Good day, and welcome to the Distribution Solutions Group First Quarter 2024 Earnings Conference Call. [Operator Instructions] Please note this conference is being recorded. I will now turn the conference over to your host, Steven Hooser, with Three Part Advisors. Sir, you may begin.

Good morning, everyone, and welcome to the Distribution Solutions Group First Quarter 2024 Earnings Call. Joining me on today's call are DSG's Chairman and Chief Executive Officer, Bryan King; and Executive Vice President and Chief Financial Officer, Ron Knutson. In conjunction with today's call, we have provided a financial results slide deck that is posted on the company's website at investor.distributionsolutionsgroup.com. Please note that statements made on this call and in today's 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 described. 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, 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 our earnings release. The earnings release issued earlier today was posted on the Investor Relations section of our website. A copy of the release has also been included in a current report on 8-K filed with the SEC. Lastly, this call is being webcast on the Internet via the Distribution Solutions Group Investor Relations page on our website. A replay of the teleconference will be made available through May 16, 2024. With that, I'd now like to turn the call over to Bryan King. Bryan?

Thanks, Steven, and thank you all for joining us to review first quarter 2024. I'll be starting on Slide 4 to review overall financial results. Our 2024 first quarter sales totaled $416 million, up 19.5% on strategic inorganic growth compared to the first quarter a year ago. As we signaled on our Q4 2023 call, DSG was up against double-digit comps in the first quarter of 2023 of nearly 14% and faced continued softness in certain end markets, which we will highlight later in the call. Despite those continued pockets of softness, we maintained a positive organic trajectory on a 2-year organic basis of 4.7%, which we acknowledge is below our expectation for organic growth that we require from our investment initiatives into the business when we use a longer time horizon lens. Consolidated EBITDA margins enjoyed a sequential improvement from 8.4% in the fourth quarter of 2023 to an adjusted EBITDA margin of 8.7% in the first quarter of 2024, but we're below where we expect them to be, partially because of the pockets of end market softness, but also significantly influenced by the internal initiatives that we are executing, where there are near-term costs, but where real expense optimization and profitability and efficiency is getting unlocked. We continue to enjoy strong visibility into how those initiatives are reworking significant elements of our cost structure while visibly improving our value-added offering for our customers and customer-facing colleagues and refining the profitability discipline on that revenue across each of our 3 DSG verticals. Today, I will reemphasize DSG's overarching goals and longer-term performance milestone objectives, reinforcing our confidence in the huge opportunity in front of us and the material progress we are making, even in the face of some marketplace softness and the accountability and engagement our collective team embraces.…

Thank you, Bryan, and good morning, everyone. Turning to Slide 5. I will first summarize our business, which includes our acquisitions for the trailing 12 months. Lawson represents 31% of total DSG revenue, Gexpro Services 23%, and the TestEquity Group represents 46% of revenues. Our run rate adjusted revenue is now approximately $1.73 billion. And as Bryan mentioned, we serve over 180,000 customers across more than 500,000 SKUs. Now turning to Slide 6, I'll summarize the reported results for the first quarter, and then I'll break out each reporting segment. Consolidated revenue for the quarter was $416.1 million. This represents an increase of $67.8 million or 19.5%, primarily driven by the 2023 and 2024 acquisitions. Excluding the acquisitions, organic sales declined by 8.6% on a comparable day basis, however, grew 4.7% on a 2-year stacked basis. The organic decline versus a year ago was driven primarily within the Test & Measurement business and very strong comps from a year ago in all verticals. On a sequential basis versus the fourth quarter of 2023, organic sales grew by 2.1% as we saw several end markets such as technology, strengthen sequentially and also realize continued strong sales in aerospace and defense. Q1 of 2024 reflected growth in net margin dollars of $2.2 million versus the fourth quarter of 2023. As indicated on the Q4 2023 earnings call, we expected margin pressure in the first half of 2024. While the quarter ended with softer sales, our margin profile came in line with our near-term expectations. For the quarter, we generated adjusted EBITDA of $36.1 million or 8.7% of sales, a sequential improvement over 8.4% in Q4, and I'll expand further at the segment level here in a minute. We reported operating income of $2.8 million for the quarter, net of $10.7 million of…

Thank you, Ron. The first quarter met our near-term targets, especially given the continued softness in the several end markets highlighted, and we're pleased to see positive trends in many verticals that have been under pressure for several quarters. Turning to Slide 11. DSG's capital allocation framework remains disciplined and flexible, encouraging healthy competition for capital across our businesses. At the core, we believe in the compounding effect of cash flow reinvestment in the business on a per share basis. With a focus on bridging to higher structural margins, we believe that inorganic growth provides strategic opportunities for bolt-on acquisitions that provide us scale, geographic density, new customer channels, cross-sell opportunities and product or service level category expansion, all with an objective to enjoy sustained and structurally higher returns on invested capital, more driven by organic growth than inorganic growth as the platform matures. Finally, the capital allocation equation will not be complete without focusing on prudent debt paydowns and opportunistic share repurchases. These allow us to rebalance the company's weighted average cost of capital and return capital to the shareholders, especially as the platform matures. Combining our asset-light model and increasing working capital efficiencies improves our overall liquidity position, allowing us to reduce our net borrowings. Let me wrap up my comments on Slide 12. The first quarter showed sequential top line and bottom line progress against challenging prior year sales comparisons and some very real pockets of soft demand. Lawson had solid margins as we continue to dial in a number of the key initiatives and acquisitions for our longer-term opportunity to take this unique VMI offering to structurally higher margins. Gexpro Services returned to double-digit margins as expected and enjoyed seeing its collection of end market verticals firm up confidence in their OEM schedules for the back…

[Operator Instructions] Our first question is coming from Tommy Moll with Stephens Inc.

I wanted to start on S&S. I presume that was a directly sourced deal. So any context you could give us on a relationship there, how the deal came to you and then also just the go-forward on integration? And while I'm at it, Bryan, you said some complementary things about your development team. You want to put a bogey on how many more deals you'll get over the finish line this year. It sounds like the pipeline is full.

Thanks, Tommy. Let's start with S&S, and I'll let Ron add some additional color here. But -- so the Kent Automotive division, which was something that was bought, Ron, maybe 20 years ago or so?

Yes, 20-plus.

Over 20 years ago, is the kind of a line of business inside of the Lawson Products business model, very similar, but just largely discrete set of SKUs for collision and maintenance repair work on automotive. And S&S was the best competitor that was competing with us in the Midwest. And they had built a really strong, dense market share. They were started in the 60s, I think, early 60s, 2 families owned them. And the operating family that had kind of taken over from the original founding family had done an extremely good job running the business. And so we started a dialogue with them maybe a couple of years ago. And this has taken quite a long time and a lot of time on both sides to try and work through getting a transaction done. But it was so important to building value in the Kent Automotive division that our leadership team and our corporate development team and the sellers stayed committed to the process. So we're -- we couldn't be more excited about an acquisition that we've done over the last several years. This one took a lot of effort from a lot of people, not to take anything away from others that we've done. But yes, it was direct source, it was direct dialogue. There were lots of nuances to work through, but it provides a tremendous amount of EBITDA margin uplift and strategically an opportunity for complementary product leadership to drive structurally higher organic revenue opportunity for both sides over the coming years. As we've started to do more work on Lawson Products and I'll digress just for a second, I know I'm going to get trouble for this. But there's lines of businesses inside of Lawson that are not -- don't have structurally today…

Yes. The only thing I would add to that, Bryan, is a lot of the Kent Automotive growth over the many -- over the past few years has been certainly building relationships with auto dealerships, but also heavier in the collision repair shops. And S&S Automotive heavily focused on auto dealerships. And so typically, there -- the auto dealership spend is typically greater than a collision repair shop. So to Bryan's point, I think it puts us in a great position, there's -- to expand SKU availability within all of the end customers, very really little to no end customer overlap and very little SKU overlap as well. So great opportunity on both ends to be able to leverage both product availability and then also really having now a foothold into servicing the auto dealership market.

I wanted to follow up on the outlook you provided. Ron, I appreciate the context on the second quarter from a revenue standpoint. I wanted to ask on margin, just to make sure I heard you correctly. Did I hear you say for each segment and then obviously for the consolidated results, you're looking for margins to be up sequentially in 2Q? And if I did hear that correctly, any noteworthy callouts on that trajectory would be appreciated.

Sure. Yes, Tommy. So yes, you did hear that correctly. From an organic sales perspective, we've got certainly visibility into the first month of the quarter here. Again, we'll be up against some sales pressure against the, call it, 5% organic growth that we realized in the second quarter of '23. And then just, I would say, probably some continued pressure that sits out on Test & Measurement that seems to be kind of prolonging longer than what we initially anticipated from probably as we were looking at this late last year. From a margin perspective, yes, you heard that correctly as well. Our expectation going into the second quarter is that we would realize margin -- incremental margin improvement sequentially within all 3 of the verticals. Individually, there's initiatives taking place within Lawson, Gexpro Services and TestEquity Group to be able to -- for us to be able to make that comment. And we feel like we're on a nice path as 2024 develops to be able to sequentially see some improvement there. We -- as you know, we don't provide formal guidance. So I can't really give you a number around that, but we do expect sequential improvement from where we ended the first quarter.

Just on -- Ron, on the -- just to add that, one of the things that we did get with the close of April was -- and again, 2 months is not a trend is that we're seeing -- we've seen now 2 months of a very slight tick up relative to what we saw in the fourth quarter and the first couple of months of the first quarter on the Test & Measurement side. So we're hoping that what that is indicating is more clean channel in terms of inventory overhang. And we are feeling like that there's money out there to spend on test and measurement equipment. It's just a matter of the confidence that the customer has in letting that spending on more of a capital asset loose.

Our next question is coming from Kevin Steinke with Barrington Research.

So I just wanted to ask about the Lawson sales representative head count, about 860. It seems to be down a bit from where it was historically, but you also mentioned that you had open positions that you're recruiting for and you want to build that out in certain territories. So maybe just talk about the trend in the Lawson sales rep head count, both kind of from an attrition standpoint and where you'd like to grow it, how do you like to grow it going forward?

Sure. Kevin, I'll take that. So yes, as we commented in our prepared remarks, we are down slightly from an overall head count perspective. And I would say that it's not overly unexpected through some of the changes that we put in place through 2023 to help our sales reps become more productive, along with some of the shifts that we've talked about in terms of building out our inside sales team and so forth. We did expect that we would take incrementally a few steps down just in terms of the total count. We are actively, in the marketplace, recruiting for additional sales reps, and I would say probably better defining the territories that we believe that can drive our sales on a go-forward basis. We are now looking at more of a combination of really very specific market data in terms of those end markets that we believe can really provide an opportunity for us, not only for where some of our existing sales reps are at, but also new territories that we can enter into. So we -- we've -- so again, I wouldn't say that it's overly surprising that we're down from a rep count perspective. We'll say that for us, feet on the ground and a number of inside sales reps can put some pressure on our average daily sales just in terms of the number of sales reps on a combined basis that are out actively selling. But we believe that, that's part of the growth as we move throughout the rest of 2024.

I'm just going to touch on that. Kevin, the part of Cesar and the analysis that we did, we brought in a -- we intuitively -- Ron and I've known this now probably for the last couple of years. It was refreshing for Cesar in bringing in an outside consulting firm to really look at what we needed to do in order to make sure that our reps were making structurally more money while at the same time as our cost to serve was also heading in the right direction. And so we had, at one point, Ron, 1,050, almost 1,100 reps, and we had [indiscernible] territories at that time. And today, the way we look at the business is more like at this stage, 900 -- there're 900 defined territories. And so that means that we kind of went back and reworked and looked at what a territory needed to look like in order to make sure that we were allowing a sales rep an opportunity, both someone who is a starting rep to get to have a higher likelihood of success and to get to profitability for us faster. We're adding a lot of tools for them, which are also going to help them. But a lot of the insight is taking territories that we had that were maybe too thin or that were -- that needed to be reworked. And it's hard to do that when you've got somebody in those territories. And so part of the process was making sure that we -- as we've had some turnover that we were slow to backfill some of those chairs so that Cesar and his team could really look at how to consolidate and rework and to get some better organization out of how we had our territories…

No, that's fine, Bryan.

There's 70 chairs that we're chasing right now, Kevin.

[Operator Instructions] Our next question is coming from Katie Fleischer with KeyBanc Capital.

I'm on for Ken Newman today. I was wondering if you could give a little bit more color on the commentary from the government orders that drove some of the weakness in Lawson and maybe when you would expect an inflection in that.

Yes. I hit that in my early comments and Ron can probably give more discreteness to it. There was a change in the way that the government -- every 5 or 7 years, I guess, they change their order entry program, and that's something that could be disruptive for all of us that sell in -- small piece goods into the Class C parts into the government. And then there's also was just kind of a lot of spending that was -- that we knew -- that we know is out there and that we can see that's coming towards us, but it was a pretty significant delay in some spending that took place in the first quarter. There was about equal parts between a broad set of customers across our up and down the street core business at Lawson and then government. And the 2 of the -- decrease from prior year first quarter for Lawson was about equally weighted to those 2 areas or strategic accounts were up in the first quarter versus a year ago, and that's just continuing to grow engagement with the relationships that we've got there. But that was a big detractor to Lawson's organic growth in the first quarter. Ron, do you want to...

Yes. Bryan, I would just add to that. You're spot on in terms of the ordering system that we're now and others as well are required to go through. And it's just a longer process, Katie. So it's -- we saw some of that decrease versus a year ago within that end segment for us. The other piece I would say is, I mean, the government, the military business is its great business for Lawson. I mean there is a high demand of the consumable Class C parts that we sell. We've not lost any locations, any large locations that we've historically seen some pretty large volumes in the past. So it's not that we're concerned about any customer attrition around that. It's just -- it's more timing. Our sense is that, that will come back to us for the most part throughout the rest of 2024. Certainly, it's not an all catch up, let's call it, in 1 quarter. I think it will come back gradually to us as 2024 develops.

Okay. That's helpful. And then just one more on Test & Measurement. So I know you mentioned that it's difficult to have a really strong sense of when these markets are going to inflect just based on the limited visibility. But what are some signs that you would look for from your end markets or from your customers that would give you confidence that this demand is starting to come back?

Yes, Bryan, do you want me to touch on that one?

Yes. Why don't you hit that, Ron, and at least start it off? Thank you.

Yes. So -- and Katie, Bryan had commented on this a little bit as well. When we look at that Test & Measurement business, even on a monthly basis as to how the first quarter developed, we -- March was stronger than both January and February on a stand-alone basis and really was back to levels that we saw kind of in the November and December time frame. So we feel like we've -- that business has kind of leveled off at the bottom right now. What I would say is that in the Test & Measurement piece for us is really kind of 2 separate -- I divide it into 2 separate areas. One, TEquipment, which is one of the acquisitions that was made a year or so ago, they sell what I would say, more handheld units, lower average purchase price. That business was up sequentially Q4 into Q1 of this year. So that's a good sign that we continue to see down a little bit versus a year ago quarter, but sequentially up Q4 versus Q3. So I think that's a good sign that there's some additional demand coming back in the lower price point items. On the larger items, we continue to see some pressure there. But to my point earlier, March was the strongest month of the quarter. So for us, we're staying very connected into our customer base. Again, really no customer attrition there. It's more that -- what we're hearing from our customers is that the capital spend continues to be delayed. And the other piece, and I think we commented on this in the Q4 call, and I described it as almost the perfect storm was that perfect storm going in the wrong direction. But the demand dried up primarily from delay of capital projects on higher interest rates, not shortly thereafter all the supply chain issues surrounding that end market were resolved. So there was a pent-up demand that came through or pent-up supply that came through and kind of mid-2023 -- early to mid-2023, that release of the supply chain kind of hit squarely with the slowdown in the demand. So hopefully, that helps. But Bryan, certainly, any additional thoughts you may have on that.

So look, that is -- I think Ron laid out a nice framework there. Katie, there -- when we're looking at TestEquity and we're looking at Hisco and we're looking across that division, there was a -- we hit the nadir as it turned out from what we've seen so far in January and February. We kind of hit the bottom of the lowest average or kind of lowest volume that we were seeing through Test & Measurement specifically. And that's really, for us, looking at the desktop larger versions as opposed to what we're selling through TEquip or the flute type handhelds. And Keysight and Tektronix would be our largest vendors there by far. And there was a nice kind of inflection point, it appears, but 2 months isn't a trend because we still got lots of kind of concern about what's going on, on the true demand side. But some of the messiness in the channel and some of the activity in terms of quoting picked back up, and we saw by March, the revenue levels and then April stepped up again back to kind of where they were at the highest level during the 3 months of the fourth quarter, not yet by any means back to where they were in the first half of last year or even the third quarter. And so that -- the nice thing is that we've kind of -- we saw a sell-off or kind of a decline in activity. One of the things that we are also looking at is when we look at the OEM side of our engagements with Hisco, which are largely with similar type of customers and similar sort of industry verticals, we are seeing -- we're seeing percentage declines in OEM programs that are still active in some of those segment markets. So if you think about wireless and communications or industrial electronics, the Hisco is seeing some -- had some volume in the activity in the programs that were coming through the OEM programs of declines there. And those were reflecting kind of more amplified impact that we were seeing over TestEquity on buying test and measurement equipment. So there's confirmation that it's -- some of what's going on seems to be in those industry verticals and that they're just -- they aren't making as much through their OEM facilities or if they're having some struggles in their own end markets, they're probably not spending as much money on their R&D equipment in their labs. And so at some point in time, we're -- just because the way that we think it's trending, we think that those dollars are going to be coming back. But we don't feel like we've lost customers. We do think we lost orders at times during the fourth quarter and maybe even a little bit in the first quarter where there was a natural pricing activity that we weren't willing to match.

Thank you. As we have no further questions on the lines at this time, I will turn the call back over to Mr. Bryan King for any closing remarks.

Well, that's, I think, it. We really appreciate everybody's time. Obviously, we've got still a lot of moving parts in the business. We are very encouraged with the work and accountability that our teams have been putting in across each of the 3 verticals. And we've got a lot of confidence in the business that we're continuing to build and how we can drive returns on invested capital and structural margins over the coming years. Thank you for your time today. We look forward to speaking with you again when we report our second quarter results in early August. And have a great day.

Thank you. This concludes today's conference, and you may disconnect your lines at this time, and we thank you for your participation.