Good day, and welcome to the Distribution Solutions Group Second Quarter 2024 Earnings Conference Call. At this time all participants are in a listen-only mode and a question-and-answer session will follow the formal presentation. [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's second 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 IR website at investor.dstributionsolutionsgroup.com. Please note that statements 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 made today but disclaim any 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 release issued earlier today was posted on the Investor Relations section of our website. A copy of the release is also included in a current report on Form 8-K filed with the SEC. Lastly, this call is being webcast and on the Internet via the Distribution Solutions Group Investor page and on the company's website. A replay of this teleconference will be available through August 15, 2024. I will now turn the call over to Bryan King. Bryan?

Thanks, Steven and good morning, everyone. Thank you for joining us this morning and on a packed earnings day for many of you. We will try and move through our prepared comments expeditiously while welcoming follow-up conversations from you if we may be of further help. Starting on Slide 4, I want to provide introductory comments about the quarter and speak in some depth about our recently announced acquisition of Source Atlantic. Then Ron will cover the financial results for the quarter in detail. Together, we will provide some thoughts around the second half of 2024, and I will incorporate an update on our progress on some of the strategic initiatives at Lawson, Gexpro Services and the TestEquity Group as well as on DSG. First off, I'm very pleased with our second quarter results in several key areas. Consolidated sales grew to a record $440 million, up 16.3% compared to last year's second quarter, driven by acquisition-related revenue lift. Although DSG's second quarter sales, excluding acquired revenue declined on marketplace sluggishness consistent with the last several quarters and against tough sales comps relative to last year's second quarter our quarterly organic sales base did show improvement sequentially, growing by almost 4% compared to this year's first quarter. Each of our verticals made solid progress in the quarter on important strategic initiatives despite the challenges from sustained macroeconomic headwinds that include higher for longer interest rates that appear to me in pouring through the sales data across our industrial distribution businesses to be negatively weighing on most all of our industrial end markets in the U.S. Notably, we do continue to see the sequential recovery in certain end markets as we start to lap some easier comps from later last year, especially in areas where we have previously highlighted, where we…

Thank you, Bryan and good morning, everyone. Turning to Slide 6, I'll summarize reported results for the quarter, and then I'll break out each of the reporting segments. I'm excited to share these results given the step-up in our adjusted margin as a percent of sales and also in realized dollars for the quarter. Consolidated revenue for the quarter was $439.5 million. This represents an increase of $61.6 million or 16.3% primarily driven by 2023 and 2024 acquisitions. Excluding the acquisitions, organic sales declined by 5.7% versus a year ago, however, grew 3.8% sequentially over the first quarter. The sequential increase was driven by the continued recovery in many end markets such as Test and Measurement, technology, renewables and some project-related business. Q2 2024 reflected significant growth in net margin dollars of $9.1 million, up over 25% versus the first quarter. Our margin profile came in line with our near-term expectations and exhibits the strength of our model on a modest sales increase. For the quarter, we generated adjusted EBITDA of $45.2 million or 10.3% of sales, a sequential improvement over our margins of 8.7% in the first quarter and 8.4% in Q4. I'll expand further on this at the segment level here in a minute. We reported operating income of $14.2 million for the quarter, inclusive of $12.2 million of acquisition-related intangible amortization expense and $12.5 million of aggregate costs from stock-based compensation, acquisition, severance and retention-related expenses, merger and acquisition costs and other nonrecurring items. Adjusted operating income was $38.9 million as compared to $34.9 million a year ago quarter and $29.8 million in the first quarter. We reported GAAP diluted income per share of $0.04 for the quarter, inclusive of higher depreciation and amortization and a valuation allowance on certain deferred tax assets compared to earnings per…

Thank you, Ron. Turning to our capital allocation framework on Slide 11. Our DSG model works well because we are committed to a disciplined and competitive approach to capital allocation and holding ourselves and our colleagues to be accountable to build a business that will sustain driving a long-term compounding effect for exceptional shareholder returns. As part of that framework, our leadership team is focused on efficiently and continually managing working capital, which results in discipline around stronger cash flows, allowing for more deliberate reinvestment. Our trailing 12 months of cash from operations was $106 million on trade working capital of approximately $450 million at the end of the quarter. Cash flow per share is an important driver to our model as we focus on the compounding effect of cash flow reinvestment. In our DSG journey over the last two-plus years since the merger, we've proven that strategic bolt-on acquisitions are providing our platform with scale to sustain and drive higher long-term organic growth, margins, and returns on invested capital through creating better geographic density with added product and service categories, offering expanded cross-selling opportunities and ultimately the very tangible bridge to the higher structural margins and returns on invested capital that drive exceptional shareholder returns. Over the last decade, from where we are today, we have enjoyed a 14% IRR on our Lawson investment, and I am confident we will do better over the next decade with expanded discipline and opportunities presented by DSG. As our platform matures over the longer term, we expect that growth in our current key verticals should come more from organic than inorganic sources and that we can fade our DSG returns on invested capital, structurally higher from the approximately 12% level where we are starting. Our five-year goals that we set out during…

Thank you. [Operator Instructions]. And our first question this morning is coming from Kevin Steinke from Barrington Research. Kevin, your line is live. Please go ahead.

Thanks and good morning. I wanted to start out by asking about the Test and Measurement business within TestEquity. It sounds like some recovery going on there. Last quarter, I got the impression that maybe that market was a little -- recovering a little more slowly than you had anticipated. You've been talking about excess inventory in the market. So just maybe talk about the pace of the recovery there and what you expect for the second half and just overall, the state of inventory in the market and customers' plans for capital spending in that area, etcetera.

Ron, why don't you start there?

Yes, I'll jump in. Thanks for that question, Kevin. So we mentioned this a little bit on the first quarter call as well that we were starting to see some sequential improvement in the Test and Measurement business really as each month surpassed in the first quarter. We continue to see that trend here in the second quarter as well. And even though we feel like there's some market recovery there, certainly interest rates really haven't moved since the end of the first quarter. And I would really probably describe it more that we're taking share, candidly. I think you're well aware that that's a very vendor relationship type of business on the Test and Measurement side. And we've continued to work really, really hard with our top suppliers in order to gain more of their business. We've had a couple of customers that we've regained that really kind of faded off on us in 2023. So that's helped help build it as well. As we think about the rest of the year, certainly, the overall interest rate environment, I think will probably still put some pressure on that overall end market. But we've got great initiatives going on internally within the TestEquity Group in order to expand those supplier relationships and to go back and get some of these customers that have faded a little bit on us in 2023. And as I mentioned, the first -- I mean if I look at the first six months of the year for this year, it's a nice sequential movement in the right direction. So we feel good about that piece of our business continuing to lift us for the rest of 2024.

Kevin, just to add to that, we messaged, I think, through the end of the fourth quarter. And again, at the end of the first, that there was some lack of -- there was some purging of inventory that was taking place by some people who had entered that marketplace with an inventory position that they hadn't historically been as big of a participant selling those vendors' products. And so there was some undisciplined in my opinion, markdowns by some folks that we might submit an RFP or somebody may have come to us for technical support, major customers, somebody we've worked with and consistently worked with for years. We would spec out a purchase and then somebody would come in underneath us and dump some inventory. And that created some additional choppiness over the first kind of end of the last year and the first quarter this year. A lot of that seems -- appears to have abated itself. So that's where we're picking back up the same customers. Those orders were out there. We were actually doing the stack work on them, and then we just lost them at the goal line by not breaking discipline on pricing. In some cases, we probably look back in the fourth quarter and wonder whether or not we should have taken those orders, but we wouldn't have cleaned the market with that kind of excess inventory that was in the channel for some of the smaller competitors that don't have as much market share selling those major manufacturers products in North America. So that's part of it. We do think that there's some green shoots. We are seeing some end market customers that are returning. We highlighted a couple of them in the call to the Test and Measurement area. But we're still being cautious in terms of capital spending, just given until we see interest rates in the marketplace, appearing to have more confidence that we're back into economic expansion. But there is just some cycling of purchases that we're seeing come back in and that we're getting more of our share than we were at the end of the fourth quarter.

Okay, that's all very helpful commentary. I appreciate it. And Ron, you mentioned when talking about the second half that you're seeing some softness in short-cycle MRO and you saw some organic revenue softness in Lawson in the second quarter. Can you maybe expand on that a little bit more, has that market softened up a little bit more than you might have expected entering -- as you enter 2024?

Yes. So Kevin, as we look at our kind of end segments that we manage the Lawson business within our strategic customers and military, our Core Street business and Kent Automotive. We have seen some softening across most of those segments as we look at the second quarter and even a little bit in the first quarter. ISM is still running well below 50%. We've seen probably a bigger impact on the military. I know we talked about this on our first quarter call, just in terms of the ordering process. That volume has not yet fully come back to us. So we're a little cautious on the short-cycle piece of this business within Lawson. And the other piece I would say, and Bryan commented on this in his prepared remarks, we are actively out recruiting and hiring new sales members, expanding our sales team. Certainly, we took that down as we were refining some of the process, and now we're in a position where we feel like we're in a really good position to build that back up. And we're targeting to hire nearly 70 individuals between now and the end of the year. And so that will give us a little bit of a lift here in 2024. But in reality, those hires will benefit 2025 and 2026, certainly more than 2024. So we're a little cautious on the Lawson side right now. I mean, you saw really nice net margin expansion. And I think going, call it, in the mid-11s to the mid-13s, kind of back to where we were on a full run rate basis in 2023. So we're managing the business daily from a cost perspective and from a gross margin perspective.

Yes. Kevin, I think your intuition is right there. What's been surprising, I think, a little bit to all of us is that the longer cycle OEM visibility appears to be getting or staying firm or getting better, especially across some of our markets like renewables and technology and aerospace defense on the Gexpro Services side. And even that's firming some on the TestEquity group side. And we're obviously going to lap some easier comps there as well. But our operating with less salespeople than we did a year ago or two years ago, we knew was going to weigh some on our ability to drive organic growth in Lawson, but it was critical to our strategy to driving returns on invested capital and EBITDA margins higher and ultimately cash dollars higher. And so now we're layering back in that growth lens on filling in optimized sales territories and with optimized tools. We thought it was premature to do that until we got some of those pieces better lined out for new hires and could bring them in with a clear expectation and a clear opportunity that was maybe different than some of the way that we onboarded salespeople several years ago. And I think they have an opportunity to earn a lot more and the quality and experience that they'll have what we think will allow for us to hire even better consistency on new hires there. So that's a big part of it. But there's no doubt when we look at the short-cycle side of the business, and we're going through each customer that's a repeat customer and the size of their orders, there's been a lot more noise over the last several months than there was at the last half of last year.

Kevin, I just want to put just one maybe additional data point out there for you. So and really, I think it follows on to Bryan's comments. I mean we're a more profitable organization within Lawson, given a lot of these changes, operating now in the mid-13s versus the high single digits going back a couple of years ago. And even though we saw some sales pressures into the second quarter, if you look at Lawson, the net margin dollars realized is up almost $9 million going from Q1 into Q2. Now call it, about $1 million, $1.1 million of that was the acquisition that we made kind of mid in the second quarter. But structurally, we're a more profitable business. And to Bryan's point, we're now -- I think we're in a much better position to go out and put a full court press on filling in some of these open territories, given some of the structural changes we've made over the last year to 18 months.

Okay, thanks. That's helpful. And lastly, I wanted to ask about Source Atlantic. Congratulations on that agreement. It looks like it will be a really nice deal for you. You did mention it obviously hasn't closed yet, but it's a bit lower margin than consolidated DSG right now, but you have plans to improve that over time. Again, as we think about layering that into our model in the future when the deal closes, can you talk to how much of an impact that could potentially have on your consolidated margin, I know it's not an overly large acquisition but Ron, I don't know if you could touch on that at all?

Yes, I can. So -- and maybe I can give you a couple of points of reference to without giving specific numbers. So Bryan had mentioned that really getting that piece of the business to a run rate double-digit EBITDA margins exiting 2025. And we did mention the Canadian $250 million. And maybe the best way the way to frame it up is when we purchased Bolt Supply, we were in the, call it, mid- to high single digit. And I would say and we've now pushed that business up into the 13% to 14% range from an EBITDA perspective. I would put Source Atlantic kind of in that same initial kind of out of the gate in terms of when we bring them in here later this year. So again, not a huge impact to 2024, given our overall $1.8 billion in sales and $180 million in EBITDA. But probably you'll see a bigger impact as 2025 develops going kind of from that mid to high single digits into double-digit territory by the time we get out of 2025.

Okay, thanks. Appreciate the commentary. I will turn it back over.

Great, thanks Kevin.

Thank you. [Operator Instructions]. And there are no further questions in queue at this time. I would now like to turn the floor back to Bryan King for closing remarks.

Okay. Thank you, operator. Thank you, everyone for helping us or joining us today. I know that we've got a lot of other distributors that -- in a 9:00 call for many of you. So thank you so much for joining us. We look forward to talking to you for the next quarter's earnings and have a great balance of the summer.

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