Business context and reporting period
Distribution Solutions Group, Inc. (NASDAQ: DSGR) reported the quarter and nine months ended September 30, 2022. Formerly Lawson Products, the company changed its name in May 2022 and operates Lawson, TestEquity and Gexpro Services, serving MRO, OEM and industrial technology markets.
The April 1, 2022 mergers with TestEquity and Gexpro Services were accounted for as a reverse acquisition. Accordingly, historical results reflect TestEquity and Gexpro Services as the accounting acquirer, while Lawson results are included only from April 1, 2022. The reported year-over-year comparisons are therefore not like-for-like.
Financial performance and position
| Metric | Q3 2022 | Q3 2021 | Nine months 2022 | Nine months 2021 |
|---|---|---|---|---|
| Revenue | $347.2 million | $132.1 million | $822.6 million | $391.1 million |
| Gross profit / margin | $119.2 million / 34.3% | $34.8 million / 26.4% | $274.6 million / 33.4% | $98.8 million / 25.3% |
| Operating income / margin | $22.0 million / 6.3% | $5.5 million / 4.2% | $29.1 million / 3.5% | $13.2 million / 3.4% |
| Net income (loss) | $16.5 million | $1.2 million | $9.3 million | $(0.2) million |
| Diluted EPS | $0.84 | $0.12 | $0.53 | $(0.02) |
| Adjusted EBITDA (non-GAAP) | $34.7 million | $11.8 million | $79.9 million | $30.2 million |
Q3 revenue growth reflects the merger and acquisitions as well as organic growth. Management reported organic growth of 16.9% at TestEquity and 13.9% at Gexpro Services; Lawson’s comparable revenue increased 16.8%. Lawson’s gross margin declined to 51.4% from an adjusted 54.6%, primarily due to inflation, supply constraints, customer mix, a $1.7 million inventory charge and merger-related inventory step-up amortization. TestEquity and Gexpro Services reported Q3 gross margins of 23.1% and 28.9%, respectively.
Q3 net income included a $9.6 million benefit from remeasurement of merger earnout liabilities. For the first nine months, results also included a $3.4 million loss on extinguishment of debt and $9.6 million of merger transaction costs. These items affect comparisons with underlying operating performance.
At September 30, 2022, cash and cash equivalents were $25.2 million. Total debt was $418.8 million, including $123.9 million drawn on the revolving facility; net of letters of credit, revolver availability was $75.1 million. Reported liquidity was $100.3 million. The company was compliant with its financial covenants. Total assets were $1.23 billion and stockholders’ equity was $546.7 million.
Operating activities used $19.3 million of cash in the first nine months, compared with $17.1 million provided in the prior year. The company attributed the outflow mainly to higher receivables and inventory associated with sales growth, inflation and supply-chain disruption. Investing activities used $120.6 million, largely for acquisitions; financing activities provided $151.8 million. Management stated available cash, credit availability and operating cash flows should meet liquidity needs for the next 12 months; scheduled principal payments over that period were $15.0 million.
Material changes, outlook and risks
- The mergers and 2022 acquisitions substantially expanded the company and its balance sheet; preliminary purchase-price allocations remain subject to refinement. Goodwill was $351.1 million and net intangible assets were $236.9 million at quarter-end.
- Management cited persistent inflation, supplier-cost increases, transportation and labor expense, and supply-chain constraints as pressures on fulfillment and margins. Price increases have generally helped offset higher costs, but the company cautioned that pass-through may not be complete or timely.
- TestEquity’s electronic production supplies business remained affected by semiconductor shortages; management anticipated recovery might not occur until 2023. TestEquity also relies on one supplier for a significant portion of inventory purchases.
- The filing provides no numerical revenue, earnings or margin guidance. Management described plans for organic growth, acquisitions, digital-commerce investment and operating synergies, while noting execution and integration risks.
- A February 2022 cybersecurity incident potentially involving unauthorized access required notifications and other response measures. The company had recorded a $0.4 million insurance receivable and could not estimate total remediation costs.
- A shareholder derivative action related to the mergers was filed October 3, 2022. DSG intends to defend the action but could not estimate a reasonably possible loss; no amount was accrued. The company also disclosed less than $0.1 million accrued for environmental monitoring.
- Contractual inventory purchase commitments were approximately $167 million, expected to be paid within 12 months. A November 2022 board action increased the stock repurchase authorization to $12.5 million.
- Entities affiliated with LKCM and company leadership held approximately 75% of shares after the mergers, creating concentrated voting influence. Up to 1.7 million merger-related shares may be issued under earnout provisions.
Important facts for investors to verify
- Use pro forma and segment disclosures to assess performance on a comparable basis: reported consolidated comparisons omit pre-merger Lawson results and include acquisitions for differing periods.
- Separate recurring operating performance from the $9.6 million Q3 earnout remeasurement benefit, merger and integration costs, inventory adjustments and debt-extinguishment loss.
- Monitor working-capital conversion and operating cash flow, given the nine-month cash outflow and substantial inventory and receivables balances.
- Track debt, variable-rate financing costs, covenant headroom and revolver availability as the company funds integration, acquisitions and working capital.
- Assess margin recovery and integration progress amid inflation, supplier concentration, chip shortages, supply-chain constraints and the company’s sizable purchase commitments.
- Follow resolution of the derivative lawsuit, the cybersecurity incident, acquisition purchase-price allocations, potential earnout share issuance and internal-control integration. Management said disclosure controls were effective, but planned to exclude TestEquity and Gexpro Services from its 2022 internal-control assessment.