Distribution Solutions Group, Inc. — Q2 2023 Form 10-Q
Reporting period: Three and six months ended June 30, 2023. Amounts are in U.S. dollars; financial figures below are rounded to millions unless stated otherwise.
Business context and reporting comparability
DSG is a specialty distributor serving MRO, OEM and industrial technology markets through Lawson, TestEquity and Gexpro Services. It acquired Hisco on June 8, 2023, combining Hisco with TestEquity. Hisco contributed only the post-acquisition period to Q2 results.
Q2 2022 included all three existing operating businesses, so the quarterly comparison is more representative than the six-month comparison. The six months ended June 30, 2022 included Lawson only from the April 1, 2022 merger date; DSG cautions that six-month results are not directly comparable.
Key financial results
| Metric | Q2 2023 | Q2 2022 | YTD 2023 | YTD 2022 |
|---|---|---|---|---|
| Revenue | $378.0m | $321.3m | $726.3m | $475.4m |
| Gross profit / margin | $136.0m / 36.0% | $114.6m / 35.6% | $268.9m / 37.0% | $155.4m / 32.7% |
| Operating income / margin | $13.8m / 3.6% | $4.1m / 1.3% | $30.5m / 4.2% | $7.1m / 1.5% |
| Net income (loss) | $3.0m | $(4.7)m | $8.9m | $(7.3)m |
| Diluted EPS | $0.14 | $(0.23) | $0.41 | $(0.47) |
| Adjusted EBITDA (non-GAAP) | $40.1m | $31.7m | $79.5m | $45.2m |
Q2 revenue increased 17.6% year over year. Management attributed growth to acquisitions and organic sales growth. Q2 gross margin improved 0.4 percentage points; operating margin increased 2.3 points. Higher interest expense was a significant offset: $9.5m versus $3.8m in Q2 2022. Q2 2022 also included a $2.8m debt-extinguishment loss and a $5.7m earnout fair-value loss.
- Lawson: Q2 revenue $119.1m, up 11.0%; operating income $8.5m versus a $2.6m loss. Gross margin rose to 55.7% from 52.9%, supported by pricing, volume and lower freight costs.
- TestEquity: Q2 revenue $136.1m, up 39.0%, including $43.4m from acquisitions, while legacy revenue fell $5.2m amid weaker test-and-measurement demand. Operating loss was $3.2m; Adjusted EBITDA increased 9.8% to $9.5m.
- Gexpro Services: Q2 revenue $108.3m, up 8.5%, with organic growth; operating income rose 62.9% to $8.8m and gross margin improved to 29.9%.
Adjusted EBITDA is a non-GAAP measure and includes specified add-backs, including acquisition, integration, stock-compensation and other costs. It should be considered alongside, not instead of, GAAP results.
Cash flow, debt and liquidity
- Six-month operating cash flow was $27.5m, compared with cash used of $39.5m in 2022. Investing activities used $262.8m, primarily for the Hisco acquisition; financing activities provided $274.9m.
- At June 30, cash and cash equivalents were $44.2m; restricted cash was $20.6m. Total debt was $598.4m, including $305.0m borrowed under the incremental term loan for the Hisco transaction. Long-term debt, net of current maturities and financing costs, was $558.8m.
- Reported liquidity was $233.8m: $44.2m cash and $189.6m available under the revolving facility, net of letters of credit. The company reported compliance with its credit covenants at quarter-end. Approximately $30.3m of principal payments were due over the following 12 months; credit-facility loans mature April 2027.
- Hisco consideration was $270.4m net of cash, with potential earnout consideration up to $12.6m and $37.5m of employee retention bonuses payable in cash or stock, subject to service requirements. The acquisition purchase-price allocation remained preliminary.
Outlook, risks and unusual items
The filing gives no quantified full-year revenue, earnings or cash-flow guidance. Management expected to spend approximately $6m–$8m on capital expenditures during the remainder of 2023. It said the semiconductor chip shortage was weighing on TestEquity’s electronic production supplies business and anticipated recovery in late 2023 or early 2024. Management cited inflation-related supplier, transportation and labor costs, and said price increases were implemented in 2022 and 2023.
- The average U.S. manufacturing PMI was 46.9 in the first half of 2023 versus 56.3 in the prior-year period, indicating a weaker manufacturing backdrop under the filing’s stated interpretation.
- Disclosure controls and procedures were deemed ineffective at June 30, 2023 because of a previously identified material weakness in internal control over financial reporting. Remediation was ongoing; management had not concluded the weakness was remediated. DSG planned to exclude Hisco from its 2023 internal-control assessment.
- Pending matters include merger-related derivative litigation and a putative class action related to the 2022 cyber incident. The company said it could not reasonably estimate potential losses and recorded no amounts for these matters. It had accrued approximately $0.1m for environmental monitoring; future monitoring costs were described as fully accrued and not significant.
- LKCM-affiliated entities and CEO J. Bryan King beneficially owned approximately 77.9% of shares at June 30, 2023, giving them significant influence and creating controlled-company governance and potential share-sale risks.
- Other disclosed risks include acquisition integration, debt and covenant compliance, interest rates, inventory obsolescence, supplier concentration at TestEquity, cybersecurity, and the ability to fund working capital and acquisitions.
Most important facts for investors to verify
- Separate organic growth from acquired revenue, particularly Hisco’s limited contribution to Q2 and the acquisition-driven portion of TestEquity growth.
- Track legacy TestEquity demand, semiconductor supply recovery, and the durability of Lawson’s and Gexpro Services’ margin improvements.
- Monitor debt balances, borrowing availability, interest expense, required repayments and covenant headroom following the Hisco financing.
- Review integration costs, Hisco retention payments and earnout exposure, and final purchase-accounting adjustments.
- Follow remediation of the material weakness, the cyber and merger litigation, and any updates to estimated exposure or governance risks.