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

Good morning, and welcome to the Distribution Solutions Group First Quarter 2023 Earnings Call. In conjunction with today's call, we have provided a Q1 earnings presentation that has been posted on the company's IR website at investor.distributionsolutionsgroup.com. Please note that statements on this call and in the press release contain forward-looking statements concerning goals, beliefs, expectations, strategies, plans, future operating results and underlying assumptions that are subject to risks and uncertainties that could cause actual results to differ materially from those expressed or implied. In addition, statements made during this call are based on the company's views as of today. The company anticipates that future developments may cause those views to change and we may elect to update the forward-looking statements made today, but disclaim no obligation to do so. Management will also refer to non-GAAP measures and reconciliations to the nearest GAAP measures can be found at the end of the earnings release. The earnings press release issued earlier today was posted on the Investor Relations section of our website. A copy of the release has also been included in the current report on Form 8-K filed with the SEC. This call is being audio webcast on the internet via the Distribution Solutions Group Investor Relations page. A replay of the teleconference will be available through May 18, 2023. I will now turn the call over to Bryan King, DSG's Chairman and Executive Officer. Bryan?

Thanks, Steven and thank you all for joining to review our first quarter results. Joining me for today's call is Ron Knutson, DSG's Executive Vice President and Chief Financial Officer. Distribution Solutions Group delivered another record quarter of outstanding financial performance with expansion in both revenue and profitability. Steven mentioned the slide deck that we're using in conjunction with our prepared remarks. Starting on Slide 4, we delivered strong sales of 28% on a comparable basis, which included almost 14% of organic growth. In addition, we generated first quarter adjusted EBITDA of $39 million representing our fourth consecutive quarter of expanded EBITDA margin into the double-digits. We believe that our scale and breadth of products and services continue to provide competitive advantages in the specialty industrial distribution industry. Our DSG operational teams are working well together and we're seeing good evidence of wallet share growth, volume increases and encouraging and validating cross-selling wins as well as continued identification of an initiative to capture cost synergies across each of our verticals. The first quarter's results further confirm the financial and commercial logic of the combination that took place only a year ago, an improved business model we now enjoy. The strength, depth and strong collegiality across the combined expertise of our leadership team is enhancing our performance and accelerating building a best-in-class specialty distribution company with strong market leadership across several distinct but increasingly coordinated value-added verticals. As shareholders, together we will continue to benefit as our team identifies and executes on myriad value creation opportunities. As we highlighted during our fourth quarter call, we continued strong sales momentum in the first quarter. Our business has successfully captured market share, delivered incremental margin expansion and generated additional cash flow in our first fiscal period of this new year and culminated a…

Thank you, Bryan, and good morning, everyone. Turning to Slide 7. We're excited this morning to share with you the first quarter results of Distribution Solutions Group. Let me remind you that given the reverse merger accounting treatment, Lawson Products was not in the prior year first quarter results in 2022. However, all 3 of the businesses are included for the first quarter of the 2023 GAAP results. For ease of comparing the results, the slides that we're utilizing this morning adjust and include first quarter Lawson's financial results for 2022. But let me summarize the first quarter results. On a combined basis, we reported strong top line and bottom line results. As Bryan mentioned, we reported total sales growth of 28%, with organic sales growing 13.7% through both price and volume expansion. The first quarter results reflect 4 quarters of sequential margin improvement with Q1 finishing above 11% of revenue. I'll now walk through some of the specific numbers on a combined basis and most of this is on Page 7 of our presentation. First, consolidated revenue for Q1 was $348.3 million, with the inclusion of Lawson on a comparative basis, revenue increased 28% or $76.3 million over the first quarter of 2022, driven by organic growth plus approximately $39 million coming from acquisitions. Second, reported GAAP operating income was $16.7 million compared to $3 million a year ago quarter. On an adjusted basis, excluding merger-related costs, acquisition costs, stock-based compensation, severance and other nonrecurring items, adjusted EBITDA improved by $16.7 million to $39.4 million or 11.3% of revenue. And third, we reported GAAP diluted earnings per share of $0.28 for the first quarter compared to a loss of $0.25 a year ago quarter. On an adjusted basis, diluted EPS was $0.52 for the quarter versus 0 a year…

Thank you, Ron. Let's turn to Slide 13 for a few additional comments before we get into the Q&A. Our approach to capital deployment and working capital investments are not unique. Our underlying philosophy is anchored in a discipline to allocate capital to the highest return projects while building the best positioned long-term specialty distributor with the deepest and widest smoke possible around our value-added focus areas of leadership for our customers. Since we are an asset-light business, our organic growth primarily comes in the form of investment in trade working capital and great people as well as inorganic investments through M&A. We've invested significantly in all 3 over the last year. The returns on our incremental investments in working capital made to support organic growth or without a doubt, the highest returns on a pretax basis. They often approximate 80% to 100% or significantly higher, consistent with what we've observed over a long cycle have been and continue to be the returns of our peers of best-in-class specialty distributors. Our second best return on investment at this point is identifying and buying the most strategically enhancing but accretive acquisitions that make our specialty verticals, both individually and holistically more competitive. These acquisitions should enhance our ability to organically grow at a faster, more profitable rate. In turn, sustaining and driving higher returns on working capital, all of which will significantly cheapen back the purchase price. We certainly believe that Hisco like others we have done over the last years and others we are currently dialoguing with, will do that. While we are committed to this approach, we are not in any hurry to buy something that is only accretive. Along those lines, our debt leverage is an important focus, especially given the rising rate environment. And currently, our leverage…

[Operator Instructions] Our first question today is coming from Kevin Steinke from Barrington Research.

Ron, I appreciate your comments there about the fact that maybe the margin improvement won't be as when you're going forward as it has been, but obviously, you've hit that and now exceeded that near-term 10% goal that you had discussed. And when you get Hisco layered in, you expect that to accelerate improvement in your structural margin profile. Have you given any thought about what kind of the next target could be that we should think about in terms of adjusted EBITDA margin? Or is it kind of too early to commit to a particular number?

This is Ron. I'll take that and then maybe Bryan will make a couple of comments as well. So we've not publicly put out any specific percentages. But as we indicated in both Bryan's prepared remarks as well as mine, we did exceed our plan that we had initially set up for the first quarter, seeing a nice improvement of 300 bps over Q1 a year ago and also 100 bps over Q4. We ended Q4 at 10.3%, and we got to the $11.3 million -- what I would say is that, I mean, there were really no, I would say, kind of onetime items that gave us a big benefit in the first quarter. So to Bryan's point, structurally, I think all 3 of the businesses are getting the benefit of a lot of the actions that we took in 2022. So again, probably premature to commit to a percentage, but we're seeing that spillover effect of those actions that we made in '22 into '23. I did in my prepared remarks, I did indicate that we're up against some tougher comps as we enter into the latter half of the year. And I think to Bryan's point, certainly won't be as linear, and we're making investments within all 3 of the companies as well. So -- but we feel really, really good about the first quarter and not only the net margin expansion, but also the gross margin expansion as well. So I'll pause there and maybe if Brian wants to add some comments as well.

I think you said it well, Ron. What I would add to it is just to what Kevin's question about or alluding to structural margin. We demonstrated to ourselves and I think the marketplace, hopefully, that the business is able to generate now over 11% structural margins, and it's on a continuum that we see continuing to go up over time. There's going to be elements of -- when we pull TestEquity and Hisco together, we've said in our comments that together, it accelerates getting both of them up to similar margins to what the total company did this year, but coming from a lower level. And then Lawson has -- we've been talking for years about the contribution margin that Lawson enjoys when revenue is growing and pulling the businesses together is unlocking an opportunity for Lawson to access some new customers and to enjoy some growth that we had struggled with. And there are some really exciting initiatives that Cesar and his team have been working on to continue that growth and to really free up more opportunities for our salespeople to go hunt new customers or to super serve the customers that they've got where they're continuing to grow wallet share. So that -- we would expect that as those efforts that we're rolling out more this year and we've been working on at the first part of this year, are getting traction, that loss in structural margin, which was 14.7% this quarter, significantly higher than what we had been seeing in the last few years, but part of the real strategy here that we had pulling DSG together. -- are going to continue to march forward. So we think the whole is going to get pulled up. I don't think it's going to be linear. The slope was dramatic, obviously, between last quarter and this over 100 basis points in a quarter. And that's what I was trying to make sure that we measure -- have a more measured perspective. Especially distributors that are out there that are public. We've gone back and studied them through their continuums over the last 30 years. And to get -- to line up where we would like to and where we want to be, several hundred more basis points is our objective, but it's going to take us 3, 5, 7 years to get to where we think that we can get this business. So hopefully, that's helpful.

Yes, absolutely. Very helpful commentary. So where are we in terms of the journey with pricing? I don't know, Ron, did you mention the overall contribution to your 13.7% organic growth from price? And if not, what was that? And then I guess that would kind of play into the tougher comps perhaps as you move forward this year in terms of starting to lap some of those price increases?

Yes, I did not indicate the consolidated number, but out of the 13.7%, about 10 points of that was price related. And the other, call it, 3.5% to 4% was volume on a consolidated basis. And all three of the businesses we're taking -- continuing to take pricing actions and again, kind of the spillover effect from the actions taken in 2022 into 2023. So yes, you're right. It does play a bit into the tougher comps later in the year. I would say that we're still continuing to see some vendor cost increases come through, although they've moderated a bit from where we were in 2022. But all 3 of the businesses are keenly managing and expanding their gross margin percentage, not only from necessary pricing actions but other initiatives around freight, rebates, we put a portion of our costs up in the gross profit as well. So we're getting some basis points lift on just the increase in sales there on a higher sales base. So I think good progress on all fronts and certainly driving to expand that gross margin percentage over time as well. Short answer is about 10% of the 13.7% was price related for the quarter.

Got it. No, great. That's helpful. Just wanted to touch too on Lawson and it seems like some really strong momentum there. And you mentioned the 9% growth in ship-to locations. Any more just commentary on what's contributing to that? You discussed your expansion to new sales channels and what have you and just trying to get a sense of the momentum that's building there and perhaps could continue to build as you start to roll out some of the CRM tools and build out those sales channels.

Sure. So I can start and then maybe have Bryan jump in as well. So it's -- yes, very, very pleased on the Lawson results for the quarter, the 14.7% that Bryan quoted really nice improvement. And I would say that is primarily coming from sales growth as well as gross margin expansion and really leveraging our cost structure that we knew we could get. We've talked publicly about getting 30% to 40% flow through on the Lawson business. And I think you saw the power of that here in the first quarter of 2023. So relative to the 9% increase in unique ship-to locations, that's a metric that we're measuring across the entire business on all the segments and -- as I think about this for the investments that we've made in 2022 and not really just 2022, but even going back previous to that, Lawson has made some pretty significant investments in the strategic account area, where we develop long-term relationships with large customers servicing many of their locations with a pricing strategy and a rebate strategy. So we have specifically invested in strategic account managers and customer support individuals to support that piece of the business as well as the Kent automotive business. As we look at the trajectory of those 2 pieces of our business over the last 5 years, they've really been the strongest. And I think it's been not only developing those core relationships with the larger customers that are very sticky slightly less gross margins. So we're up against that from a headwind perspective, but we're still seeing gross margin expansion on a consolidated basis. So yes, it -- we're driving our business really from both existing customers as well as new customers. And certainly, those unique ship-to locations is a big piece of the overall growth for us.

Okay. Great. I just wanted to ask lastly here about what you've seen in April in terms of sales growth trends. And you mentioned some moderation in a few markets perhaps related to the economy, but it doesn't sound like that's a meaningful headwind at this point, I guess. So just any costs on April and the trend and the economy.

So Kevin, yes, I would say for April, we've continued to see pretty positive results. I would say, we've seen a little bit of moderation in some of the end markets. We both Bryan and I commented on the Test and Measurement side within the TestEquity business. But kind of putting that aside, -- for the most part, I would say our April sales are kind of running in line with where we exited the first quarter on a consolidated basis with a couple of markets being up a couple of our verticals being up, losses being up versus where we exited the first quarter. T&M being down a little bit. And I would say with injection of services, a little bit of a mix there, but we are seeing some growth now on the renewable side, which we were up against some weaker numbers a year ago. But overall, we feel pretty good about where April is finished from a sales perspective, and don't see any major red flags that sit out there here for the month.

Kevin, I just would add that we're -- we spend a lot of time looking at all of our collective end markets that we're serving and trying to understand how to continue to add balance to them so that we -- between MRO and OEM, which Cisco does some very deliberate things for us. And so we are encouraged as we kind of look at what we're trying to build longer term in terms of kind of some of the -- I'm about to fall into my CFA talk, but correlation coefficients of the different industries and different economic backdrops. And so we're -- right now we're seeing things like renewables where a year ago, the one acquisition that we had made at Gexpro Services that was actually -- when we reported last quarter, how exceptionally well, we brought down EBITDA multiples on acquisitions that we've made over the course of 12 months. The one that was the outlier to the negative, even though our average was very good was the fact that renewables had given us some challenges. And we knew that we had a tough backdrop there. And that backdrop is starting to really open up. And the strategy that Bob and his team put in place by pulling some renewable pieces together in order to have a much more robust offering for that market to firm up our leadership in that market is taking hold. And so while we aren't yet getting the benefit of that market being back at peak levels, the acceleration there is comping against much easier comps a year ago. We're enjoying aerospace and defense is a strong space for Gexpro services right now. And so they have some verticals that are stronger. We went into the year anxious about their semiconductor end…

And the next question is coming from Brad Hathaway from Far View.

Thanks for an incredible job in the quarter and really impressed with both the organic growth and the incremental margins. I didn't think we'd see 11% this quickly, so well done on that. I wanted to ask you quickly, though, to double-click on the cross-selling, both between verticals, which I think you've talked about a bit before and also, I think you mentioned a little bit within verticals, I think you mentioned in the Gexpro section, something about with it. And I'd just love to understand kind of maybe a little more detail on some of the opportunities you see there both from -- between Gexpro and Lawson, but also within Gexpro, within TestEquity themselves.

Ron, I'll lead on this, and then I want you to help me get some tightness on what I'm saying. Brad, the example I used on renewables is probably one of the best examples that we've got to show how -- pulling some of these acquisitions together inside of a vertical has accelerated opportunity. But then in addition to that, it's pulling what Bob coined early on, the power of three, which is the way that he's been really firing his sales force at the Gexpro services to go out and engage with their embedded relationships. And so there's the renewables piece, we needed to land the -- some of the hearing a little bit of feedback. But we were -- we needed to land some of those major OEMs in the renewable space. We had some of them. We didn't have all of them. And so the acquisitions themselves are bringing deep engagements with certain customers that we knew that we had a broader product offering that we could set of solutions that if we could get tightly coupled with them that we could broaden out our engagement with. And so on the renewable side, there was one of the major OEMs in the wind space that we did not have as much of an engagement with or relationship with. And one of the acquisitions brought that relationship with then several of our acquisitions that we made on Gexpro solutions were deliberately mapped out to significantly expand our solution -- our ability to provide solutions for not only the OEMs that we were working with, but the OEM that we landed through an acquisition. And that has given Bob and his team an ability to take a much more robust set of offerings to them. We've led with being…

I would add, Brad, just there's an excess of 300 active leads. I think we talked about this on the Q4 call, where we are incentivizing our sales teams across all of the companies to bring these leads that Bryan referenced into the other organizations. So we're actively working in excess of 300 leads. And it has been realized sales multimillion already coming through. Now some of that happened in 2022. But I would say it's on a steeper scale as we enter into 2023. So I mean, it's not an 8-figure number yet from a sales perspective, but it's a few million dollars that we've been able to realize on top line growth.

And the next question is coming from Katie Fleischer from KeyBanc Capital.

On for Ken today. I wanted to follow up on your pricing -- or on the pricing question from earlier. Can you clarify if price cost was positive to margin? And what's the expectation for the rest of the year?

So yes. So Katie, yes, so the -- you're referencing back to the 10% pricing that I commented on. Yes. So we've seen more of that. I would say, here in the first quarter, given that we are lapping some of the price increases we put through during 2022. So we wouldn't expect as we enter into the latter half of the year for that pricing to stay at 10% of our combined increase on a quarterly basis for every quarter on a go-forward basis. I'd say as we think about timing in terms of some of those actions we did in 2022, they were probably later in the year versus even in Q2. So I think we're probably up against less headwinds from a pricing standpoint here in the second quarter, but probably more so in the latter half of the year. So I don't know if that answered your question or not. I mean we've not come out with any kind of formal guidance relative to what we think pricing will be from an overall perspective. But what I will say is we're still taking pricing actions in 2023 across the businesses. We're still, as I mentioned earlier, seeing some vendor increased cost increases coming through. And so we're certainly not sitting on those and absorbing those internally. We are passing -- continue to pass those -- that effect along. So -- and generally speaking, the customers have been understanding and willing to take those increases certainly in 2022 and so far here in 2023. Certainly, some conversations with some customers about tightening up a bit on that. But generally speaking, I would say that the customers are supportive in understanding those actions.

I mean, your question, I think, was pretty straightforward and that are we -- are our price actions more than eclipsing the inflationary pressure that we're feeling from our cost of goods sold to our vendors. And the short answer is absolutely. And then the longer answer is there's -- so yes, we have more than been able to capture margin and we're continuing to. The difference between specialty distribution and broad-line distributors or commodity distributors is that in periods like this, even our other services and capabilities are giving us flexibility with our customers to not only make sure that we're protecting margin on the product side, but also on the value that we're bringing with the other capabilities and the people that are supporting it. And so we're absolutely continuing to look at and make sure that we are more than being rewarded for the total capabilities besides just the cost of the actual product that we're selling through. And so it has been margin-enhancing at both the gross margin level and the EBITDA margin level.

And Ron, just to clarify one point that you made there. You mentioned before that the vendor cost increases, those are starting to moderate, correct?

Yes.

Another question here. So you talked about easing lead times in some of the individual businesses. I was wondering if that's impacting inventory decisions at all. And if you think that could lead to faster backlog monetization at the customer level?

So we definitely have seen our supply chains get easier or easing. And we did take actions a year ago and even before to make sure that we had product on hand for our customers and that did increase our working capital investment and our inventory position. This year, we think that we're going to see some real tightening up on our working capital investment. That's one of the things that we went into the year as a focus point. And we're -- the different verticals are working on that. The incremental returns have been really good just because we've had the updraft of EBITDA to go along with the increase in working capital investment. But we think they can go even better. And -- but there's the anxiety, I think, on our part of making sure that we had product on hand for customers and maybe buying more aggressively or leaning into inflationary pressures from our vendors by stocking deeper is some of that abating. And so that allows us to operate with more confidence with a leaner inventory position. Ron, I don't know whether or not we're seeing -- I think part of your question maybe, Katie, are our customers changing their purchasing behavior because they are also not as anxious. And to the extent that they were -- they're buying from us, and we're stocking more around -- and this is -- Ron, you can correct me on this, but the way that we think about it and talk about it as a team is that our customers are giving us forecast around what their needs are going to be. And we're really holding that inventory oftentimes until we're loading it into their bends, putting it on their site or managing it at the production line as…

Bryan, I think well said. I think we're seeing certainly some easing taking place on some of the -- on getting product. What we don't believe we've seen is that the pull-through from our customers is decreasing because they were -- they had inventory stocked up at an excessive level. So we still saw in the EPS business at Test and certainly with injection services and Lawson, we saw nice volume increases as well, not just price. So we're not seeing significant pullback from our customers as they try and normalize their inventory levels. And to Bryan's point, I mean, Gexpro is so well -- Gexpro Services is so well connected into the production process with the customers that they've got a great read on what the future need is for their customers and they're able to go out and source that product on a timely basis to help their overall production cycle. So -- and within the Lawson business, there's certain items that are on back order with our customers. We track that. It's pretty isolated in terms of specific SKUs. But for the most part, we've seen a decrease in back orders as well, which is an indicator that the supply chain is easy for us to be able to get that product.

Okay. That's helpful. And then just one last question for me. So I wanted to clarify on the margin cadence commentary from earlier. Should we expect an outsized move to margin sequentially versus normal seasonality? Is that what you're trying to get at?

Yes. Let me make sure I understand your definition of an outside movement beyond seasonality.

Yes. I guess just in terms of the sequential moves versus the normal seasonality, you're saying it's going to be less linear than it was in the past. In terms of sequentially, is that you're expecting an outsized difference versus prior years?

Yes. So let me try and address that from a seasonality perspective. I would say, generally speaking, Q2 and Q3 across the platform are the strongest quarters. We did see, again, we saw the nice lift here in the first quarter. And -- but generally speaking, we would see Q3 and Q4 -- sorry, Q2 and Q3 being the strongest, probably Q4 being the weakest just because of fewer selling days and then Q1 fallen after Q2 and Q3. So I think our commentary around the linear piece of that really gets to the 300 bps improvement that we saw over a year ago quarter in that when you think about the second quarter of 2022 versus where we end up here in Q2 2023, it may not be that linear. As we think about where we exited the first quarter, certainly, we believe that we can still create margin expansion and operating leverage on the top line sales growth. So Again, I think what we're saying is don't expect a 300 bps improvement every single quarter as we move throughout 2023, but exceeding 11% sets a really nice baseline to start sequential growth on as we develop the rest of 2023.

So Katie, I kind of hit on that at the end of my prepared remarks. And I just wanted to make sure that we knew when we pull these businesses together and we know from where we are today, what our longer-term objectives are. But -- and we've had conversations that we aren't going to try and give like near-term milestone guidance on where EBITDA margin should be. But what we did say a year ago was that we expected at this time of a year ago, we made the strong comment that we were -- and at that time, we were at 8.3% EBITDA margins or 8.6% EBITDA margins. And we said we -- pulling the businesses together, we expected to be -- to end the year at over 10% on a run rate basis. And we actually ended the year at slightly above that. I think it was 10.4%, something like that. And now we've moved up to where we're operating -- where we had a strong quarter at 11.3%. And we know we've got a long march to a much different structural EBITDA margin objective for this specialty distributor. But we don't expect that we're going to be picking up a couple of 100 basis points a year or over a 12-month period again. It could happen. But really, what we think is going to happen is that we're going to be continuing to have significant milestone objectives at each of the verticals. And as those verticals move up from where they have historically operated, it's going to create a blended margin of -- for the DSG kind of from a specialty distributor perspective, that's going to move DSG up more consistent with what I would expect we should have out of this type of a scaled-up…

Katie, just I just wanted to point you to on Slide 8 of the deck. We reflect what the margins are inclusive of all the acquisitions. In Q2, I think this gets to our points, Q2, inclusive of all the acquisitions that we made for the -- even the pre-acquisition period, our adjusted EBITDA percentage was 9.6%. The GAAP reported numbers was 8.3% Q2 a year ago, but inclusive of all the acquisitions that have been made, which certainly will be there in Q2 of '23 as well. If you were to look at that from a year ago, it's the 9.6%. So I think that's exactly to our point, is that kind of don't expect a 300 bps movement in over a year ago. So that margin percentage was not inclusive of the acquisitions, 9.6% in Q2, 9.9% in Q3, 10.3% in Q4. So it kind of comes back to the commentary around a lot of the actions that we took in 2022 helped drive the performance later in the year and accordingly, some tougher comps here in the second half of the year.

I would now like to turn the call back to Bryan King for closing remarks.

Thank you, operator, and thank you for those that joined us today for the call. And absolutely, thank you to all those folks that work for DSG for allowing us to have a great quarter and continuing to operate so well together as we look prospectively at what we're building. So thank you for your interest in DSG. We're excited about being your partner and we are optimistic about the business that we will continue to be together with you on. Thank you.

We look forward to talking to you next quarter. Have a great day.

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