (production of documents sufficient to show the identities of any guarantors of debt of the acquired companies) and the Court denied the remainder of the stockholders’ requests. The Court’s ruling was memorialized in an order issued on July 20, 2022. Thereafter, DSG produced excerpts of certain documents as required by the Court's ruling and subsequent order.
On October 3, 2022, the plaintiffs in the Books and Records Actions filed a shareholder derivative action (the “Derivative Action”) entitled Jeffrey Edelman and Robert Garfield v. John Bryan King et al., Case No. 2022-0886, in the Court of Chancery of the State of Delaware (the "Delaware Chancery Court"). The Derivative Action names as defendants J. Bryan King, Lee S. Hillman, Bianca A. Rhodes, Mark F. Moon, Andrew B. Albert, I. Steven Edelson and Ronald J. Knutson (collectively, “Director and Officer Defendants”), and LKCM Headwater Investments II, L.P., LKCM Headwater II Sidecar Partnership, L.P., Headwater Lawson Investors, LLC, PDLP Lawson, LLC, LKCM Investment Partnership, L.P., LKCM Micro-Cap Partnership, L.P., LKCM Core Discipline, L.P. and Luther King Capital Management Corporation (collectively, the “LKCM Defendants”). Purporting to act on behalf of DSG, in the Derivative Action the plaintiffs allege, among other things, various claims of alleged breach of fiduciary duty against the Director and Officer Defendants and the LKCM Defendants in connection with the Mergers. The Derivative Action seeks, among other things, money damages, equitable relief and the costs of the Derivative Action, including reasonable attorneys’, accountants’ and experts’ fees. On October 24, 2022, the plaintiffs voluntarily dismissed PDLP Lawson, LLC and LKCM Investment Partnership, L.P. from the Derivative Action without prejudice.
The Delaware Chancery Court held a hearing on September 13, 2023, to hear arguments on the defendants’ motions to dismiss. At the conclusion of the hearing, in rulings issued on September 13, 2023, and September 19, 2023, the entire complaint was dismissed with prejudice for failure to state a claim. On October 16, 2023, the plaintiffs filed a notice of appeal from the dismissal of their claims with respect to all defendants other than the members of the Special Committee (Messrs. Hillman, Albert and Edelson) and Mr. Moon. The Delaware Supreme Court has not set a date for the hearing on the plaintiffs’ appeal of the ruling.
DSG disagrees with and intends to vigorously defend against the Derivative Action. The Derivative Action could result in additional costs to DSG, including costs associated with the indemnification of directors and officers. At this time, DSG is unable to predict the ultimate outcome of the Derivative Action or, if the outcome is adverse, to reasonably estimate an amount or range of reasonably possible loss, if any, associated with the Derivative Action. Accordingly, no amounts have been recorded in the unaudited condensed consolidated financial statements for these matters. No assurance can be given that additional lawsuits will not be filed against DSG and/or its directors and officers and/or other persons or entities in connection with the Mergers.
Cyber Incident Litigation
On February 10, — Contingent Liabilities2022, DSG disclosed that its computer network was the subject of a cyber incident potentially involving unauthorized access to certain confidential information (the “Cyber Incident”). On April 4, 2023, a putative class action lawsuit (the “Cyber Incident Suit”) was filed against DSG entitled Lardone Davis, on behalf of himself and all others similarly situated,
v. Lawson Products, Inc., Case No. 1:23-cv-02118, in the United States District Court for the Northern District of Illinois, Eastern Division. The plaintiff in this case, who purports to represent the class of individuals harmed by alleged actions and/or omissions by DSG in connection with the Cyber Incident, asserts a variety of common law and statutory claims seeking monetary damages, injunctive relief and other related relief related to the potential unauthorized access by third parties to personal identifiable information and protected health information.
DSG disagrees with and intends to vigorously defend against the Cyber Incident Suit. The Cyber Incident Suit could result in additional costs and losses to DSG, although, at this time, DSG is unable to reasonably estimate the amount or range of reasonably possible loss, if any, that might result from adverse judgments, settlements, fines, penalties or other resolution of these proceedings based on the early stage of this proceeding, the absence of specific allegations as to alleged damages, the uncertainty as to the certification of a class or classes and the size of any certified class, if applicable, and the lack of resolution of significant factual and legal issues. Accordingly, no amounts have been recorded in the unaudited condensed consolidated financial statements for the Cyber Incident Suit. No assurance can be given that additional lawsuits will not be filed against DSG and/or its directors and officers and/or other persons or entities in connection with the Cyber Incident.
Environmental Matter
In 2012, the Company identifiedit was determined that a Company owned site it owns in Decatur, Alabama, containscontained hazardous substances in the soil and groundwater as a result of historical operations prior to the Company's ownership. The Company retained an environmental consulting firm to further investigate the contamination, including the measurementprepare a remediation plan, and monitoring of the site. In August 2013,enroll the site was enrolled in Alabama'sthe Alabama Department of Environmental Management (“ADEM”) voluntary cleanup program. On October 30, 2014, the Company received estimates from its environmental consulting firm for three potential
A remediation solutions.plan was approved by ADEM in 2018. The estimates included a range of viable remedial approaches. The first solution included limited excavation and removal of the contaminated soil along with an extensive monitoring period. The second solution included the first solution plus the installation of a groundwater extraction system. The third scenario included the first and second solutions plus treatment injections to reduce the degradation time. The estimated expenditures over the life of the three scenarios ranged from $0.3 million to $1.4 million. As the Company had determined that a loss was probable and no scenario was more likely than the other at that time, a liability in the amount of $0.3 million was established in 2014.
During 2015, after further evidence had been collected and analyzed, the Company concluded that it was probable that future remediation would be required, and accordingly accrued an additional $0.9 million for the estimated costs.
In the third quarter of 2017 the Company received estimates from its environmental consulting firm for two new remediation solutions based on a chemical injection process. The first solution would consistplan consists of chemical injections throughout the entire site to directly eliminateaffected area, as well as subsequent monitoring of the hazardous substancesarea. The injection process was completed in the soilfirst quarter of 2019 and groundwater.the environmental consulting firm is monitoring the affected area. At September 30, 2023 the Company had approximately $0.1 million accrued for potential monitoring costs included in Accrued expenses and other current liabilities in the Unaudited Condensed Consolidated Balance Sheet. The second solution would consist of chemical injections around the perimeter of the site to prevent the migration of the hazardous chemicals off-site. Neither solution would require additional excavation or repairs to be made to the property. Additionally, the estimated requiredcosts for future monitoring period would be substantially reduced. The estimated expenditures over an 18 month period under the two injection scenarios ranged from $0.9 million to $2.0 million.are not significant and have been fully accrued. The Company does not expect to capitalize any amounts related to thesethe remediation options.plan.
Purchase commitments
The Company has determined that it will initially proceedenters into inventory purchase commitments with third parties in the methodordinary course of injecting chemicals around the perimeter of the site to prevent the migration of the hazardous chemicals off-site. Asbusiness, and as of September 30, 2017,2023, had contractual commitments to purchase approximately $1.0$200 million remains accrued for this remediationof products from our suppliers and contractors, which is expected to be paid in other long-term liabilities on the accompanying consolidated balance sheet. This estimate was based on the information provided to date and as the remediation efforts proceed, additional information may impact the final cost. As of September 30, 2017, agreement with Alabama’s voluntary cleanup program on viable treatment of the property has not yet been reached and the Company continues to evaluate potential remediation alternatives that could impact the ultimate cost of remediation.next twelve months.
Note 11 - Subsequent Events15 – Related Party Transactions
On October 3, 2017, Lawson Products completedManagement Services Agreements
Prior to the purchase of The Bolt Supply House Ltd. ("Bolt Supply House"), an industrial parts distributor located in Western Canada for approximately $32.1 million which was paid using a combination of cash on hand and borrowings of $16.3 million from the Company's existing revolving credit facility. The Bolt Supply House operates thirteen strategically located branches across Alberta, Manitoba and Saskatchewan, Canada. The Bolt Supply House will continue to operate separately under its own brand asMergers, a subsidiary of Lawson's Canadian operating company.TestEquity was party to a management agreement with Luther King Capital Management Corporation (“LKCM”) for certain advisory and consulting services (the “TestEquity Management Agreement”), and a subsidiary of Gexpro Services was party to a management agreement with LKCM for certain advisory and consulting services (the “Gexpro Services Management Agreement”). In connection with the closing of the Mergers on April 1, 2022, (i) all of the TestEquity subsidiary’s rights, liabilities and obligations under the TestEquity Management Agreement were novated to, transferred to and assumed by the TestEquity Equityholder, and LKCM released the TestEquity subsidiary from all obligations and claims under the TestEquity Management Agreement, and (ii) all of the Gexpro Services subsidiary’s rights, liabilities and obligations under the Gexpro Services Management Agreement were novated to, transferred to and assumed by the Gexpro Services Stockholder, and LKCM released the Gexpro Services subsidiary from all obligations and claims under the Gexpro Services Management Agreement (collectively, the “Novations”). During the first three months of 2022, expense of $0.5 million was recorded within Selling, general and administrative expenses within the Unaudited Condensed Consolidated Statements of Income and Comprehensive Income (Loss), reflecting expenses accrued under these management agreements from January 1, 2022 through the April 1, 2022 Merger Date. As of April 1, 2022, the prior obligation of $5.3 million was effectively settled and considered to be a deemed equity contribution by LKCM recorded to additional paid in capital. As a result of the Novations, no additional expense under these management agreements has been incurred subsequent to the Mergers.
Consulting Services
Subsequent to the Mergers, individuals employed by LKCM Headwater Operations, LLC, a related party of LKCM, have provided the Company with certain consulting services in order to identify cost savings, revenue enhancements and operational synergies of the combined companies. For the nine months ended September 30, 2023, expense of $0.4 million was recorded within Selling, general and administrative expenses within the Unaudited Condensed Consolidated Statements of Income and Comprehensive Income (Loss), reflecting expenses accrued for these consulting services.
TestEquity and Gexpro Services Mergers
Immediately prior to the Mergers, entities affiliated with LKCM and J. Bryan King (President and Chief Executive Officer of DSG and Chairman of the DSG Board of Directors), including private investment partnerships for which LKCM serves as investment manager, owned a majority of the ownership interests in the TestEquity Equityholder (which in turn owned all of the outstanding equity interests of TestEquity as of immediately prior to the completion of the TestEquity Merger). As of the Merger Date, Mr. King was a director of the TestEquity Equityholder. In addition, as of the Merger Date, Mark F. Moon (a member of the DSG Board of Directors) was a director of, and held a direct or indirect equity interest in, the TestEquity Equityholder.
Immediately prior to the Mergers, entities affiliated with LKCM and Mr. King, including private investment partnerships for which LKCM serves as investment manager, owned a majority of the ownership interests in the Gexpro Services Stockholder (which in turn owned all of the then outstanding stock of Gexpro Services).
Immediately prior to the Mergers, entities affiliated with LKCM and Mr. King beneficially owned approximately 48% of the then-outstanding shares of DSG common stock. As a result of the issuance of 20.6 million shares at the closing of the Mergers and the issuance of the additional 3.4 million shares in accordance with the earnout provisions of the TestEquity Merger Agreement and the Gexpro Services Merger Agreement on March 20, 2023, entities affiliated with LKCM and Mr. King beneficially owned in the aggregate approximately 32.6 million shares of DSG common stock representing approximately 77.4% of the outstanding shares of DSG common stock as of March 31, 2023.
Rights Offering
Certain entities affiliated with LKCM and J. Bryan King exercised their basic subscription rights and over-subscription rights in the Rights Offering and purchased approximately 3.6 million additional shares of DSG common stock at a purchase price of $22.50 per share. Following the completion of the Rights Offering on May 30, 2023, entities affiliated with LKCM and Mr. King beneficially owned in the aggregate approximately 36.4 million shares of DSG common stock as of June 1, 2023, representing approximately 77.6% of the outstanding shares of DSG common stock as of September 30, 2023.
Board of Directors
M. Bradley Wallace, who became a director of the Company upon his election at the Company's 2023 annual stockholders meeting on May 19, 2023, is a Founding Partner of LKCM Headwater Investments, the private capital investment group of LKCM.
Note 16 – Segment Information
Based on operational, reporting and management structures, the Company has identified three reportable segments based on the nature of the products and services and type of customer for those products and services. A description of our reportable segments is as follows:
Lawson is a distributor of specialty products and services to the industrial, commercial, institutional and government maintenance, repair and operations market.
TestEquity is a distributor of test and measurement equipment and solutions, industrial and electronic production supplies, vendor managed inventory programs, converting, fabrication and adhesive solutions from its leading manufacturer partners supporting the technology, aerospace, defense, automotive, electronics, education, automotive and medical industries.
Gexpro Services is a global supply chain solutions provider, specializing in developing and implementing vendor managed inventory and kitting programs to high-specification manufacturing customers.
The Company also has an “All Other” category which includes unallocated DSG holding company costs that are not directly attributable to the ongoing operating activities of our reportable segments and includes the results of the Bolt Supply House ("Bolt") non-reportable segment. Revenue within the All Other category represents the results of Bolt. Bolt generates revenue primarily from the sale of MRO products to its walk-up customers and service to its customers through its 14 branch locations. Bolt does not provide VMI services for its customers or provide services in addition to product sales to customers. Revenue is recognized at the time that control of the product has been transferred to the customer which is either upon delivery or shipment depending on the terms of the contract.
Financial information for the Company's reportable segments is presented below. Asset information by operating segment is not presented below since the chief operating decision maker does not review this information by segment.
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended September 30, | | Nine Months Ended September 30, |
(in thousands) | 2023 | | 2022 | | 2023 | | 2022 |
Revenue | | | | | | | |
Lawson(1) | $ | 114,477 | | | $ | 109,418 | | | $ | 358,903 | | | $ | 216,752 | |
TestEquity | 207,657 | | | 116,709 | | | 451,082 | | | 286,984 | |
Gexpro Services | 103,232 | | | 103,749 | | | 312,523 | | | 285,224 | |
All Other(2) | 13,543 | | | 17,275 | | | 42,655 | | | 33,612 | |
Total revenue | $ | 438,909 | | | $ | 347,151 | | | $ | 1,165,163 | | | $ | 822,572 | |
| | | | | | | |
Operating income (loss) | | | | | | | |
Lawson(1) | $ | 10,643 | | | $ | 5,352 | | | $ | 27,358 | | | $ | 2,792 | |
TestEquity | (5,027) | | | 7,576 | | | (8,183) | | | 7,443 | |
Gexpro Services | 7,332 | | | 7,992 | | | 23,484 | | | 16,972 | |
All Other(2) | (165) | | | 1,107 | | | 621 | | | 1,921 | |
Total operating income (loss) | $ | 12,783 | | | $ | 22,027 | | | $ | 43,280 | | | $ | 29,128 | |
(1)Includes the operating results of Lawson only subsequent to the Merger Date of April 1, 2022 and not Lawson operating results prior to the Mergers.
(2) Includes the operating results of All Other only subsequent to the Merger Date of April 1, 2022 and not All Other operating results prior to the Mergers.
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of financial condition and results of operations should be read in conjunction with the unaudited condensed consolidated financial statements and related notes included in this Quarterly Report on Form 10-Q, the audited consolidated financial statements, accompanying notes and other information included in our Annual Report on Form 10-K filed for the year ended December 31, 2022 and the Lawson Products, Inc. unaudited condensed consolidated financial statements and accompanying notes included in our Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2022.
References to “DSG”, the “Company”, "we", "our" or "us" refer to Distribution Solutions Group, Inc. and all entities consolidated in the accompanying unaudited condensed consolidated financial statements.
Overview
The Maintenance, RepairOrganization and OperationsStructure
Distribution Solutions Group, Inc. ("DSG"), is a multi-platform specialty distribution company providing high touch, value-added distribution solutions to the maintenance, repair and operations ("MRO"), the original equipment manufacturer ("OEM") and the industrial technologies markets. The Mergers that were consummated on April 1, 2022 resulted in the combination of Lawson, TestEquity and Gexpro Services. For a description of the Mergers, see Note 1 – Nature of Operations and Basis of Presentation within Item 1. Financial Statements.
We manage and report our operating results through three reportable segments: Lawson, TestEquity and Gexpro Services. A summary of our segments is presented below. For additional details about our segments, see Note 16 – Segment Information within Item 1. Financial Statements.
Lawson is a distributor of specialty products and services to the industrial, commercial, institutional and government MRO market.
TestEquity is a distributor of test and measurement equipment and solutions, industrial and electronic production supplies, vendor managed inventory programs, converting, fabrication and adhesive solutions from its leading manufacturer partners supporting the technology, aerospace, defense, automotive, electronics, education, automotive and medical industries.
Gexpro Services is a global supply chain solutions provider, specializing in developing and implementing vendor managed inventory ("VMI") and kitting programs to high-specification manufacturing customers.
In addition to these three reportable segments, we have an “All Other” category which includes unallocated DSG holding company costs that are not directly attributable to the ongoing operating activities of our reportable segments and the results of a non-reportable segment.
Recent Events
HIS Company, Inc. Acquisition
On June 8, 2023, DSG acquired all of the issued and outstanding capital stock of Hisco, a distributor of specialty products serving industrial technology applications, pursuant to the Purchase Agreement dated March 30, 2023. The total purchase consideration exchanged for the Hisco Transaction was $268.5 million, net of cash acquired of $12.2 million, with a potential additional earn-out payment subject to Hisco achieving certain performance targets. DSG will also pay $37.5 million in cash or DSG common stock in retention bonuses to certain Hisco employees that remain employed with Hisco or its affiliates for at least twelve months after the closing of the Hisco Transaction.
In connection with the Hisco Transaction, DSG combined the operations of TestEquity and Hisco, creating one of the largest suppliers serving the electronics design, production, and repair industries. Accordingly, Hisco results are included in the TestEquity reportable segment after the date of acquisition.
DSG funded the Hisco Transaction with borrowings under its 2023 Credit Agreement and proceeds raised from the Rights Offering, both discussed below. Refer to Note 3 – Business Acquisitions for further details about the Hisco Transaction.
Debt Amendment
On June 8, 2023, the Company entered into the First Amendment to Amended and Restated Credit Agreement (the “First Amendment”), which amended the Amended and Restated Credit Agreement, dated as of April 1, 2022 (as amended by the First Amendment, the “2023 Credit Agreement”), by and among the Company, certain subsidiaries of the Company as borrowers or guarantors, the lenders party thereto and JPMorgan Chase Bank, N.A., as administrative agent. The First Amendment provides for a $305 million incremental term loan. Refer to Note 9 – Debt for additional information about the 2023 Credit Agreement.
Rights Offering
On May 30, 2023, the Company raised approximately $100 million pursuant to a Rights Offering of transferable subscription rights to holders of DSG common stock as of the close of business on May 1, 2023. Refer to Note 11 – Stockholders' Equity for additional information about the Rights Offering.
DSG Vision and Strategic Focus
The complementary distribution operations of Lawson, TestEquity and Gexpro Services were combined in 2022 for the purpose of creating a global specialty distribution company enabling each of Lawson, TestEquity and Gexpro Services to maintain their respective high-touch, value-added service delivery models and customer relationships in their specialty distribution businesses under the leadership of their separate business unit management teams. The DSG leadership team provides oversight to these separate leadership teams. This structure helps the combined company to leverage best practices, back-office resources and technologies across the three operating companies to help drive cost synergies and efficiencies. The combined company has the ability to utilize its combined financial resources to accelerate a strategy of expansion through both business acquisitions and organic growth.
Organic Growth Strategy
We intend to grow our businesses organically by exploring growth opportunities that provide different channels to reach customers, increase revenue and generate positive results. We plan to utilize our Company structure to grow organic revenue through collaborative selling across our customer bases and expanding the digital capabilities across our platform.
Acquisition Strategy
In addition to organic growth, we plan to actively pursue acquisition opportunities complementary to our businesses and that we believe will be financially accretive to our organization.
Sales Drivers
DSG believes that the Purchasing Managers Index ("PMI") published by the Institute for Supply Management is an indicative measure of the relative strength of the economic environment of the industry in which it operates. The PMI is a composite index of economic activity in the U.S. manufacturing sector. A measure of the PMI index above 50 is generally viewed as indicating an expansion of the manufacturing sector while a measure below 50 is generally viewed as representing a contraction. The average monthly PMI was 47.2 in the nine months ended September 30, 2023 compared to 54.9 in the nine months ended September 30, 2022.
Lawson Sales Drivers
The North American MRO market is highly fragmented. We competeLawson competes for business with several national distributors as well as a large number of regional and local distributors. The MRO business is significantly impacted by the overall strength of the manufacturing sector of the U.S. economy. One measure used to evaluate the strength of the industrial products market
Lawson's revenue is the PMI index published by the Institute for Supply Management, which is considered by many economists to be a reliable near-term economic barometer of the manufacturing sector. A measure above 50 generally indicates expansion of the manufacturing sector while a measure below 50 generally represents contraction. The average monthly PMI was 58.6 in the third quarter of 2017 compared to 51.2 in the third quarter of 2016, indicating a strong U.S. manufacturing economy.
Our sales are also affectedinfluenced by the number of sales representatives and their productivity. Our sales force consisted of an average of 991Lawson plans to continue concentrating its efforts on increasing the productivity and 1,007 sales representatives during the third quarters of 2017 and 2016, respectively. Our sales rep productivity, measured as sales per rep per day, increased to $1,212 in the third quarter of 2017 from $1,089 in the third quarter of 2016. We anticipate moderate growth in the size of ourits sales force forteam. Additionally, Lawson drives revenue through the remainderexpansion of 2017products sold to existing customers as we concentrate our efforts on providing trainingwell as attracting new customers and supportadditional ship-to locations. Lawson also is expanding its inside sales team to continuehelp drive field sales representative productivity and also utilizes an e-commerce site to increasegenerate sales.
TestEquity Sales Drivers
Across the productivitytest and measurement, industrial and electronic production supplies businesses, the North American market is highly fragmented with competitors ranging from large global distributors to national and regional distributors.
Specifically in respect of our existing sales representatives.
In orderits electronic production supplies business, the current semi-conductor chip shortage is negatively impacting TestEquity’s business as such chips are key elements to utilize excess capacitythe electronic production process. TestEquity anticipates that recovery of our existingthis important part of its customers’ supply chain network, we completed a sale of our discontinued Fairfield distribution centerwill occur in the first nine monthshalf of 2017, resulting2024.
Through the Hisco Transaction, TestEquity expanded its product offerings, including adhesives, chemicals and tapes as well as specialty materials such as electrostatic discharge, thermal management materials and static shielding bags. Hisco operates in 38 locations across North America, including its Precision Converting facilities that provide value-added fabrication and its Adhesive Materials Group that provides an array of custom repackaging solutions. Hisco also offers vendor-managed inventory and RFID programs with specialized warehousing for chemical management, logistics services and cold storage.
Gexpro Services Sales Drivers
The global supply chain solutions market is highly fragmented across Gexpro Services' key vertical segments. Gexpro Services’ competitors range from large global distributors and manufacturers to small regional domestic distributors and manufacturers. Gexpro Services' revenue is influenced by our OEMs’ production schedules, new product introduction launches, and service project needs.
Gexpro Services drives revenue through increasing wallet share with existing customers, customer-led geographic expansion, and new customer development in its six key vertical markets. Additionally, Gexpro Services drives revenue through expansion of its installation and aftermarket services by leveraging its portfolio of recent acquisitions.
Supply Chain Disruptions
We continue to be affected by rising supplier costs caused by inflation and increased transportation and labor costs. We have instituted various price increases during 2022 and 2023 in response to rising supplier costs, as well as increased transportation and labor costs in order to manage our gross profit margins.
Cyber Incident Litigation
On February 10, 2022, DSG disclosed that Lawson Products' computer network was the subject of a gaincyber incident potentially involving unauthorized access to certain confidential information (the “Cyber Incident”). DSG engaged a cybersecurity forensics firm to assist in the investigation of $5.4 million.the incident and to assist in securing its computer network.
In October 2017Because of the nature of the information that may have been compromised, DSG was required to notify the parties whose information was potentially compromised of the incident as well as various governmental agencies and has taken other actions, such as offering credit monitoring services. At September 30, 2023, DSG had not incurred material costs as a result of the Cyber Incident and, at this time, is unable to estimate the total cost of any remediation that may be required. On April 4, 2023, a putative class action lawsuit (the “Cyber Incident Suit”) was filed against DSG. For more information about the Cyber Incident Suit, refer to Note 14 – Commitments and Contingencies within Item 1. Financial Statements.
Critical Accounting Policies and Use of Estimates
The unaudited condensed consolidated financial statements were prepared in accordance with GAAP. A discussion of our critical accounting policies and estimates is contained within Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations in DSG's Annual Report on Form 10-K for the year ended December 31, 2022. There have been no significant changes to our previously disclosed critical accounting policies and use of estimates. The following provides information on the accounts requiring more significant estimates.
Inventory Reserves - Inventories principally consist of finished products stated at the lower of cost or net realizable value using the first-in-first-out method for the Lawson segment and primarily the weighted average method for the TestEquity and Gexpro Services segments. Most of our products are not exposed to the risk of obsolescence due to technology changes. However, some of our products do have a limited shelf life, and from time to time we add and remove items from our catalogs, brochures or website for marketing and other purposes.
To reduce the cost basis of inventory to a lower of cost or net realizable value, a reserve is recorded for slow-moving and obsolete inventory based on historical experience and monitoring of current inventory activity. Estimates are used to determine the necessity of recording these reserves based on periodic detailed analysis using both qualitative and quantitative factors. As part of this analysis, the Company considers several factors including the inventories length of time on hand, historical sales, product shelf life, product life cycle, product category and product obsolescence. In general, depending on the product category, we reserve inventory with low turnover at higher rates than inventory with higher turnover.
At September 30, 2023, our inventory reserve was $15.9 million, equal to approximately 4.8% of our gross inventory. A hypothetical change of one hundred basis points to our reserve as a percentage of total inventory would have affected our cost of goods sold by $3.2 million.
Income Taxes - Deferred tax assets or liabilities reflect temporary differences between amounts of assets and liabilities for financial and tax reporting. Such amounts are adjusted, as appropriate, to reflect changes in enacted tax rates expected to be in effect when the temporary differences reverse. Significant judgment is required in determining income tax provisions as well as deferred tax asset and liability balances, including the estimation of valuation allowances and the evaluation of uncertain tax positions.
Goodwill Impairment - Goodwill represents the cost of business acquisitions in excess of the fair value of identifiable net tangible and intangible assets acquired. The Company reviews goodwill for potential impairment annually on October 1st, or when an event or other circumstances change that would more likely than not reduce the fair value of the asset below its carrying value.
The first step in the multi-step process to determine if goodwill has been impaired and to what degree is to review the relevant qualitative factors that could cause the fair value of the reporting unit to decrease below the carrying value of the reporting unit. The Company considers factors such as macroeconomic, industry and market conditions, cost factors, overall financial performance and other relevant factors that would affect the individual reporting units. If the Company determines that it is more likely than not that the fair value of the reporting unit is greater than the carrying value of the reporting unit, then no further impairment testing is needed. If the Company determines that it is more likely than not that the carrying value of the reporting unit is greater than the fair value of the reporting unit, the Company will move to the next step in the process. The Company will estimate the fair value of the reporting unit and compare it to the reporting unit's carrying value. If the carrying value of the reporting unit exceeds its fair value, the Company will record an impairment of goodwill equal to the amount the carrying value of the reporting unit exceeds its fair value, up to the total amount of goodwill previously recognized.
Business Combinations - We allocate the purchase price paid for assets acquired The Bolt Supply House Ltd (See Note 11 - Subsequent Events) which will affect Lawson's operatingand liabilities assumed in connection with our acquisitions based on their estimated fair values at the time of acquisition. This allocation involves a number of assumptions, estimates, and judgments in determining the fair value, as of the acquisition date, of the following:
•intangible assets, including the valuation methodology (the relief of royalty method for trade names and multi-period excess earnings method for customer relationships), estimations of future cash flows, discount rates, royalty rates, recurring revenue attributed to customer relationships, and our assumed market segment share, as well as the estimated useful life of intangible assets;
•deferred tax assets and liabilities, uncertain tax positions, and tax-related valuation allowances;
•inventory;
•property, plant and equipment;
•pre-existing liabilities or legal claims;
•contingent consideration, including estimating the likelihood and timing of achieving the relevant thresholds; and
•goodwill as measured as the excess of consideration transferred over the net of the acquisition date fair values of the assets acquired and the liabilities assumed.
Our assumptions and estimates are based upon comparable market data and information obtained from our management and the management of the acquired companies. We allocate goodwill to the reporting units of the business that are expected to benefit from the business combination.
Factors Affecting Comparability to Prior Periods
Our results beginning withof operations for the fourth quarter of 2017.
Quarternine months ended September 30, 2017 compared2023 are not directly comparable to quarterprior results for the nine months ended September 30, 20162022 due to the Mergers that were completed on April 1, 2022. The Mergers were accounted for as a reverse merger under the acquisition method of accounting in accordance with the accounting guidance for reverse acquisitions as provided in Accounting Standards Codification 805, Business Combinations ("ASC 805"). Under this guidance, TestEquity and Gexpro Services were treated as a combined entity as the accounting acquirer for financial reporting purposes,
38
|
| | | | | | | | | | | | | |
| 2017 | | 2016 |
($ in thousands) | Amount | | % of Net Sales | | Amount | | % of Net Sales |
| | | | | | | |
Net sales | $ | 75,651 |
| | 100.0 | % | | $ | 70,199 |
| | 100.0 | % |
Cost of goods sold | 29,646 |
| | 39.2 | % | | 27,626 |
| | 39.4 | % |
Gross profit | 46,005 |
| | 60.8 | % | | 42,573 |
| | 60.6 | % |
| | | | | | | |
Operating expenses: | | | | | | | |
Selling expenses | 24,354 |
| | 32.2 | % | | 23,568 |
| | 33.6 | % |
General and administrative expenses | 20,561 |
| | 27.2 | % | | 16,616 |
| | 23.6 | % |
Operating expenses | 44,915 |
| | 59.4 | % | | 40,184 |
| | 57.2 | % |
| | | | | | | |
Operating income | 1,090 |
| | 1.4 | % | | 2,389 |
| | 3.4 | % |
| | | | | | | |
Interest expense | (133 | ) | | (0.1 | )% | | (167 | ) | | (0.2 | )% |
Other income, net | 843 |
| | 1.1 | % | | 66 |
| | 0.1 | % |
| | | | | | | |
Income before income taxes | 1,800 |
| | 2.4 | % | | 2,288 |
| | 3.3 | % |
| | | | | | | |
Income tax expense | 479 |
| | 0.7 | % | | 463 |
| | 0.7 | % |
| | | | | | | |
Net income | $ | 1,321 |
| | 1.7 | % | | $ | 1,825 |
| | 2.6 | % |
Net Sales
Net sales increased 7.8%and DSG was identified as the accounting acquiree. This determination was primarily made as TestEquity and Gexpro Services were under the common control of an entity that owned a majority of the voting rights of the combined entity, and therefore, only DSG experienced a change in control. Accordingly, the unaudited condensed consolidated financial statements for the nine months ended September 30, 2022reflect the results of operations of TestEquity and Gexpro Services on a consolidated basis, and the results of operations of DSG's legacy Lawson business are only included subsequent to $75.7 millionthe April 1, 2022 Merger Date. The combined operations of all three entities are included in the third quarter of 2017 compared to $70.2 million inunaudited condensed consolidated financial statements for the third quarter of 2016 with one less selling day. Average daily sales improved 9.5% to $1.201 million in the third quarter of 2017 compared to $1.097 million in the prior year quarter. The third quarters of 2017three and 2016 had 63 and 64 selling days, respectively. Sales were positively impacted by increased productivity of sales representativesnine months ended September 30, 2023 and the effectthree months ended September 30, 2022.
Non-GAAP Financial Measures
The Company's management believes that certain non-GAAP financial measures may provide users of acquisitions completedthis financial information with additional meaningful comparisons between current results and results in 2016, augmented byprior operating periods. Management believes that these non-GAAP financial measures can provide additional meaningful reflection of underlying trends of the business because they provide a comparison of historical information that excludes certain infrequently occurring, seasonal or non-operational items that impact the overall improvementcomparability. These non-GAAP financial measures should be viewed in addition to, and not as an alternative for, the MRO marketplace.Company's reported results prepared in accordance with GAAP.
Non-GAAP Adjusted EBITDA
Management believes Adjusted EBITDA is an important measure of the Company's operating performance. We experienced strong growth in our large nationaldefine Adjusted EBITDA as operating income plus depreciation and regional accounts. Average daily salesamortization, stock-based compensation, severance and acquisition related retention costs, costs related to the execution and integration of the Mergers and other acquisitions, inventory net realizable value adjustments, amortization of fair value step-up resulting from the 2016Mergers and other acquisitions, grew 1.0%.and other non-recurring items. The following table provides our calculation of Adjusted EBITDA for the three and nine months ended September 30, 2023 and 2022:
Gross ProfitReconciliation of Operating Income to Non-GAAP Adjusted EBITDA (Unaudited)
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended September 30, | | Nine Months Ended September 30, |
(in thousands) | 2023 | | 2022(7) | | 2023 | | 2022(7) |
Operating income (loss) | $ | 12,783 | | | $ | 22,027 | | | $ | 43,280 | | | $ | 29,128 | |
Depreciation and amortization | 17,010 | | | 8,979 | | | 47,316 | | | 31,314 | |
| | | | | | | |
| | | | | | | |
Stock-based compensation(1) | 1,049 | | | (3,568) | | | 5,441 | | | 445 | |
Severance and acquisition related retention expenses(2) | 10,478 | | | 944 | | | 13,266 | | | 2,353 | |
Merger and acquisition related costs(3) | (94) | | | 2,402 | | | 9,063 | | | 10,809 | |
Inventory net realizable value adjustment(4) | — | | | 1,737 | | | — | | | 1,737 | |
Inventory step-up(5) | 2,150 | | | 1,082 | | | 2,866 | | | 2,867 | |
| | | | | | | |
Other non-recurring(6) | 327 | | | 1,097 | | | 1,924 | | | 1,202 | |
Adjusted EBITDA | $ | 43,703 | | | $ | 34,700 | | | $ | 123,156 | | | $ | 79,855 | |
Gross profit increased to $46.0 million in the third quarter of 2017 compared to $42.6 million in the third quarter of 2016,(1) Expense (benefit) primarily due to higher sales, and increased slightly as a percent of sales to 60.8% from 60.6% a year ago. The increase in gross profit margin from a year ago was primarily driven by volume related vendor concessions and lower bins and cabinets provided to our customers which were partially offset by higher sales to larger national customers, who typically generate lower product margins.
Selling Expenses
Selling expenses consist of compensation and support for our sales representatives. Selling expenses increased to $24.4 million in the third quarter of 2017 from $23.6 million in the prior year quarter due primarily to an increase in compensation costs resulting from higher sales, partially offset by lower health insurance expenses. Selling expenses as a percent of sales decreased to 32.2% from 33.6% in the third quarter of 2016, as fixed selling expenses were leveraged over a higher sales base.
General and Administrative Expenses
General and administrative expenses consist of expenses to operate our distribution network and overhead expenses to manage the business. General and administrative expenses increased to $20.6 million in the third quarter of 2017 from $16.6 million in the prior year quarter primarily due to $3.0 million of additional stock-based compensation, of which a portion varies with the companyCompany’s stock priceprice.
(2) Includes severance expense from actions taken in 2023 and restoring incentive compensation accruals based on improved operating results.2022 not related to a formal restructuring plan and acquisition related retention expenses for the Hisco Transaction.
Interest Expense
Interest expense decreased slightly due to lower average borrowings outstanding.
Other Income, Net
Other income, net increased $0.8 million over the prior year quarter, due primarily(3) Transaction and integration costs related to the effectMergers and other acquisitions.
(4) Inventory net realizable value adjustment recorded to reduce inventory related to discontinued products where the anticipated net realizable value was lower than the cost reflected in our records.
(5) Inventory fair value step-up adjustment for Lawson resulting from the reverse merger acquisition accounting and acquisition accounting for additional acquisitions completed by Gexpro Services or TestEquity.
(6) Other non-recurring costs consist of changesnon-capitalized deferred financing costs incurred in conjunction with the exchange rate on Canadian transactions.2023 Credit Agreement, certain non-recurring strategic projects and other non-recurring items.
Income Tax Expense
Primarily due to historical cumulative losses, substantially all(7) Includes the operating results of our deferred tax assets are subject to a tax valuation allowance. Although we are in a full tax valuation allowance position, an income tax expense of $0.5 million and $0.5 million were recorded in the third quarters of 2017 and 2016, respectively, primarily due to reserves for uncertain tax positions, federal alternative minimum taxes and state taxes.
If the Company continues to demonstrate that it can consistently generate income, we may be able to make a determination that there is a sufficient amount of positive evidence to conclude that it is more likely thanLawson subsequent, but not that we will be able to utilize our deferred tax assets to offset future taxable income. This would leadprior, to the reduction of all or a portion of the valuation allowance resultingApril 1, 2022 Merger Date in an income tax benefitaccordance with GAAP accounting guidance for the period in which the reduction is recorded. We will continue to closely monitor all positive and negative evidence and will re-assess our position on a quarterly basis.reverse acquisitions.
Management uses operating income and Adjusted EBITDA to evaluate the performance of its reportable segments. See Note 16 – Segment Information within Item 1. Financial Statements for additional information about our reportable segments. The following table provides Adjusted EBITDA by reportable segment:
Nine months | | | | | | | | | | | | | | | | | | | | | | | |
| | | |
| Three Months Ended September 30, | | Nine Months Ended September 30, |
(in thousands) | 2023 | | 2022 | | 2023 | | 2022 |
Adjusted EBITDA | | | | | | | |
Lawson(1) | $ | 16,721 | | | $ | 9,670 | | | $ | 51,241 | | | $ | 19,077 | |
TestEquity | 14,298 | | | 10,122 | | | 31,450 | | | 24,260 | |
Gexpro Services | 11,552 | | | 12,485 | | | 36,368 | | | 32,409 | |
All Other(2) | 1,132 | | | 2,423 | | | 4,097 | | | 4,109 | |
Consolidated Adjusted EBITDA | $ | 43,703 | | | $ | 34,700 | | | $ | 123,156 | | | $ | 79,855 | |
(1)Includes the operating results of Lawson subsequent, but not prior, to the April 1, 2022 Merger Date in accordance with GAAP accounting guidance for reverse acquisitions.
(2) Includes the operating results of All Other subsequent, but not prior, to the April 1, 2022 Merger Date in accordance with GAAP accounting guidance for reverse acquisitions.
Supplemental Information - Lawson Non-GAAP Adjusted Operating Income and Non-GAAP Adjusted EBITDA
For management to discuss Lawson's operating results on a comparable basis, Lawson's historical, pre-merger components of operating income have been provided separately in the table below. In addition, Lawson's GAAP results of operations were adjusted to include the results prior to the April 1, 2022 Merger Date in order to reflect the total operating activities attributable to Lawson for each period presented. Management believes this historical information provides the most meaningful basis of comparison for Lawson's operations, is more useful in identifying current business trends, and is important for the user of our financial statements in understanding Lawson's business. Refer to Note 1 – Nature of Operations and Basis of Presentation and Note 3 – Business Acquisitions within Item 1. Financial Statements for information about the Mergers.
These non-GAAP amounts are not considered to be prepared in accordance with GAAP, have not been prepared as pro forma results under applicable regulations, may not reflect the actual results we would have achieved had the Mergers occurred at the beginning of 2022, and should not be viewed as a substitute for the results of operations presented in accordance with GAAP. Lawson's historical operating results prior to the Mergers were obtained from the unaudited condensed consolidated financial statements included in DSG's Quarterly Report on Form 10-Q filed for the quarterly period ended September 30, 2017 comparedMarch 31, 2022.
Lawson Non-GAAP Adjusted Results - Calculation of Supplemental Information (Unaudited)
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
(in thousands) | Nine Months Ended September 30, 2023 | | Nine Months Ended September 30, 2022 |
Lawson Operating Income | GAAP Results(1) | | Pre-Merger Results | | Adjusted Results(2) | | GAAP Results(1) | | Pre-Merger Results(3) | | Adjusted Results(2) |
| | | | | | | | | | | |
Revenue | $ | 358,903 | | | $ | — | | | $ | 358,903 | | | $ | 216,752 | | | $ | 104,902 | | | $ | 321,654 | |
Cost of goods sold | 155,533 | | | — | | | 155,533 | | | 103,733 | | | 49,371 | | | 153,104 | |
Gross profit | 203,370 | | | — | | | 203,370 | | | 113,019 | | | 55,531 | | | 168,550 | |
Selling, general and administrative expenses | 176,012 | | | — | | | 176,012 | | | 110,227 | | | 44,435 | | | 154,662 | |
Operating income (loss) | $ | 27,358 | | | $ | — | | | $ | 27,358 | | | $ | 2,792 | | | $ | 11,096 | | | $ | 13,888 | |
| | | | | | | | | | | |
Lawson Adjusted EBITDA(4) | $ | 51,241 | | | $ | — | | | $ | 51,241 | | | $ | 19,077 | | | $ | 8,042 | | | $ | 27,119 | |
(1)Operating income prepared in accordance with GAAP, which includes Lawson’s results of operations subsequent, but not prior, to September 30, 2016the April 1, 2022 Merger Date. See Note 1 – Nature of Operations and Basis of Presentation and Note 3 – Business Acquisitions within Item 1. Financial Statements.
|
| | | | | | | | | | | | | |
| 2017 | | 2016 |
($ in thousands) | Amount | | % of Net Sales | | Amount | | % of Net Sales |
| | | | | | | |
Net sales | $ | 225,274 |
| | 100.0 | % | | $ | 209,258 |
| | 100.0 | % |
Cost of goods sold | 89,249 |
| | 39.6 | % | | 81,700 |
| | 39.0 | % |
Gross profit | 136,025 |
| | 60.4 | % | | 127,558 |
| | 61.0 | % |
| | | | | | | |
Operating expenses: | | | | | | | |
Selling expenses | 72,964 |
| | 32.4 | % | | 69,525 |
| | 33.2 | % |
General and administrative expenses | 58,790 |
| | 26.1 | % | | 54,446 |
| | 26.1 | % |
Total S,G&A | 131,754 |
| | 58.5 | % | | 123,971 |
| | 59.3 | % |
Gain on sale of property | (5,422 | ) | | (2.4 | )% | | — |
| | — | % |
Operating expenses | 126,332 |
| | 56.1 | % | | 123,971 |
| | 59.3 | % |
| | | | | | | |
Operating income | 9,693 |
| | 4.3 | % | | 3,587 |
| | 1.7 | % |
| | | | | | | |
Interest expense | (393 | ) | | (0.2 | )% | | (486 | ) | | (0.2 | )% |
Other income, net | 953 |
| | 0.5 | % | | 439 |
| | 0.2 | % |
| | | | | | | |
Income before income taxes | 10,253 |
| | 4.6 | % | | 3,540 |
| | 1.7 | % |
| | | | | | | |
Income tax expense | 802 |
| | 0.4 | % | | 526 |
| | 0.3 | % |
| | | | | | | |
Net income | $ | 9,451 |
| | 4.2 | % | | $ | 3,014 |
| | 1.4 | % |
Net Sales
Net sales(2)Lawson's results of operations adjusted for comparability on a period-over-period basis. These non-GAAP results represent Lawson’s total operating activities for the nine months ended September 30, 2017 increased 7.7%2023 and 2022, regardless of the Merger date (that is, they reflect both pre- and post-Merger results of Lawson).
(3)Lawson's results of operations for the three months ended March 31, 2022, which occurred prior to $225.3 million from $209.3 millionthe April 1, 2022 Merger Date, were not included in the Company's GAAP operating results under reverse merger acquisition accounting.
(4)Refer to the Non-GAAP Adjusted EBITDA section above for a reconciliation of Adjusted EBITDA to operating income.
Composition of Results of Operations
The following results of operations for the three and nine months ended September 30, 2023 and the three months ended September 30, 2022 include the combined operations of DSG. The following results of operations for the nine months ended September 30, 2016. Average daily2022include the accounts of the TestEquity and Gexpro Services combined entity, as the accounting acquirer, and the results of DSG's legacy Lawson business have only been included for activity subsequent, and not prior, to the April 1, 2022 Merger Date.
RESULTS OF OPERATIONS
Three Months Ended September 30, 2023 Compared to Three Months Ended September 30, 2022
Consolidated Results of Operations
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended September 30, |
| 2023 | | 2022 |
(Dollars in thousands) | Amount | | % of Revenue | | Amount | | % of Revenue |
| | | | | | | |
Revenue | | | | | | | |
Lawson | $ | 114,477 | | | 26.1% | | $ | 109,418 | | | 31.5% |
TestEquity | 207,657 | | | 47.3% | | 116,709 | | | 33.6% |
Gexpro Services | 103,232 | | | 23.5% | | 103,749 | | | 29.9% |
All Other | 13,543 | | | 3.1% | | 17,275 | | | 5.0% |
Total Revenue | 438,909 | | | 100.0% | | 347,151 | | | 100.0% |
Cost of goods sold | | | | | | | |
Lawson | 48,395 | | | 11.0% | | 53,183 | | | 15.3% |
TestEquity | 164,589 | | | 37.5% | | 89,704 | | | 25.8% |
Gexpro Services | 72,990 | | | 16.6% | | 73,794 | | | 21.3% |
All Other | 7,638 | | | 1.7% | | 11,303 | | | 3.3% |
Total Cost of goods sold | 293,612 | | | 66.9% | | 227,984 | | | 65.7% |
Gross profit | 145,297 | | | 33.1% | | 119,167 | | | 34.3% |
| | | | | | | |
Selling, general and administrative expenses | | | | | | | |
Lawson | 55,439 | | | 12.6% | | 50,883 | | | 14.7% |
TestEquity | 48,095 | | | 11.0% | | 19,429 | | | 5.6% |
Gexpro Services | 22,910 | | | 5.2% | | 21,963 | | | 6.3% |
All Other | 6,070 | | | 1.4% | | 4,865 | | | 1.4% |
Total Selling, general and administrative expenses | 132,514 | | | 30.2% | | 97,140 | | | 28.0% |
Operating income (loss) | 12,783 | | | 2.9% | | 22,027 | | | 6.3% |
| | | | | | | |
Interest expense | (12,895) | | | (2.9)% | | (6,097) | | | (1.8)% |
Loss on extinguishment of debt | — | | | —% | | — | | | —% |
Change in fair value of earnout liabilities | 667 | | | 0.2% | | 9,641 | | | 2.8% |
Other income (expense), net | (1,133) | | | (0.3)% | | (550) | | | (0.2)% |
| | | | | | | |
Income (loss) before income taxes | (578) | | | (0.1)% | | 25,021 | | | 7.2% |
| | | | | | | |
Income tax expense (benefit) | 990 | | | 0.3% | | 8,480 | | | 2.4% |
| | | | | | | |
Net income (loss) | $ | (1,568) | | | (0.4)% | | $ | 16,541 | | | 4.8% |
| | | | | | | |
| | | | | | | |
Overview of Consolidated Results of Operations
Our consolidated revenue increased $91.8 million in the third quarter of 2023 compared to the third quarter of 2022 primarily driven by $106.3 millionfrom acquisitions completed in 2023 and 2022 and organic sales improved 8.2%growth. Consolidated gross profit and Selling, general and administrative expenses also increased over the prior year primarily driven by the inclusion of the acquisitions completed in 2023 and 2022.
Refer to $1.179Results by Reportable Segment below for a complete discussion of our results of operations.
Results by Reportable Segment
Lawson Segment
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended September 30, | Change |
(Dollars in thousands) | 2023 | | 2022 | | Amount | | % |
| | | | | | | |
Revenue | $ | 114,477 | | | $ | 109,418 | | | $ | 5,059 | | | 4.6 | % |
Cost of goods sold | 48,395 | | | 53,183 | | | (4,788) | | | (9.0) | % |
Gross profit | 66,082 | | | 56,235 | | | 9,847 | | | 17.5 | % |
Selling, general and administrative expenses | 55,439 | | | 50,883 | | | 4,556 | | | 9.0 | % |
Operating income (loss) | $ | 10,643 | | | $ | 5,352 | | | $ | 5,291 | | | 98.9 | % |
| | | | | | | |
Gross profit margin | 57.7 | % | | 51.4 | % | | | | |
| | | | | | | |
Adjusted EBITDA(1) | $ | 16,721 | | | $ | 9,670 | | | $ | 7,051 | | | 72.9 | % |
(1)Refer to the Non-GAAP Adjusted EBITDA section in Overview for a reconciliation of Adjusted EBITDA to operating income.
Revenue and Gross Profit
Revenue increased $5.1 million, or 4.6%, to $114.5 million in the third quarter of 2023 compared to $109.4 million in the third quarter of 2022. The increase was primarily driven by the realization of price increases enacted throughout 2022 and 2023 to offset rising supplier costs and strengthening sales to Lawson's strategic and governmental customers and automotive end market.
Gross profit increased $9.8 million to $66.1 million in the third quarter of 2023 compared to gross profit of $56.2 million in the prior year quarter primarily as a result of increased sales, price increases, lower net freight expense and spreading fixed expenses for certain warehouse activities over a higher sales level. Lawson gross profit as a percent of revenue was 57.7% in the third quarter of 2023 compared to 51.4% in the prior year quarter. The gross profit margin percentage increase for the third quarter of 2023 was primarily the result of price increases and leveraging operating costs over a higher sales base. The prior year quarter was negatively impacted by increased supplier costs from inflation and supply chain disruptions, and a sales shift toward lower margin customers.
Selling, General and Administrative Expenses
Selling, general and administrative expenses consist of compensation and support for Lawson sales representatives and expenses to operate Lawson's distribution network and overhead expenses.
Selling, general and administrative expenses increased $4.6 million to $55.4 million in the third quarter of 2023 compared to $50.9 million in the prior year quarter. The increase was primarily driven by higher stock-based compensation as a benefit was realized in 2022, higher compensation expense incurred to support increased sales and health insurance costs in 2023 partially offset by lower acquisition related and non-recurring consulting costs costs.
Adjusted EBITDA
During the three months ended September 30, 2023, Lawson generated Adjusted EBITDA of $16.7 million, an increase of $7.1 million, or72.9% from the same period a year ago primarily driven by increased revenue and margins and leveraging of costs.
TestEquity Segment
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended September 30, | | Change |
(Dollars in thousands) | 2023 | | 2022 | | Amount | | % |
| | | | | | | |
Revenue | $ | 207,657 | | | $ | 116,709 | | | $ | 90,948 | | | 77.9 | % |
Cost of goods sold | 164,589 | | | 89,704 | | | 74,885 | | | 83.5 | % |
Gross profit | 43,068 | | | 27,005 | | | 16,063 | | | 59.5 | % |
Selling, general and administrative expenses | 48,095 | | | 19,429 | | | 28,666 | | | 147.5 | % |
Operating income (loss) | $ | (5,027) | | | $ | 7,576 | | | $ | (12,603) | | | N/M |
| | | | | | | |
Gross profit margin | 20.7 | % | | 23.1 | % | | | | |
| | | | | | | |
Adjusted EBITDA(1) | $ | 14,298 | | | $ | 10,122 | | | $ | 4,176 | | | 41.3 | % |
N/M Not meaningful
(1)Refer to the Non-GAAP Adjusted EBITDA section in Overview for a reconciliation of Adjusted EBITDA to operating income.
Revenue and Gross Profit
Revenue increased $90.9 million, or 77.9%, to $207.7 million in the third quarter of 2023 compared to $116.7 million in the third quarter of 2022. The increase was primarily driven by $106.3 million of revenue generated from acquisitions completed in 2023 and 2022 offset by a $15.4 million decline in legacy TestEquity revenue primarily due to a slowdown in the test and measurement market, primarily caused by tightening of capital budgets in TestEquity's customer base.
Gross profit increased $16.1 million to $43.1 million in the third quarter of 2023 compared to gross profit of $27.0 million in the prior year quarter primarily as a result of the inclusion of the acquisitions completed in 2023 and 2022, which generated $20.5 million of additional gross profit in the third quarter of 2023. TestEquity gross profit as a percent of revenue was 20.7% in the third quarter of 2023 compared to 23.1% in the prior year quarter. The gross profit margin percentage decline for the third quarter of 2023 was primarily due to the amortization of the fair value step-up of inventory of $2.2 million related to the Hisco Transaction and a shift of customer sales mix.
Selling, General and Administrative Expenses
Selling, general and administrative expenses consist of compensation and support for TestEquity's sales representatives and expenses to operate TestEquity's distribution network and overhead expenses.
Selling, general and administrative expenses increased $28.7 million to $48.1 million in the third quarter of 2023 compared to $19.4 million in the prior year quarter. This increase was due to approximately $27.2 millionof additional expenses, including depreciation and amortization, primarily driven by the acquisitions completed in 2023 and 2022, partially offset by lower merger and acquisition expenses in the third quarter of 2023 compared to the prior year quarter.
Adjusted EBITDA
During the three months ended September 30, 2023, TestEquity generated Adjusted EBITDA of $14.3 million, an increase of $4.2 million, or 41.3% from the same period a year ago with approximately $8.3 million driven by the acquisitions completed in 2023 and 2022, offset by a reduction of $4.1 million in legacy TestEquity due to the decline in revenue.
Gexpro Services Segment
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended September 30, | | Change |
(Dollars in thousands) | 2023 | | 2022 | | Amount | | % |
| | | | | | | |
Revenue | $ | 103,232 | | | $ | 103,749 | | | $ | (517) | | | (0.5) | % |
Cost of goods sold | 72,990 | | | 73,794 | | | (804) | | | (1.1) | % |
Gross profit | 30,242 | | | 29,955 | | | 287 | | | 1.0 | % |
Selling, general and administrative expenses | 22,910 | | | 21,963 | | | 947 | | | 4.3 | % |
Operating income (loss) | $ | 7,332 | | | $ | 7,992 | | | $ | (660) | | | (8.3) | % |
| | | | | | | |
Gross profit margin | 29.3 | % | | 28.9 | % | | | | |
| | | | | | | |
Adjusted EBITDA(1) | $ | 11,552 | | | $ | 12,485 | | | $ | (933) | | | (7.5) | % |
(1)Refer to the Non-GAAP Adjusted EBITDA section in Overview for a reconciliation of Adjusted EBITDA to operating income.
Revenue and Gross Profit
Revenue decreased $0.5 million, or 0.5%, to $103.2 million in the third quarter of 2023 compared to $103.7 million in the third quarter of 2022. The decrease was primarily driven by the timing of project work in Gexpro Services' customer base as well as market softness in the technology vertical market.
Gross profit increased $0.3 million to$30.2 million in the third quarter of 2023 compared to gross profit of $30.0 million in the prior year quarter. Gexpro Services gross profit as a percent of revenue was 29.3% in the third quarter of 2023 compared to 28.9% in the prior year quarter primarily driven by an improvement in the global supply chain and enhanced margin management on Gexpro Services' product offerings.
Selling, General and Administrative Expenses
Selling, general and administrative expenses consist of sales and marketing expenses primarily relating to compensation, costs associated with supporting Gexpro Services’ service facilities, overhead expenses within finance, legal, human resources and information technology, and other costs required to operate Gexpro Services’ business and service customers.
Selling, general, and administrative expenses increased $0.9 million to $22.9 million in the third quarter of 2023 compared to $22.0 million in the prior year quarter. The increase was primarily driven by higher compensation and product fulfillment costs.
Adjusted EBITDA
During the three months ended September 30, 2023, Gexpro Services generated Adjusted EBITDA of $11.6 million, a decrease of $0.9 million, or 7.5%, from the same period a year ago primarily driven by flat revenue and an increase in Selling, general, and administrative expenses.
Consolidated Non-operating Income and Expense
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended September 30, | | Change |
(Dollars in thousands) | 2023 | | 2022 | | Amount | | % |
| | | | | | | |
Interest expense | $ | (12,895) | | | $ | (6,097) | | | $ | (6,798) | | | 111.5 | % |
| | | | | | | |
Change in fair value of earnout liabilities | $ | 667 | | | $ | 9,641 | | | $ | (8,974) | | | N/M |
Other income (expense), net | $ | (1,133) | | | $ | (550) | | | $ | (583) | | | 106.0 | % |
Income tax expense (benefit) | $ | 990 | | | $ | 8,480 | | | $ | (7,490) | | | (88.3) | % |
N/M Not meaningful
Interest Expense
Interest expense increased $6.8 million in the third quarter of 2023 compared to the prior year quarter. The increase was primarily driven by higher interest rates and outstanding borrowings partially driven by the Hisco Transaction.
Change in Fair Value of Earnout Liabilities
The benefit in the third quarter of 2023 related to the change in fair value of the earnout liabilities associated with the Frontier acquisition and the Hisco Transaction. The $9.6 million benefit in the third quarter of 2022 primarily related to the change in fair value of the earnout derivative liability associated with the earnout provisions of the Merger Agreements.
Income Tax Expense (Benefit)
Income tax expense was $1.0 million, a (171.3)% effective tax rate for the three months ended September 30, 2023 compared to income tax expense of $8.5 million and a 33.9% effective tax rate for the three months ended September 30, 2022. The change in the year-over-year effective tax rate was primarily due to adjustments to uncertain tax positions, a book loss for the current quarter, and other permanent items.
Nine Months Ended September 30, 2023 Compared to Nine Months Ended September 30, 2022
Consolidated Results of Operations
| | | | | | | | | | | | | | | | | | | | | | | |
| Nine Months Ended September 30, |
| 2023 | | 2022 |
(Dollars in thousands) | Amount | | % of Net Sales | | Amount | | % of Net Sales |
| | | | | | | |
Revenue | | | | | | | |
Lawson(1) | $ | 358,903 | | | 30.8 | % | | $ | 216,752 | | | 26.4 | % |
TestEquity | 451,082 | | | 38.7 | % | | 286,984 | | | 34.9 | % |
Gexpro Services | 312,523 | | | 26.8 | % | | 285,224 | | | 34.7 | % |
All Other | 42,655 | | | 3.7 | % | | 33,612 | | | 4.1 | % |
Total Revenue | 1,165,163 | | | 100.0 | % | | 822,572 | | | 100.0 | % |
Cost of goods sold | | | | | | | |
Lawson(1) | 155,533 | | | 13.3 | % | | 103,733 | | | 12.6 | % |
TestEquity | 351,417 | | | 30.2 | % | | 220,247 | | | 26.8 | % |
Gexpro Services | 219,430 | | | 18.8 | % | | 202,133 | | | 24.6 | % |
All Other | 24,592 | | | 2.1 | % | | 21,853 | | | 2.7 | % |
Total Cost of goods sold | 750,972 | | | 64.5 | % | | 547,966 | | | 66.6 | % |
Gross profit | 414,191 | | | 35.5 | % | | 274,606 | | | 33.4 | % |
| | | | | | | |
Selling, general and administrative expenses | | | | | | | |
Lawson(1) | 176,012 | | | 15.1 | % | | 110,227 | | | 13.4 | % |
TestEquity | 107,848 | | | 9.3 | % | | 59,294 | | | 7.2 | % |
Gexpro Services | 69,609 | | | 6.0 | % | | 66,119 | | | 8.0 | % |
All Other | 17,442 | | | 1.5 | % | | 9,838 | | | 1.2 | % |
Total Selling, general and administrative expenses | 370,911 | | | 31.8 | % | | 245,478 | | | 29.8 | % |
| | | | | | | |
Operating income (loss) | 43,280 | | | 3.7 | % | | 29,128 | | | 3.5 | % |
| | | | | | | |
Interest expense | (30,057) | | | (2.6) | % | | (16,704) | | | (2.0) | % |
Loss on extinguishment of debt | — | | | — | % | | (3,395) | | | (0.4) | % |
Change in fair value of earnout liabilities | 646 | | | 0.1 | % | | 3,948 | | | 0.5 | % |
Other income (expense), net | (2,869) | | | (0.2) | % | | 224 | | | — | % |
| | | | | | | |
Income (loss) before income taxes | 11,000 | | | 0.9 | % | | 13,201 | | | 1.6 | % |
| | | | | | | |
Income tax expense (benefit) | 3,637 | | | 0.3 | % | | 3,912 | | | 0.5 | % |
| | | | | | | |
Net income (loss) | $ | 7,363 | | | 0.6 | % | | $ | 9,289 | | | 1.1 | % |
(1)Includes the operating results of Lawson subsequent, but not prior, to the Merger Date of April 1, 2022.
Overview of Consolidated Results of Operations
Our consolidated results of operations include the financial impact of the Mergers that were completed on April 1, 2022 and the other acquisitions completed in 2023 and 2022. The increase in gross profit for the first nine months of 2023 compared to the first nine months of 2022 was primarily due to the inclusion of Lawson operations only subsequent, and not prior, to the Merger Date and the other acquisitions completed in 2023 and 2022. Expenses for the first nine months of 2023 compared to the first nine months of 2022 were impacted by the inclusion of Lawson and the other acquisitions completed in 2023 and 2022.
Refer to Results by Reportable Segment below for a complete discussion of our results of operations.
Results by Reportable Segment
Lawson Segment
| | | | | | | | | | | | | | | | | | | | | | | |
| Nine Months Ended September 30, | | Change |
(Dollars in thousands) | 2023 | | 2022 | | Amount | | % |
| | | | | | | |
Revenue | $ | 358,903 | | | $ | 216,752 | | | $ | 142,151 | | | — | % |
Cost of goods sold | 155,533 | | | 103,733 | | | 51,800 | | | — | % |
Gross profit | 203,370 | | | 113,019 | | | 90,351 | | | — | % |
Selling, general and administrative expenses | 176,012 | | | 110,227 | | | 65,785 | | | — | % |
Operating income (loss) | $ | 27,358 | | | $ | 2,792 | | | $ | 24,566 | | | — | % |
| | | | | | | |
Gross profit margin | 56.7 | % | | 52.1 | % | | | | |
| | | | | | | |
Adjusted EBITDA(1) | $ | 51,241 | | | $ | 19,077 | | | $ | 32,164 | | | 168.6 | % |
(1)Refer to the Non-GAAP Adjusted EBITDA section in Overview for a reconciliation of Adjusted EBITDA to operating income.
The increase in revenue, gross profit and operating income for the first nine months of 2023 compared to the first nine months of 2022 was primarily due to the inclusion of Lawson operations beginning on the Merger Date and not including any Lawson operations prior to the Merger Date.
Supplemental Information
For management to discuss Lawson's operating results on a comparable basis, Lawson's GAAP results of operations for the nine months ended September 30, 2022 were adjusted to include its results prior to the April 1, 2022 Merger Date in order to reflect the total operating activities attributable to Lawson for each period presented. These non-GAAP Adjusted Results for the nine months ended September 30, 2022 presented in the table below are referred to within this supplemental results of operations discussion as "Adjusted".
| | | | | | | | | | | | | | | | | | | | | | | |
| Nine Months Ended September 30, | | Adjusted Change |
(Dollars in thousands) | 2023 | | Adjusted 2022(1) | | Amount | | % |
| | | | | | | |
Revenue | $ | 358,903 | | | $ | 321,654 | | | $ | 37,249 | | | 11.6% |
Cost of goods sold | 155,533 | | | 153,104 | | | 2,429 | | | 1.6% |
Gross profit | 203,370 | | | 168,550 | | | 34,820 | | | 20.7% |
Selling, general and administrative expenses | 176,012 | | | 154,662 | | | 21,350 | | | 13.8% |
Operating income (loss) | $ | 27,358 | | | $ | 13,888 | | | $ | 13,470 | | | 97.0% |
| | | | | | | |
Gross profit margin | 56.7 | % | | 52.4 | % | | | | |
| | | | | | | |
Adjusted EBITDA(2) | $ | 51,241 | | | $ | 27,119 | | | $ | 24,122 | | | 88.9% |
(1)For comparability purposes, Lawson's GAAP results of operations were adjusted to include the historical unaudited results of Lawson prior to the Merger Date. Refer to the section Factors Affecting Comparability to Prior Periods and the non-GAAP measures section Supplemental Information - Lawson Non-GAAP Adjusted Operating Income and Non-GAAP EBITDA for more information related to the calculation of adjusted amounts.
(2)Refer to the Non-GAAP Adjusted EBITDA section in Overview for a reconciliation of Adjusted EBITDA to operating income.
Revenue and Gross Profit
Revenue increased $37.2 million, or 11.6%, to $358.9 million in the first nine months of 2023 compared to adjusted revenue of $321.7 million in the same period of 2022. The increase was primarily driven by the realization of price increases enacted throughout 2022 and 2023 to offset rising supplier costs and strengthening sales to Lawson's strategic and governmental customers and automotive end market.
Gross profit increased $34.8 million to $203.4 million in the first nine months ended September 30, 2023 compared to adjusted gross profit of $168.6 million in the same period of 2022 primarily as a result of increased sales, price increases, lower net freight expense and spreading operating expenses over a higher sales level. Lawson gross profit as a percent of revenue was
56.7% in the first nine months of 2023 compared to adjusted gross profit as a percent of adjusted revenue of 52.4% in the prior year period. The gross profit margin percentage improvement for the first nine months of 2023 was primarily the result of price increases, lower net freight costs and leveraging costs over a higher sales base. Theadjusted gross profit margin percentage for the same period of 2022 was impacted by increased supplier costs from inflation and supply chain disruptions and a sales shift toward lower margin customers. Adjusted gross profit margin for 2022 was also impacted by the amortization of the fair value step-up of inventory of $1.9 million related to the Mergers.
Selling, General and Administrative Expenses
Selling, general and administrative expenses consist of compensation and support for Lawson sales representatives as well as expenses to operate Lawson's distribution network and overhead expenses.
Selling, general and administrative expenses increased $21.4 million to $176.0 million in the first nine months of 20172023 compared to $1.090adjusted Selling, general and administrative expenses of $154.7 million in the same period of 2022. The increase was primarily driven by higher compensation expense incurred to support increased sales, additional depreciation and amortization as a result of the fair value step-up adjustments related to the reverse merger acquisition accounting and higher stock-based compensation in 2023 due to a benefit realized in 2022, partially offset by lower acquisition related costs in 2023.
Adjusted EBITDA
During the nine months ended September 30, 2023, Lawson generated Adjusted EBITDA of $51.2 million, an increase of $24.1 million, or 88.9% from the same period a year ago primarily driven by increased revenue and gross profit margin.
TestEquity Segment
| | | | | | | | | | | | | | | | | | | | | | | |
| Nine Months Ended September 30, | | Change |
(Dollars in thousands) | 2023 | | 2022 | | Amount | | % |
| | | | | | | |
Revenue | $ | 451,082 | | | $ | 286,984 | | | $ | 164,098 | | | 57.2 | % |
Cost of goods sold | 351,417 | | | 220,247 | | | 131,170 | | | 59.6 | % |
Gross profit | 99,665 | | | 66,737 | | | 32,928 | | | 49.3 | % |
Selling, general and administrative expenses | 107,848 | | | 59,294 | | | 48,554 | | | 81.9 | % |
Operating income (loss) | $ | (8,183) | | | $ | 7,443 | | | $ | (15,626) | | | N/M |
| | | | | | | |
Gross profit margin | 22.1 | % | | 23.3 | % | | | | |
| | | | | | | |
Adjusted EBITDA(1) | $ | 31,450 | | | $ | 24,260 | | | $ | 7,190 | | | 29.6 | % |
N/M Not meaningful
(1)Refer to the Non-GAAP Adjusted EBITDA section in Overview for a reconciliation of Adjusted EBITDA to operating income.
Revenue and Gross Profit
Revenue increased $164.1 million, or 57.2%, to $451.1 million in the first nine months of 2023 compared to $287.0 million in the same period in 2022. The increase was primarily driven by $180.9 million of revenue generated from acquisitions completed in 2023 and 2022 offset by a $16.8 million decline in legacy TestEquity due to a slowdown in the test and measurement market, primarily caused by tightening of capital budgets in TestEquity's customer base.
Gross profit increased $32.9 million to $99.7 million in the first nine months of 2023 compared to $66.7 million in the same period of 2022 primarily as a result of the inclusion of the acquisitions completed in 2023 and 2022, which generated $38.3 million of additional gross profit during the first nine months of 2023. TestEquity gross profit as a percent of revenue decreased to 22.1% in the first nine months of 2023 compared to 23.3% in the prior year period.primarily due to the amortization of the fair value step-up of inventory of $2.9 million related to the Hisco Transaction and a shift in sales mix from the lower gross margin rates from the 2022 and 2023 acquisitions.
Selling, General and Administrative Expenses
Selling, general and administrative expenses consist of compensation and support for TestEquity's sales representatives and expenses to operate TestEquity's distribution network and overhead expenses.
Selling, general and administrative expenses increased $48.6 million to $107.8 millionin the first nine months of 2023 compared to $59.3 million in the same period of 2022. Approximately $42.3 million of the increased expenses, including depreciation and amortization, was primarily driven by the acquisitions completed in 2023 and 2022 and higher merger and acquisition expenses in the first nine months of 2023 compared to the same period a year ago.
Adjusted EBITDA
During the nine months ended September 30, 2023, TestEquity generated Adjusted EBITDA of $31.5 million, an increase of $7.2 million, or 29.6% from the same period a year ago with approximately $13.4 million driven by the acquisitions completed in 2023 and 2022, offset by a reduction of $6.2 million in legacy TestEquity due to the decline in revenue.
Gexpro Services Segment
| | | | | | | | | | | | | | | | | | | | | | | |
| Nine Months Ended September 30, | | Change |
(Dollars in thousands) | 2023 | | 2022 | | Amount | | % |
| | | | | | | |
Revenue | $ | 312,523 | | | $ | 285,224 | | | $ | 27,299 | | | 9.6 | % |
Cost of goods sold | 219,430 | | | 202,133 | | | 17,297 | | | 8.6 | % |
Gross profit | 93,093 | | | 83,091 | | | 10,002 | | | 12.0 | % |
Selling, general and administrative expenses | 69,609 | | | 66,119 | | | 3,490 | | | 5.3 | % |
Operating income (loss) | $ | 23,484 | | | $ | 16,972 | | | $ | 6,512 | | | 38.4 | % |
| | | | | | | |
Gross profit margin | 29.8 | % | | 29.1 | % | | | | |
| | | | | | | |
Adjusted EBITDA(1) | $ | 36,368 | | | $ | 32,409 | | | $ | 3,959 | | | 12.2 | % |
(1)Refer to the Non-GAAP Adjusted EBITDA section in Overview for a reconciliation of Adjusted EBITDA to operating income.
Revenue and Gross Profit
Revenue increased $27.3 million, or 9.6%, to $312.5 million in the first nine months of 2023 compared to $285.2 million in the same period of 2022. The increase was primarily driven by growth in the base business through an expansion of products and services to existing customers as well as the addition of new customers.
Gross profit increased $10.0 million to $93.1 million in the first nine months of 2023 compared to $83.1 million in the same period of 2022. Gexpro Services gross profit as a percent of revenue was 29.8% in the first nine months of 2023 compared to 29.1% in the prior year period driven by an improvement in the global supply chain and margin management on its product offering.
Selling, General and Administrative Expenses
Selling, general and administrative expenses consist of sales and marketing expenses primarily relating to compensation, costs associated with supporting Gexpro Services’ service facilities, overhead expenses within finance, legal, human resources and information technology, and other costs required to operate Gexpro Services' business and service customers.
Selling, general, and administrative expenses increased $3.5 million to $69.6 million in the first nine months ended September 30, 2023 compared to $66.1 million in the same period of 2022. The increase was primarily driven by $1.7 million of additional expenses from the Frontier acquisition completed at the end of the first quarter of 2022 and additional compensation and product fulfillment costs to support the organic growth.
Adjusted EBITDA
During the nine months ended September 30, 2023, Gexpro Services generated Adjusted EBITDA of $36.4 million, an increase of $4.0 million, or 12.2% from the same period a year ago primarily driven by increased revenue and gross profit margin.
Consolidated Non-operating Income and Expense
| | | | | | | | | | | | | | | | | | | | | | | |
| Nine Months Ended September 30, | | Change |
(Dollars in thousands) | 2023 | | 2022 | | Amount | | % |
| | | | | | | |
Interest expense | $ | (30,057) | | | $ | (16,704) | | | $ | (13,353) | | | 79.9 | % |
Loss on extinguishment of debt | $ | — | | | $ | (3,395) | | | $ | 3,395 | | | N/M |
Change in fair value of earnout liabilities | $ | 646 | | | $ | 3,948 | | | $ | (3,302) | | | N/M |
Other income (expense), net | $ | (2,869) | | | $ | 224 | | | $ | (3,093) | | | N/M |
Income tax expense (benefit) | $ | 3,637 | | | $ | 3,912 | | | $ | (275) | | | (7.0) | % |
N/M Not meaningful
Interest Expense
Interest expense increased $13.4 million in the first nine months of 20172023 compared to the same period of 2022 primarily due to an increase in interest rates and 2016 had 191higher borrowings related to the Mergers and 192 selling days, respectively.the other 2022 and 2023 acquisitions.
Sales
Loss on Extinguishment of Debt
The $3.4 million loss on extinguishment of debt in the nine months ended September 30, 2022 was primarily due to the write-off of previously capitalized financing costs as a result of the debt refinancing related to the Mergers.
Change in Fair Value of Earnout Liabilities
The benefit in the first nine months of 2017 were positively impacted by increased productivity2023 related to the change in fair value of sales representativesthe earnout liabilities associated with the Frontier acquisition and the effect of acquisitions completed in 2016, augmented by the overall improvementHisco Transaction. The $3.9 million benefit in the MRO marketplace. The Company experienced growth in all major categories including regional, large national, Kent Automotive and governmental accounts. Average daily sales from the 2016 acquisitions grew 1.4%.
Gross Profit
Gross profit increased to $136.0 million in the first nine months of 2017 compared2022 primarily related to $127.6the change in fair value of the earnout derivative liability associated with the earnout provisions of the Merger Agreements.
Other Income (Expense), Net
Other income (expense), net consists of effects of changes in foreign currency exchange rates, interest income, net and other non-operating income and expenditures. The $3.1 million change in the first nine months of 2016 and decreased as a percent2023 compared to the same period of sales to 60.4% from 61.0% a year ago. The decline in gross profit margin from a year ago2022 was primarily driven by higher sales to larger national customers, who typically generate lower product margins, the impact of the 2016 acquisitions, and transportation costs associated with the movement of certain inventorypartly due to the closure of the Fairfield, New Jersey, distribution center.unfavorable changes in foreign currency exchange rates and other insignificant changes in other non-operating income and expenditures.
Selling ExpensesIncome Tax Expense (Benefit)
Selling expenses increased to $73.0Income tax expense was $3.6 million, a 33.1% effective tax rate for the first nine months of 2017 from $69.52023 compared to an income tax expense of $3.9 million inand a 29.6% effective tax rate for the first nine months of 2016, due primarily to increased compensation costs on higher sales. Selling expenses as a percent of sales decreased to 32.4%2022. The change in the first nine months of 2017 from 33.2% in the first nine months of 2016, as fixed selling expenses were leveraged over a higher sales base.
General and Administrative Expenses
General and administrative expenses increased to $58.8 million in the first nine months of 2017 from $54.4 million in the prior year periodyear-over-year effective tax rate was primarily due to $4.1 million of additional stock-based compensation of which a portion varies with the company stock pricestate taxes, foreign income and restoring incentive compensation accruals due to improved operating results. These increase were offset partially by lower depreciation and acquisition related expenses.
Gain on sale of property
In the second quarter of 2017, we received net cash proceeds of $6.2 million and recognized a gain of $5.4 million from the sale of our Fairfield, New Jersey distribution center.
Interest Expense
Interest expenses decreased $0.1 million in the first nine months of 2017, over the prior year, due primarily to lower average borrowings oustanding.
Other Income, Net
Other income, net increased $0.5 million in the first nine months of 2017, over the prior year, due primarily to the effect of favorable changes in the exchange rate on Canadian transactions.
Income Tax Expense
Primarily due to historical cumulative losses, substantially all of our deferred tax assets are subject to a tax valuation allowance. Although we are in a full tax valuation allowance position,other permanent items. The 2022 income tax expenseswas also impacted by the creation of $0.8 million and $0.5 million were recorded in the first nine months of both 2017 and 2016, primarily due to reservesa consolidated group for uncertainfederal income tax positions, federal alternative minimum taxes and state taxes.
If the Company continues to demonstrate that it can consistently generate income, we may be able to makepurposes as a determination that there is a sufficient amount of positive evidence to conclude that it is more likely than not that we will be able to utilize our deferred tax assets to offset future taxable income. This would lead to the reduction of all or a portionresult of the valuation allowance resulting in an income tax benefit forcompletion of the period in which the reduction is recorded. We will continueMergers.
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents were $80.5 million on September 30, 2023 compared to closely monitor all positive and negative evidence and will re-assess our position$24.6 million on a quarterly basis.December 31, 2022.
Liquidity and Capital Resources
Available cash and cash equivalents, were $19.0 million on availability under its 2023 Credit Agreement and cash flows from operations will be sufficient to meet its liquidity needs for the next twelve months. As of September 30, 2017 compared2023, the Company had $80.5 million of cash and cash equivalents and $198.3 million of borrowing availability remaining, net of outstanding letters of credit, under the 2023 Credit Agreement.
On June 2, 2023, the Company raised approximately $100 million from the Rights Offering, in which 4,444,444 shares of DSG common stock were sold at a purchase price of $22.50 per share. On June 8, 2023, the Company borrowed $305.0 million under the incremental term loan of the 2023 Credit Agreement. The Company used these combined proceeds primarily to $10.4fund the Hisco Transaction and to pay down its revolving credit facility.
Our primary short-term and long-term liquidity and capital resource needs are to finance operating expenses, working capital, capital expenditures, potential business acquisitions, strategic initiatives and general corporate purposes. Our current
debt obligations under the 2023 Credit Agreement mature in April 2027. Required principal payments on the 2023 Credit Agreement for the next twelve months are $30.3 million. Refer to Note 9 – Debt within Item 1. Financial Statements for additional information related to our debt obligations. Access to debt capital markets has historically provided the Company with sources of liquidity, beyond normal operating cash flows. We do not anticipate having difficulty in obtaining financing from those markets in the future, however, we cannot provide assurance that events beyond our control will not have a material adverse impact on December 31, 2016. our liquidity.
Sources and Uses of Cash
The following table presents a summary of our cash flows:
| | | | | | | | | | | | | | | | | |
| Nine Months Ended September 30, | | |
(in thousands) | 2023 | | 2022 | | Change |
Net cash provided by (used in) operating activities | $ | 74,053 | | | $ | (19,280) | | | $ | 93,333 | |
Net cash provided by (used in) investing activities | $ | (266,720) | | | $ | (120,550) | | | $ | (146,170) | |
Net cash provided by (used in) financing activities | $ | 269,295 | | | $ | 151,820 | | | $ | 117,475 | |
Cash Provided by (Used in) Operating Activities
Net cash provided by operations was $3.8 million infor the nine months ended September 30, 2017, as cash generated by operating earnings2023 was $74.1 million primarily due to net income including non-cash items, partially offset by cash investedinvestments in trade working capital primarily to support the increasehigher sales and other net cash flow items.
Net cash used in sales. The $5.3 million of cash provided by operations infor the nine months ended September 30, 20162022 was $19.3 million, excluding non-cash items, primarily generateddue to increased accounts receivables driven by operating earnings.higher sales and increased inventories due to increased supplier costs driven by inflation and global supply chain disruptions.
In 2017, we completed the sale of our distribution center locatedCash Provided by (Used in) Investing Activities
Net cash used in Fairfield, New Jersey, receiving net cash proceeds of $6.2 million. Capital expenditures, primarilyinvesting activities for improvements to our distribution centers and information technology, were $1.2 million and $2.6 million in the nine month periods ended September 30, 2017 and 2016, respectively.
On September 30, 2017, we had no borrowings on our revolving line of credit and no dividends were paid to shareholders in the nine months ended September 30, 2017 and 2016. Dividends are currently restricted under the Loan Agreement to amounts not to exceed $7.02023 was $266.7 million, annually.
Subsequentprimarily due to the reporting periodHisco Transaction, as well as purchases of property, plant and equipment and rental equipment which was partially offset by the sale of rental equipment.
Net cash used in investing activities for the nine months ended September 30, 2022 was $120.6 million, primarily due to acquisitions completed by TestEquity and Gexpro Services, as well as purchases of property, plant and equipment and rental equipment which was partially offset by the sale of rental equipment.
Cash Provided by (Used in) Financing Activities
Net cash provided by financing activities for the nine months ended September 30, 2017, we completed2023 was $269.3 million due to proceeds from the acquisition2023 Credit Agreement and the Rights Offering partially offset by repayment of The Bolt Supply House Ltd. for forprevious indebtedness and principal payments on the term loans. In conjunction with the Hisco Transaction, the Company borrowed $305.0 million under the incremental term loan facility on June 8, 2023 and raised approximately $32.1$100 million which was paid by using a combinationthrough the Rights Offering closed during the second quarter of cash on hand2023. During the first nine months of 2023, deferred financing costs of $3.4 million were incurred related to the 2023 Credit Agreement and borrowingsoffering costs of $16.3$1.5 million from our existing revolving credit facility.were incurred related to the Rights Offering.
Loan Agreement
At September 30, 2017, we had additional borrowing availability of $36.0 million. We believeNet cash provided by operationsfinancing activities for the nine months ended September 30, 2022 was $151.8 million, primarily due to proceeds from term loans and funds available under our Loanrevolving credit facilities to finance the Mergers and other acquisitions, partly offset by repayment of previous indebtedness. Deferred financing costs of $12.0 million were incurred during the first nine months of 2022 related to these financing activities.
Financing and Capital Requirements
Credit Facility
On June 8, 2023, in connection with the Hisco Transaction, DSG entered into the First Amendment, which amended and replaced the Amended and Restated Credit Agreement are sufficientdated April 1, 2022 with the 2023 Credit Agreement, and provided for a $305.0 million incremental term loan facility. The 2023 Credit Agreement also provides for the Company to fund our operating requirements, strategic initiatives and capital improvements throughoutincrease the remainder
In additioncommitments from time to other customary representations, warranties and covenants, if the excess borrowing capacity is below $10.0time by up to $200 million we are required to meet a minimum trailing twelve month EBITDA to fixed charges ratio, as defined in the amended Loanaggregate, subject to, among other things, receipt of additional commitments from existing and/or new lenders and pro forma compliance with certain financial covenants.
The 2023 Credit Agreement includes a $200 million senior secured revolving credit facility, a $250 million senior secured initial term loan facility, a $305 million incremental term loan and a $50 million senior secured delayed draw term loan facility. Refer to Note 9 – Debt within Item 1. Financial Statements for a description of the 2023 Credit Agreement.
On September 30, 2017, our borrowing capacity exceeded $10.02023, we had $589.6 million therefore, in outstanding borrowings under the 2023 Credit Agreement and $198.3 million of borrowing availability remaining, net of outstanding letters of credit, under the senior secured revolving credit facility component.
As of September 30, 2023, we were not subject to thisin compliance with all financial covenant. However, for informational purposes we have provided the result of the financial covenant below:
|
| | | | |
Quarterly Financial Covenant | | Requirement | | Actual |
EBITDA to fixed charges ratio | | 1.10 : 1.00 | | 3.20 : 1.00 |
covenants under our 2023 Credit Agreement. While we were in compliance with theour financial covenant for the quarter endedcovenants as of September 30, 2017,2023, failure to meet thisthe covenant requirementrequirements of the 2023 Credit Agreement in future quarters could lead to higher financing costs and increased restrictions, or reduce or eliminate our ability to borrow funds, or accelerate the payment of our indebtedness and could have a material adverse effect on our business, financial condition and results of operations.
Purchase Commitments
As of September 30, 2023, we had contractual commitments to purchase approximately $200 million of products from our suppliers and contractors over the next twelve months.
Capital Expenditures
During the nine months endedSeptember 30, 2023, total capital expenditures for property, plant and equipment and rental equipment were $18.9 million excluding proceeds from the sale of rental equipment. The Company expects to spend approximately $3 million to $4 million for capital expenditures during the remainder of 2023 to support ongoing operations.
Stock Repurchase Program
The Company's Board of Directors previously authorized a stock repurchase program that permits the Company to repurchase its common stock. The timing and the amount of any repurchases will be determined by management under parameters established by the Board of Directors and depend on various factors including an evaluation of our stock price, corporate and regulatory requirements, capital availability and other market conditions.
During the third quarter of 2022, the Company repurchased 108,178 shares of Company common stock under the repurchase plan at an average cost of $17.93 per share for a total cost of $1.9 million. No shares were repurchased during 2023. The Company had $7.6 million of remaining availability for stock repurchases under the program as of September 30, 2023. See Note 11 – Stockholders' Equity within Item 1. Financial Statementsfor further information.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There haveITEM 3 of Part I has been no material changes in market risk at September 30, 2017omitted from that reported in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016.this report.
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Under the supervision and with the participation of our senior management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of the end of the period covered by this report (the “Evaluation Date”). Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded as of the Evaluation Date that ourThese disclosure controls and procedures were effective suchare designed to ensure that (i) the information relating to Lawson,DSG, including ourDSG's consolidated subsidiaries, required to be disclosed in our SEC reports (i) is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and (ii) include,includes, without limitation, controls and procedures designed to ensure that information required to be disclosed is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded as of the Evaluation Date that our disclosure controls and procedures were not effective as of September 30, 2023 because of the previously reported material weakness in internal control over financial reporting, as described below.
ThereOngoing Remediation of Material Weaknesses in Internal Control over Financial Reporting
As previously disclosed under Item 9A. Controls and Procedures in our Annual Report on Form 10-K for the year ended December 31, 2022, the Company’s management concluded that its internal control over financial reporting was not effective based on the material weakness identified. As a result of our expanding business operations, primarily related to the April 1, 2022 Mergers, we have experienced an increase in complex and non-routine accounting transactions and control activities necessary to properly present consolidated results. Specifically, in our TestEquity operating segment, we did not have sufficient technical accounting resources and personnel (i) to help ensure proper application of U.S. generally accepted accounting principles ("U.S. GAAP") in the accounting for certain areas primarily related to accounting for business acquisitions and the disposal of rental equipment, or (ii) to effectively design and execute our process level controls around (a) revenue recognition, (b) account reconciliations, (c) accounting policies and (d) proper segregation of duties.
The remediation efforts summarized below, which have been or will be implemented, are intended both to address the identified material weakness and to enhance the Company’s overall internal control environment.
Accounting Expertise and Personnel
•Management is assessing the accounting function and is planning to hire additional accounting personnel to improve the accounting capabilities and capacity, and to ensure internal control activities are maintained and performed.
Accounting Policies and Controls
•Management has expanded our training related to internal controls to include workshops designed to improve control awareness and educate all applicable personnel at the business unit level on internal control topics.
•Management has designed and implemented controls over the review of the accuracy and completeness of inputs provided to and outputs provided by third-party specialists, including the memorialization of accounting treatment conclusions for acquisitions.
•Management will strengthen accounting policies, specifically within complex, non-routine transactions, revenue recognition and accounting for business acquisitions, and verify procedures against U.S. GAAP.
•Management will design and implement entity level monitoring controls to support the review and preparation of complete and accurate financial information.
Segregation of Duties
•Management has evaluated logical access and eliminated known segregation of duties conflicts.
•Management has designed and is in the process of implementing periodic logical access review controls to monitor user access and proper segregation of duties.
We have designed our remediation plan to address the material weakness mentioned above and strengthen our overall internal control over financial reporting. However, we will not be able to determine if the material weakness has been remediated until our efforts are completed and we have reassessed the procedures and controls put in place. We will continue to review our financial reporting controls and procedures. As we finalize and implement the remediation plan outlined above, we may also identify additional measures to address the material weakness or modify certain of the remediation procedures described above. We also may implement additional changes to our internal control over financial reporting as may be appropriate in the course of remediating the material weakness. Management will continue to take steps to remedy the material weakness to reinforce the overall design and capability of our control environment.
Changes in Internal Control over Financial Reporting
Given the significance and timing of the Hisco Transaction and the complexity of systems and business processes, we intend to exclude the Hisco operating company from our assessment and report on internal control over financial reporting for the year ending December 31, 2023. Other than the Hisco Transaction and our ongoing remediation efforts discussed above, there were no changes in our internal control over financial reporting, as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act, during theour most recently completed fiscal quarter ended September 30, 2017 that materially affected or are reasonably likely to materially affect our internal control over financial reporting.
PART II
OTHER INFORMATION
ITEMS 1, 1A, 2, 3, 4 and 5 of Part II are inapplicablenot applicable and have been omitted from this report.
ITEM 1. LEGAL PROCEEDINGS
See Note 14 – Commitments and Contingencies to our unaudited condensed consolidated financial statements, included within Item 1. Financial Statements, which is incorporated herein by reference, for a description of certain of our pending legal proceedings, which are incorporated herein by reference. In addition, the Company is involved in legal actions that arise in the ordinary course of business.
ITEM 1A. RISK FACTORS
Other than the risk factors discussed below, there have been no material changes from the risk factors disclosed in the “Risk Factors” section in our Annual Report on Form 10-K for the year ended December 31, 2022.
Business Risks
Cyber-attacks or other information security incidents could have a material adverse effect on our business, operating results and financial condition, subject us to additional legal costs and damage our reputation in the marketplace.
We are increasingly dependent on digital technology to process and record financial and operating data and communicate with our employees and business partners. During the normal course of business we receive, retain and transmit certain confidential information that our customers provide to purchase products or services or to otherwise communicate with us, as well as certain information about our employees and other persons and entities.
Our technologies, systems, networks and data and information processes (and those of our business partners) have been, and may in the future be, the target of cyber-attacks and/or information security incidents that may have resulted in, or may in the future result in, the unauthorized release, misuse, loss or destruction of proprietary, personal and other information, or other disruption of our business operations, including compromise of our email systems. For example, in February 2022, DSG became aware that its computer network was the subject of a cyber incident potentially involving unlawful access (the “Cyber Incident”). Because of the nature of the information that may have been compromised, we were required to notify the parties whose information was potentially compromised of the incident as well as various governmental agencies and have taken other actions, such as offering credit monitoring services. In addition, from time to time our email systems (and those of our business partners communicating with us) have been subjected to malicious attacks, including phishing attacks.
Such attacks or incidents could have a material adverse effect on our operating results and financial condition, subject us to additional legal costs and damage our reputation in the marketplace. For example, a putative class action lawsuit was filed
against DSG in April 2023 asserting a variety of claims seeking monetary damages, injunctive relief and other related relief in connection with the Cyber Incident, which could result in additional legal and other costs.
The techniques used by criminals to obtain unauthorized access to sensitive data change frequently and often are not recognizable until launched against a target or until a breach has already occurred. Accordingly, we may be unable to anticipate these techniques or implement adequate preventative measures. As cyber threats continue to evolve, we may be required to expend additional resources to continue to modify or enhance our protective measures or to investigate and fix any information security vulnerabilities.
We maintain and have access to data and information that is subject to privacy and security laws, data protection laws and applicable regulations. The interpretation and application of such laws, including federal, state and international laws, relating to the collection, use, retention, disclosure, security and transfer of personally identifiable data in the United States (including but not limited to the California Consumer Privacy Act and the California Privacy Rights Act), Europe (including but not limited to the European Union's General Data Protection Regulation) and elsewhere, are uncertain and evolving. Despite our efforts to protect such information, cyber incidents or misplaced or lost data could have a materially adverse impact on our business, and may divert management and employee attention from other business and growth initiatives. Further, an information privacy or security incident could result in legal or reputational risks and could have a materially adverse impact on our business, financial condition and results of operations.
Any pursuit or completion by DSG of additional acquisition opportunities would involve risks that could adversely affect our business, financial condition and results of operations.
One of our growth strategies is to actively pursue additional acquisition opportunities which complement our business model. However, there are risks associated with pursuing acquisitions, which include the incurrence of significant transaction costs without the guarantee that such transactions will be completed and the risk that we may not realize the anticipated benefits of the acquisition once it is completed. We may fail to successfully identify the right opportunities and/or to successfully integrate the acquired businesses, operations, technologies, systems and/or personnel with those of DSG, which could adversely affect our business, financial condition and results of operations.
Common Stock Risks
Entities affiliated with LKCM and J. Bryan King beneficially own a significant majority of the outstanding DSG common stock and, therefore, have significant influence over our Company, which could delay or deter a change in control or other business combination or otherwise cause us to take actions with which you may disagree.
Based on a Schedule 13D filed with the SEC by LKCM and various other persons and entities (as amended through September 8, 2023), entities affiliated with LKCM beneficially owned in the aggregate approximately 36.4 million shares of DSG common stock as of September 1, 2023, representing approximately 77.6% of the outstanding shares of DSG common stock as of September 30, 2023. J. Bryan King, Chairman and Chief Executive Officer of the Company, is a Principal of LKCM. In addition, M. Bradley Wallace, who became a director of the Company upon his election at the Company’s 2023 annual stockholders meeting on May 19, 2023, is a Founding Partner of LKCM Headwater Investments, the private capital investment group of LKCM As a result, LKCM has significant influence over the outcome of matters requiring a stockholder vote, including the election of directors and the approval of other significant matters, and LKCM’s interests may not align with the interests of other stockholders. This concentration of ownership could also have the effect of delaying or preventing a change of control or other business combination that might be beneficial to our stockholders.
In addition, as a result of this concentrated ownership interest of DSG common stock, DSG believes that it qualifies as a “controlled company.” Under Nasdaq Listing Rules, a listed company of which more than 50% of the voting power is held by an individual, group or another company is a “controlled company” and, accordingly, DSG believes that, if it so desired, it would be generally exempt from the requirements of Rule 5605(b), (d) and (e) of the Nasdaq Listing Rules that among other things would otherwise require DSG to have:
•a majority of the DSG Board of Directors comprised of independent directors;
•a compensation committee comprised solely of independent directors; and
•director nominees be selected, or recommended to the DSG Board of Directors for selection, either by (1) DSG's independent directors constituting a majority of the DSG Board of Directors’ independent directors in a vote in which only independent directors participate or (2) a nominating committee comprised solely of independent directors.
Entities affiliated with LKCM beneficially own a significant number of shares of DSG common stock, and any sales of any such shares or the possibility of any such sales could have a negative effect on the price of DSG common stock.
Entities affiliated with LKCM beneficially own a significant number of shares of DSG common stock.In accordance with the Merger Agreements, DSG granted to certain entities affiliated with LKCM certain registration rights with respect to the shares of DSG common stock that DSG issued to those entities in connection with the Mergers. Any sales of any of the shares of DSG common stock held by any entities affiliated with LKCM (whether those shares were acquired by those entities in connection with the Mergers or in other transactions), or the anticipation of the possibility of any such sales, could create downward pressure on the market price of DSG common stock.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES, USE OF PROCEEDS, AND ISSUER PURCHASES OF EQUITY SECURITIES
Recent Sales of Unregistered Equity Securities
The Purchase Agreement for the Hisco Transaction allowed certain eligible Hisco employees to invest all or a portion of their respective closing payment in DSG common stock at $22.50 per share, up to an aggregate value of DSG common stock issued to such eligible Hisco employees of $25.0 million. On September 6, 2023, the Company issued to 19 eligible Hisco employees a total of 144,608 shares of DSG common stock in exchange for a total of approximately $3.25 million in cash. The issuance of these shares of DSG common stock was exempt from registration under the Securities Act of 1933, as amended, in reliance on Section 4(a)(2) of the Act and Rule 506(b) of Regulation D promulgated under the Act. Such shares are restricted securities, subject to restrictions on their transfer. See Note 3 – Business Acquisitions to our unaudited condensed consolidated financial statements, included within Item 1. Financial Statements, which is incorporated herein by reference, for a description of the Hisco Transaction, which is incorporated herein by reference.
Issuer Purchases of Equity Securities
There were no repurchases of any shares of DSG common stock during the three months ended September 30, 2023.
ITEM 6. EXHIBITS
|
| | | | | | | |
Exhibit # | Description of Exhibit | |
| | |
| | |
| | |
| Amended and Restated Credit Agreement, dated as of June 8, 2023, by and among Distribution Solutions Group, Inc., the subsidiaries of Distribution Solutions Group, Inc. party thereto, the Lenders party thereto and JPMorgan Chase Bank, N.A., as Administrative Agent, incorporated by reference to the Company’s Current Report on Form 8-K (File No. 000-10546) filed June 9, 2023. | |
| | |
| | |
| | |
101.INS101 | The following financial statements from the Quarterly Report on Form 10-Q for the quarter ended September 30, 2023, formatted in Inline XBRL: (i) Condensed Consolidated Balance Sheets, (ii) Condensed Consolidated Statement of Operations and Comprehensive Income (Loss), (iii) Condensed Consolidated Statements of Stockholders’ Equity, (iv) Condensed Consolidated Statements of Cash Flows, and (v) Notes to Condensed Consolidated Financial Statements. | |
101.INS | Inline XBRL Instance Document – the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document | |
101.SCH101.SCH* | Inline XBRL Taxonomy Extension Schema Document | |
101.CAL101.CAL* | Inline XBRL Taxonomy Extension Calculation Linkbase Document | |
101.DEF101.DEF* | Inline XBRL Taxonomy Extension Definition Linkbase Document | |
101.LAB101.LAB* | Inline XBRL Taxonomy Extension Label Linkbase Document | |
101.PRE101.PRE* | Inline XBRL Taxonomy Extension Presentation Linkbase Document | |
104 | The cover page from the Quarterly Report on Form 10-Q for the quarter ended September 30, 2023, formatted in Inline XBRL and contained in Exhibit 101 | |
† Certain schedules and/or similar attachments omitted pursuant to Item 601(a)(5) of Regulation S-K promulgated by the U.S. Securities and Exchange Commission. The Company agrees to furnish supplementally a copy of any omitted schedule or similar attachment to the U.S. Securities and Exchange Commission upon request.
*Filed herewith.
**Furnished herewith.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrantregistrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| | | | | | | | | | | |
| | | DISTRIBUTION SOLUTIONS GROUP, INC. |
| | | (Registrant) |
| | |
Dated: | November 2, 2023 | | /s/ J. Bryan King |
| | | J. Bryan King Chairman, President and Chief Executive Officer (principal executive officer) |
| | | |
| | |
Dated: | November 2, 2023 | | /s/ Ronald J. Knutson |
| | | Ronald J. Knutson Executive Vice President, Chief Financial Officer and Treasurer (principal financial officer) |
| | | |
| | | |
Dated: | November 2, 2023 | | LAWSON PRODUCTS, INC./s/ David S. Lambert |
| | | (Registrant)David S. Lambert Vice President, Controller and Chief Accounting Officer (principal accounting officer) |
| | |
Dated: | October 26, 2017 | | /s/ Michael G. DeCata |
| | | Michael G. DeCata
President and Chief Executive Officer
(principal executive officer)
|
| | | |
| | |
Dated: | October 26, 2017 | | /s/ Ronald J. Knutson |
| | | Ronald J. Knutson
Executive Vice President, Chief Financial Officer, Treasurer and Controller
(principal financial and accounting officer)
|