Distribution Solutions Group, Inc. — Q1 2023 Form 10-Q
Business context and period. This unaudited report covers the three months ended March 31, 2023. DSG distributes products and services to MRO, OEM and industrial technology markets through Lawson, TestEquity and Gexpro Services. The April 2022 mergers materially affect comparisons: Lawson and holding-company results are included in Q1 2023 but not Q1 2022. The reported periods are therefore not directly comparable.
Financial performance and position
| Metric | Q1 2023 | Q1 2022 |
|---|---|---|
| Revenue | $348.3 million | $154.1 million |
| Gross profit / margin | $132.9 million / 38.2% | $40.9 million / 26.5% |
| Operating income / margin | $16.7 million / 4.8% | $3.0 million / 1.9% |
| Net income (loss) | $5.9 million | $(2.5) million |
| Diluted EPS | $0.28 | $(0.25) |
| Adjusted EBITDA (non-GAAP) | $39.4 million | $13.5 million |
| Operating cash flow | $13.9 million | $(13.5) million |
The reported revenue increase chiefly reflects the added Lawson operations and 2022 acquisitions, rather than organic growth alone. On management’s adjusted, non-GAAP basis, Lawson revenue increased 19.4% year over year, while its operating income declined 25.7% to $8.2 million. TestEquity revenue rose 48.3% to $107.4 million, mainly from acquisitions; operating income was $0.03 million. Gexpro Services revenue rose 23.7% to $101.0 million, including 18.7% organic growth; operating income increased to $7.4 million.
At March 31, 2023, cash and cash equivalents were $31.1 million; total assets were $1.23 billion and stockholders’ equity was $572.4 million. Debt was $415.9 million gross, including $16.1 million current, and lease liabilities totaled $49.8 million. DSG reported $69.8 million of remaining revolver availability, or $100.9 million of total liquidity including cash. The weighted average borrowing rate was 7.1%. The company was compliant with credit-facility covenants at quarter-end; $15.0 million of principal payments were due over the next 12 months.
Material changes and notable items
- Operating cash flow improved by $27.4 million year over year. Working-capital investment included $6.0 million in receivables and $7.2 million in inventory; accounts payable provided $11.2 million.
- Investing cash outflow was $5.1 million, including $4.5 million of property, plant and equipment purchases and $2.4 million of rental equipment purchases. Financing cash outflow was $2.4 million.
- DSG issued 1.7 million merger earnout shares on March 20, 2023; the maximum shares available under those merger earnouts have now been issued.
- Inventory reserves were $12.9 million, about 4.5% of gross inventory. Management estimated a 100-basis-point change in the reserve rate would affect cost of goods sold by $2.7 million.
- Q1 Adjusted EBITDA is a non-GAAP measure and includes $2.9 million of acquisition-related costs, $1.2 million of merger/integration costs, and other adjustments. It should not be treated as a substitute for GAAP earnings or cash flow.
Outlook, risks and contingencies
Management said cash, operating cash flow and available credit should meet liquidity needs for the next 12 months. It expected $14 million to $16 million of capital expenditures during the remainder of 2023. No full-year revenue or earnings guidance is provided in the filing. Management cited inflation-driven supplier, freight and labor costs and price increases implemented in 2022 and 2023. The average manufacturing PMI fell to 47.1 in Q1 2023 from 57.8 a year earlier. TestEquity said semiconductor shortages were weighing on its electronic production supplies business and anticipated recovery in late 2023 or early 2024.
On March 30, DSG agreed to acquire Hisco for $269.1 million at closing, with a potential earnout of up to $12.6 million and $37.5 million in employee retention payments. Closing remained subject to customary and regulatory conditions. DSG planned to finance part of the purchase with additional debt and a rights offering expected to raise approximately $100 million. The offering commenced May 9, after quarter-end; LKCM and affiliates, with approximately 77% ownership, indicated an intention to subscribe for their pro rata share and any unsubscribed rights.
Key risks include substantial indebtedness and interest-rate exposure, future covenant compliance, acquisition execution and integration, supply-chain and inventory obsolescence risks, and reliance on key suppliers. Contractual supplier purchase commitments were approximately $174 million for the next 12 months. A merger-related derivative action and a putative class action concerning the 2022 cyber incident remain unresolved; DSG could not estimate potential losses and recorded no amounts for these matters. A previously reported material weakness in internal control over financial reporting remained unremediated at quarter-end, and management concluded disclosure controls were not effective. LKCM’s concentrated ownership may give it significant influence over shareholder matters.
Investor verification priorities
- Assess performance on a comparable basis, separating Lawson’s added contribution and acquisitions from organic growth; reconcile non-GAAP Adjusted EBITDA to GAAP results.
- Review the Hisco transaction’s closing status, final financing mix, rights-offering proceeds, dilution, retention payments and any resulting leverage.
- Track cash conversion, inventory and receivables, supplier commitments, and the cost and availability of borrowing.
- Monitor remediation of the material weakness and whether management later reports effective internal controls.
- Follow developments in the merger and cyber litigation, and any changes in estimated exposure or related costs.