Item 1A. Risk Factors
ITEM 1A. RISK FACTORS.
In addition to the other information in this Annual Report on Form 10-K for the fiscal year ended December 31, 2021, the following factors should be considered in evaluating Lawson's business. Our operating results depend upon many factors and are subject to various risks and uncertainties. The material risks and uncertainties known to us and described below may negatively affect our business operations or affect our financial results. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also impair our business operations or affect our financial results.
Business Risks
A significant portion of our inventory may become obsolete.
Our business strategy requires us to carry a significant amount of inventory in order to meet rapid processing of customer orders. If our inventory forecasting and production planning processes result in inventory levels exceeding the levels demanded by customers or should our customers decrease their orders with us, our operating results could be adversely affected due to costs of carrying the inventory and additional inventory write-downs for excess and obsolete inventory.
Work stoppages and other disruptions at transportation centers or shipping ports, along with other supply chain disruptions, may adversely affect our ability to obtain inventory and make deliveries to our customers.
Our ability to rapidly process customer orders is an integral component of our overall business strategy. Interruptions at our company operated facilities or disruptions at a major transportation center or shipping port, due to events such as severe weather, labor interruptions, natural disasters, acts of terrorism or other events, could affect our ability to maintain core products in inventory, deliver products to our customers on a timely basis or adversely affect demand for our products, which may in turn adversely affect our results of operations. Similarly, other supply chain disruptions have impacted our ability to maintain certain core products in inventory and deliver products to customers on a timely basis, and may continue to impact our ability to do so. Such supply chain disruptions may adversely affect our business, financial condition and results of operations.
Changes in our customers, product mix and pricing strategy could cause our gross margin percentage to decline in the future.
From time to time, we have experienced overall changes in the product mix demand of our customers. When customers or product mix changes, there can be no assurance that we will be able to maintain our historical gross profit margins. Changes in these items, as well as volume of orders, prices charged, additional freight costs or lower productivity levels, could cause our gross profit margin percentage to decline. Our gross margin percentage may also come under pressure in the future if we increase the percentage of national accounts in our customer base, as sales to these customers are generally at lower margins.
Disruptions of our information and communication systems could adversely affect the Company.
We depend on our information and communication systems to process orders, purchase and manage inventory, maintain cost-effective operations, sell and ship products, manage accounts receivable collections and serve our customers. Disruptions in the operation of information and communication systems can occur due to a variety of factors including power outages, hardware failure, programming faults and human error. Disruptions in the operation of our information and communication systems, whether over a short or an extended period of time or affecting one or multiple distribution centers, could have a material adverse effect on our business, financial condition and results of operations.
Cyber attacks or other information security incidents could have a material adverse effect on our operating results and financial condition, subject us to additional legal costs and damage our reputation in the marketplace.
We are increasingly dependent on digital technology to process and record financial and operating data and communicate with our employees and business partners. During the normal course of business we receive, retain and transmit certain confidential information that our customers provide to purchase products or services or to otherwise communicate with us.
Our technologies, systems and networks (and those of our business partners) have been and may in the future be the target of cyber attacks and/or information security incidents that may have resulted in, or may in the future result in, the unauthorized release, misuse, loss or destruction of proprietary, personal and other information, or other disruption of our business operations. For example, on February 8, 2022, Lawson became aware that its computer network was the subject of a cyber incident potentially involving unauthorized access. It is possible that certain confidential business information and personnel
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records may have been compromised. Lawson has engaged a cybersecurity forensics firm to assist in the investigation of the incident and to assist in securing its computer network.
Depending on the nature of any information that may have been compromised, Lawson may be required to notify the parties whose information was compromised of the incident as well as various governmental agencies and may be required to take other actions in the future, such as offering credit monitoring services. Lawson is continuing to investigate the incident as well as potential corrective and remedial actions to take in respect of the incident. The Company is in the early stage of the investigation, and at this time, is unable to estimate the cost of any remediation that may be required.
Such attacks or incidents could have a material adverse effect on our operating results and financial condition, subject us to additional legal costs and damage our reputation in the marketplace. As cyber threats continue to evolve, we may be required to expend additional resources to continue to modify or enhance our protective measures or to investigate and fix any information security vulnerabilities.
The inability to successfully recruit, integrate and retain productive sales representatives could adversely affect our operating results.
We have committed to a plan to increase the size of our sales force. A successful expansion in our sales force requires us to identify under-served territories that offer the greatest potential growth opportunity, locate and recruit talented sales representatives, provide them with the proper training, and successfully integrate them into our organization. This expansion will require significant investment in capital and resources. The failure to identify the optimal sales territories, recruit and retain quality sales representatives and provide them with sufficient support could adversely affect our operating results.
It is also critical to retain the experienced and productive sales representatives that have historically contributed to our success. Failure to retain a sufficient number of talented, experienced and productive sales representatives could adversely affect our financial and operating results.
Failure to retain talented employees, managers and executives could negatively impact our operating results.
Our success depends on, among other things, our ability to attract, develop and retain talented employees, including executives and other key managers. The loss of certain key executives and managers or the failure to attract and develop talented employees could have a material adverse effect on our business.
The inability of management to successfully implement changes in operating processes could lead to disruptions in our operations.
We are continually striving to improve operational efficiencies throughout our organization and to identify and initiate changes intended to improve our internal operations. The implementation of changes to our current operations involve a risk that the changes may not work as intended, may disrupt related processes, may not be properly applied or may not result in accomplishing the intended efficiencies. Failure to successfully manage the implementation of these changes could lead to disruptions in our operations.
The inability to successfully integrate additional acquisitions into our organization could adversely affect our operations and operating results.
One of our growth strategies is to actively pursue additional acquisition opportunities which complement our business model. However, there are risks associated with pursuing acquisitions, which include the incurrence of significant transaction costs without the guarantee that such transactions will be completed. Further, we may fail to successfully identify the right opportunities and/or to successfully integrate the acquired businesses, operations, technologies, systems and/or personnel with those of Lawson, which could adversely affect our operations and our operating results.
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The Company operates in highly competitive markets.
The MRO marketplace is highly competitive. Our competitors include large and small companies with similar or greater market presence, name recognition, and financial, marketing, and other resources. We believe the competition will continue to challenge our business with their product selection, financial resources and services.
Changes that affect governmental and other tax-supported entities could negatively impact our sales and earnings.
A portion of our sales are derived from the United States military and other governmental and tax-supported entities. These entities are largely dependent upon government budgets and require adherence to certain laws and regulations. A decrease in the levels of defense and other governmental spending or the introduction of more stringent governmental regulations and oversight, could lead to reduced sales or an increase in compliance costs which would adversely affect our financial position and results of operations.
Financial Risks
Failure to adequately fund our operating and working capital needs through cash generated from operations and cash available through our Credit Agreement could negatively impact our ability to invest in the business and maintain our capital structure.
Our business requires investment in working capital and fixed assets. We fund these investments from cash generated from operations and funds available from our Credit Agreement. Failure to generate sufficient cash flow from operations or from our Credit Agreement could cause us to have insufficient funds to operate our business. Adequate funds may not be available when needed or may not be available on favorable terms.
Failure to meet the covenant requirements of our Credit Agreement could lead to higher financing costs and increased restrictions and reduce or eliminate our ability to borrow funds.
Our Credit Agreement contains financial and other restrictive covenants. These covenants could adversely affect us by limiting our financial and operating flexibility as well as our ability to plan for and react to market conditions and to meet our capital needs. Failure to meet these covenant requirements could lead to higher financing costs and increased restrictions, reduce or eliminate our ability to borrow funds, or accelerate the payment of our existing indebtedness. If we require more liquidity than is currently available to us under our Credit Agreement, we may need to raise additional funds through debt or equity offerings which may not be available when needed or may not be available on terms favorable to us. Should funding be insufficient at any time in the future, we may be unable to develop or enhance our products or services, take advantage of business opportunities or respond to competitive pressures, any of which could have a material adverse effect on our business, financial condition and results of operations.
Common Stock Risks
The market price of our common stock may decline.
The price of our common stock could decrease if our financial performance is inadequate or does not meet investors' expectations, if there is deterioration in the overall market for equities, if large amounts of shares are sold in the market, if there is index trading, or if investors have concerns that our business, financial condition, results of operations and capital requirements are negatively impacted by an economic downturn.
Luther King Capital Management has significant influence over the Company, and this influence could delay or deter a change in control or other business combination or otherwise cause us to take actions with which you may disagree.
On December 31, 2021, Luther King Capital Management ("LKCM") beneficially owned 47.7% of the outstanding common stock of the Company. J. Bryan King, a director of the Company, is the Principal of LKCM. As a result, LKCM has significant influence over the outcome of matters requiring a stockholder vote, including the election of directors, and the approval of significant matters and its interests may not align with the interests of other stockholders. This concentration of ownership could also have the effect of delaying, determining or preventing a change of control or other business combination that might be beneficial to our stockholders.
Legal and Regulatory Risks
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A violation of federal, state or local environmental protection regulations could lead to significant penalties and fines or other remediation costs.
Our product offerings include a wide variety of industrial chemicals and other products which are subject to a multitude of federal, state and local regulations. These environmental protection laws change frequently and affect the composition, handling, transportation, storage and disposal of these products. Failure to comply with these regulations could lead to severe penalties and fines for each violation.
Additionally, a facility we own in Decatur, Alabama, was found to contain hazardous substances in the soil and groundwater as a result of historical operations prior to our ownership. We retained an environmental consulting firm to further investigate the contamination, including measurement and monitoring of the site. The Company concluded that further remediation was required, and accordingly, has made an accrual for the estimated cost of this environmental matter. A remediation plan was approved by the Alabama Department of Environmental Management and the remediation of the affected area is ongoing. Additional procedures may be required that could negatively impact our operating results.
Our results of operations could be affected by changes in taxation.
Our results of operations could be affected by changes in tax rates, audits by taxing authorities or changes in laws, regulations and their interpretation. Changes in applicable tax laws and regulations could affect our ability to realize our deferred tax assets, which could adversely affect our results of operations.
Risk Factors Relating to COVID-19 and Other Infectious Diseases
The coronavirus strain that began to spread in 2020 ("COVID-19") has created a worldwide pandemic which has continued to affect our business and could have further undetermined material adverse effects on our revenues, operating results and financial condition.
The COVID-19 pandemic has resulted in lost revenue to our Company, limitations on our ability to source high demand product, limitations on our sales force to perform certain functions due to state or federal stay-at-home orders, a slow-down of customer demand for our products and limitations on the ability of some customers to pay us on a timely basis. The impact of the COVID-19 pandemic on our operational and financial performance includes affecting our ability to execute our business strategies and initiatives in the expected time frame. The extent of the effect of the COVID-19 pandemic on us will depend on future developments, including the duration and spread of the COVID-19 pandemic and related restrictions on travel, transports and person to person contact, all of which are uncertain and cannot be predicted at the present time. On a broader scale, the COVID-19 pandemic has negatively impacted the global economy, disrupted global supply chains and created significant volatility and disruption of financial markets. An extended period of global supply chain and economic disruption could materially affect our sales, workforce, supply chains, results of operations, and financial condition.
Our business was defined by the state of Illinois as an essential business, allowing us to operate during the pandemic when other companies faced temporary closures during the first year of the pandemic. If the COVID-19 pandemic worsens and our status as an essential business changes, our business could be required to temporarily close as well as any or all of our facilities (including distribution facilities and/or the Bolt branch locations), which would negatively impact our operations. Other disruptions to our supply chain such as reduced capacity or temporary shutdowns of freight carriers could also negatively impact Company performance.
Our sales results may be negatively impacted in the future by any social distancing guidelines and government mandated shelter in place orders that would prevent our sales representatives from visiting customers in person, or that would otherwise reduce customer visits to our Bolt branch locations. The reduction of operations and temporary shut down by many of our customers in response to COVID-19 has also negatively impacted our sales and ability to collect on existing credit balances, and we may continue to be impacted by those reductions and shut downs until the pandemic ends.
Further, vendors who are negatively impacted by COVID-19 may temporarily shut down operations or have difficulty obtaining inventory, which could negatively impact our ability to fulfill customer orders. As a result, the Company may be negatively impacted by the COVID-19 pandemic and the various federal, state and local restrictions enacted to combat the pandemic.
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Certain items on our balance sheet require judgments on their valuation, including intangible assets and goodwill. These valuations are based on assumptions that take future financial performance into account. COVID-19 may have a negative impact to our future financial performance that would require us to revise assumptions about future financial performance and impair the value of these assets. It is reasonably possible that estimates made based on future operating results and cash flows of the Company may be materially and adversely impacted in the near term as a result of the COVID-19 pandemic, including impairment losses related to goodwill.
In addition, the increased number of employees working remotely as a result of COVID-19 can exacerbate the risks mentioned in regards to internal controls and cybersecurity.
General Risks
Our results of operations may be adversely impacted by a downturn in the economy or in certain sectors of the economy.
Any decline or uncertainty in the strength of the economy may lead to a decrease in customer spending and may cause certain customers to cancel or delay placing orders. In the first quarter of 2020, the economy experienced a significant decline due to the response of businesses and state governments to the onset of the COVID-19 pandemic. Subsequently, the economy partially recovered from the initial downturn. Some of our customers may file for bankruptcy protection, preventing us from collecting on accounts receivable and may result in our stocking excess inventory. Contractions in the credit markets may also cause some of our customers to experience difficulties in obtaining financing, leading to lower sales, delays in the collection of receivables and result in an increase in bad debt expense.
Adverse economic conditions could also affect our key suppliers and contractors. This could lead to us incurring additional expenses or result in delays in shipping products to our customers. Economic uncertainty can make it difficult to accurately predict future order activity and affect our ability to effectively manage inventory levels. There are no assurances that we would be able to establish alternative financing or obtain financing with terms similar to our present Credit Agreement.
Changes in energy costs, tariffs and the cost of raw materials used in our products could impact our cost of goods and distribution and occupancy expenses, which may result in lower operating margins.
Increases in the cost of raw materials used in our products (e.g., steel, brass, copper), tariffs and increases in energy costs will raise the production costs of our vendors. Those vendors have typically looked to pass the higher costs along to us through price increases. If we are unable to fully pass such increased prices and costs through to our customers or to modify our activities, the impact would have an adverse effect on our operating profit margins. Low oil prices may result in weaker demand from oil and gas customers in the future, resulting in lower net sales. Changes in trade policies could affect our sourcing of product and ability to secure sufficient product and/or impact the cost or price of our products, with potentially negative impacts on our reported gross profits and results of operations.
Supply chain constraints, inflationary pressure, and labor shortages could impact our cost of goods, which may result in lower gross margins.
Our businesses have been and may continue to be impacted by supply chain constraints, resulting in inflationary pressure on material costs, longer lead times, port congestion, and increased freight costs. This results in challenges in acquiring and receiving inventory in a timely fashion and fulfilling customer orders. In addition, we have been and may continue to be impacted by labor shortages. This results in challenges in fulfilling customer orders and can have a negative impact on our operating results as we may be required to utilize higher-cost temporary labor. While we have instituted various price increases during 2021 in response to rising supplier costs, as well as increased transportation and labor costs, there can be no assurance that future cost increases or decreases, if any, can be partially or fully passed on to customers, or that the timing of such sales price increases or decreases will match our supplier cost increases or decreases. As a result,we are unable to predict the impact of these constraints on our business, financial condition and results of operations.
The Company is exposed to the risk of foreign currency changes.
Two of our subsidiaries are located and operate in Canada using the Canadian dollar as its functional currency. Operating results denominated in foreign currencies are translated into U.S. dollars when consolidated into our financial statements. Therefore, we are exposed to market risk relating to the change in the value of the Canadian dollar relative to the U.S. dollar that could adversely affect our financial position and operating results.
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Risk Factors Relating to the Merger Transactions
Except as contemplated by the earnout provisions in the Merger Agreements, the number of shares of Lawson common stock to be issued in the Transactions will not be adjusted if there is a change in the value of the businesses or assets of Lawson, TestEquity and/or Gexpro Services before the Transactions are completed.
Except as contemplated by the earnout provisions in the Merger Agreements, the number of shares of Lawson common stock to be issued in the Transactions will not be adjusted if there is a change in the value of the businesses or assets of Lawson, TestEquity and/or Gexpro Services before the Transactions are completed. Although Lawson will not be required to consummate the TestEquity Merger or the Gexpro Services Merger if there has been any “Material Adverse Effect” (as specified in the TestEquity Merger Agreement or the Gexpro Services Merger Agreement, respectively) with respect to TestEquity or Gexpro Services, respectively, Lawson will not be permitted to terminate either of the Merger Agreements or re-solicit the vote of Lawson’s stockholders because of any changes in the market price of Lawson common stock or any changes in the value of TestEquity or Gexpro Services that do not constitute such a “Material Adverse Effect” with respect to TestEquity or Gexpro Services, respectively.
Completion of the Transactions will result in the issuance of a significant number of additional shares of Lawson common stock, which could have a negative effect on the price of Lawson common stock.
The Transactions will result in the issuance of an aggregate of up to 12,000,000 shares of Lawson common stock in connection with the Transactions. The issuance of such a significant number of shares of Lawson common stock could have a negative effect on the market price of Lawson common stock. Such downward pressure could also encourage short sales by certain investors, which could place further downward pressure on the market price of Lawson common stock.
In addition, Lawson has agreed to grant the TestEquity Equityholder and the Gexpro Services Stockholder with certain registration rights with respect to the shares of Lawson common stock that Lawson would issue in the Transactions. Any sales of those shares, or the anticipation of the possibility of such sales, could create downward pressure on the market price of Lawson common stock.
As a result of the issuance of Lawson common stock in the Transactions, entities affiliated with LKCM and J. Bryan King (including the TestEquity Equityholder and the Gexpro Services Stockholder) will beneficially own a significant majority of the outstanding shares of Lawson common stock.
After giving pro forma effect to the issuance of shares of Lawson common stock in connection with the Transactions, entities affiliated with LKCM and Mr. King (including the TestEquity Equityholder and the Gexpro Services Stockholder) would beneficially own in the aggregate a significant majority of the outstanding shares of Lawson common stock, ranging from (1) approximately 75% (assuming the issuance of only the minimum aggregate number of shares of Lawson common stock issuable in connection with the Mergers) to (2) approximately 77% (assuming the issuance of the maximum aggregate number of shares of Lawson common stock issuable in connection with the Mergers, including the full issuance of the maximum earnout shares potentially issuable) of the outstanding shares of Lawson common stock. This would be up from the approximately 47.7% of the outstanding shares of Lawson common stock that entities affiliated with LKCM and Mr. King beneficially owned as of December 31, 2021. Thus, entities affiliated with LKCM and Mr. King, as a group, would be able to exercise an even more significant influence over matters requiring a stockholder vote, including the election of directors and the approval of other significant matters, than they are currently able to exercise. The interests of LKCM and such other affiliated entities and persons may not align with the interests of other stockholders. This concentration of ownership could also have the effect of delaying or preventing a change of control or other business combination that might be beneficial to Lawson’s stockholders.
In addition, as a result of this issuance, Lawson expects that it will qualify as a “controlled company,” as that term is defined by Rule 5615(c) of the NASDAQ Listing Rules and, accordingly, Lawson believes that it will be generally exempt from the requirements of Rule 5615(c) of the NASDAQ Listing Rules that would otherwise require Lawson to have:
• a majority of the Lawson board of directors comprised of independent directors;
• a compensation committee comprised solely of independent directors; and
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• director nominees selected, or recommended for the Lawson board of directors’ selection, either by (1) independent directors constituting a majority of the Lawson board of directors’ independent directors in a vote in which only independent directors participate or (2) a nominating committee comprised solely of independent directors.
As a result of the issuance of Lawson common stock in the Transactions, existing stockholders will experience substantial dilution of their ownership percentage and voting power (except that entities affiliated with LKCM and Mr. King will, on a collective basis, significantly increase their beneficial ownership and voting percentage of outstanding Lawson common stock).
If the Transactions are completed and Lawson issues shares of Lawson common stock in the Transactions, existing stockholders will experience substantial dilution of their ownership percentage and voting power (except that entities affiliated with LKCM and Mr. King will, on a collective basis, significantly increase their beneficial ownership and voting percentage of outstanding Lawson common stock).
There may be difficulties in combining certain operations of TestEquity’s and Gexpro Services’ respective businesses into Lawson’s operations, and the failure to successfully combine those operations within Lawson’s expected timetable could adversely affect the Combined Company’s future results and the market price of Lawson’s common stock.
The Mergers involve the combination of businesses that currently operate as independent businesses. Lawson will be required to devote significant management attention and resources to combining certain business operations of TestEquity and Gexpro Services with Lawson’s business operations. In addition, the pursuit of the Transactions and the preparation for the completion of the Transactions have placed, and will continue to place, a significant burden on the management and internal resources of Lawson, TestEquity and Gexpro Services. There is a significant degree of difficulty and management distraction inherent in the process of closing the Transactions, which could cause an interruption of, or loss of momentum in, the activities of each company’s existing businesses, regardless of whether the Transactions are eventually completed. Both before and after the closing of the Transactions, the management teams of Lawson, TestEquity and Gexpro Services will be required to devote considerable amounts of time to this process, which may decrease the time they will have to manage their respective existing businesses, service existing customers, attract new customers and develop new products, services and strategies. One potential consequence of such distractions could be the failure of management to realize other opportunities that could be beneficial to Lawson, TestEquity or Gexpro Services, respectively.
If Lawson’s, TestEquity’s or Gexpro Services’ management is not able to effectively manage the process leading up to and following the closing of the Transactions, or if any significant business activities are interrupted as a result of the process, the businesses of Lawson, TestEquity and/or Gexpro Services could suffer.
Furthermore, it is possible that the closing process could result in the loss of key employees of Lawson, TestEquity or Gexpro Services. If Lawson is not able to successfully complete the Transactions and fully realize the anticipated savings and synergies in a timely manner, or the cost to achieve these synergies is greater than expected, Lawson may not fully realize the anticipated benefits (or any benefits) of the Transactions, or it may take longer than expected to realize any benefits. The failure to fully or timely realize the anticipated benefits could have a negative effect on the market price of Lawson common stock.
Each of Lawson, TestEquity and Gexpro Services will be subject to business uncertainties and contractual restrictions while the Transactions are pending that could materially and adversely affect each of the companies and their businesses.
Uncertainty about the effect of the Transactions on employees, customers, suppliers and others having business relationships with Lawson, TestEquity and/or Gexpro Services may have a material and adverse effect on Lawson, TestEquity and/or Gexpro Services, regardless of whether the Transactions are eventually completed, and, consequently, on the Combined Company. These uncertainties may impair Lawson’s, TestEquity’s and/or Gexpro Services’ ability to attract, retain and motivate key personnel until the Transactions are completed, or the Merger Agreements are terminated, and for a period of time thereafter. These uncertainties could also cause customers, suppliers and others that deal with Lawson, TestEquity or Gexpro Services to seek to change existing business relationships with Lawson, TestEquity or Gexpro Services. Employee retention and recruitment may be challenging for Lawson, TestEquity and Gexpro Services during the pendency of the Transactions, as employees and prospective employees may experience uncertainty about their future roles with the Combined Company. Furthermore, no assurance can be given that after the Transactions the Combined Company will be able to attract or retain key management personnel or other key employees to the same extent that Lawson, TestEquity and Gexpro Services have been previously able to attract or retain their own employees. For each of Lawson, TestEquity and Gexpro Services, the
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departure of existing key employees or the failure of potential key employees to accept employment with the Combined Company, despite Lawson’s, TestEquity’s and Gexpro Services’ retention and recruiting efforts, could have a material adverse impact on Lawson’s and the Combined Company’s business, financial condition and operating results, regardless of whether the Transactions are eventually completed.
In addition, the Merger Agreements restrict Lawson from making certain acquisitions and taking other specified actions without the consent of TestEquity or Gexpro Services until the respective Merger is consummated or the respective Merger Agreement is terminated. These restrictions may prevent Lawson from pursuing otherwise attractive business opportunities and making other changes to its business before completion of the Transactions or termination of the Merger Agreements.
Lawson may fail to complete the Transactions if certain closing conditions, many of which are outside Lawson’s control, are not satisfied.
The completion of the Transactions is subject to multiple closing conditions, including the receipt of the requisite Lawson stockholder approvals under the Merger Agreements and the receipt of proceeds of debt financing in an amount sufficient for the payment of certain payoff indebtedness, transaction expenses and other fees and expenses in connection with the Mergers. Many of these closing conditions are outside of Lawson’s control. If any of these conditions is not satisfied or waived, the Transactions may not be completed and Lawson may not realize the anticipated benefits of the Transactions. Lawson can make no assurances that the Transactions will be completed on the terms or timeline currently contemplated, or at all.
Failure to complete the Transactions could result in material adverse consequences to Lawson’s business and operations.
If the conditions to the closing of the Transactions are not met, or if the Transactions are not completed for any other reason, Lawson would be subject to a number of risks, including the following:
• The market price of Lawson common stock may decline;
• Lawson and its stockholders would not realize the anticipated benefits of the Transactions, including any anticipated synergies from combining the businesses of Lawson, TestEquity and Gexpro Services;
• Lawson may be required to pay a termination fee of $4.0 million if the TestEquity Merger Agreement is terminated under certain circumstances;
• Lawson may be required to pay a termination fee of $6.0 million if the Gexpro Services Merger Agreement is terminated under certain circumstances; and
• Lawson would remain liable for significant transaction costs that would be payable even if the Transactions are not completed.
For these and other reasons, failure to complete the Transactions could adversely affect Lawson’s business, financial condition, results of operations and stock price.
Lawson has incurred and will continue to incur significant transaction costs in connection with the Transactions.
Lawson has incurred and expects to continue to incur significant, non-recurring costs in connection with consummating the Transactions. Non-recurring transaction costs include, but are not limited to, fees paid to legal, accounting and financial advisors, filing fees and other costs. Additional unanticipated costs may be incurred in the combination process. Some of these costs will be incurred even if Lawson does not complete the Transactions.
Lawson’s estimates and judgments related to the acquisition accounting models used to record the purchase price allocation may be inaccurate.
Lawson’s management will make significant accounting judgments and estimates for the application of acquisition accounting under GAAP and the underlying valuation models. The Combined Company’s business, operating results and financial condition could be materially and adversely impacted in future periods if Lawson’s accounting judgments and estimates related to these models prove to be inaccurate.
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The Combined Company may be required to recognize impairment charges for goodwill and other intangible assets.
As a result of the Trans actions, the Combined Company is expected to have an amount of goodwill and other intangible assets on its balance sheet that is significantly greater than the amount of goodwill and other intangible assets on Lawson’s December 31, 2021 consolidated balance sheet. In ac cordance with GAAP, Lawson’s management periodically assesses Lawson’s goodwill and other intangible assets to determine if they are impaired. Significant negative industry or economic trends, disruptions to the Combined Company’s business, an inability to effectively integrate acquired businesses, unexpected significant changes, planned changes in use of the assets, divestitures and market capitalization declines may impair goodwill and other intangible assets. Any charges relating to such impairments could materially and adversely affect the Combined Company’s results of operations in the periods recognized, which could result in an adverse effect on the market price of Lawson common stock.
TestEquity’s and Gexpro Services’ international operations will subject the Combined Company to additional legal and regulatory regimes if the Mergers are completed.
TestEquity currently has business operations and/or sales in a number of foreign countries, including Canada, Mexico and the United Kingdom, and Gexpro Services currently has business operations and/or sales in a number of foreign countries, including Hungary and China. If the Mergers are consummated, Lawson and/or certain subsidiaries within the Combined Company will be subject to a wider array of foreign legal and regulatory regimes (including tax regimes) than those to which Lawson and/or certain of its subsidiaries are currently subject, and the amount of revenue generated outside of the United States by the Combined Company will be significantly more than the revenue generated outside the United States by Lawson currently. Compliance with diverse legal and regulatory requirements, including in connection with the movement or repatriation of cash, may be costly, time-consuming and require significant resources. Violations could result in significant fines or monetary damages, sanctions, prohibitions or restrictions on doing business and damage to the Combined Company’s reputation. In addition, operating in additional countries around the world will require the Combined Company to manage the potential conflicts between locally accepted business practices in any given jurisdiction and Lawson’s obligations to comply with laws and regulations with respect to such jurisdictions, in addition to the jurisdictions where Lawson currently operates, including anti-corruption laws or regulations applicable to Lawson, such as the U.S. Foreign Corrupt Practices Act (the “FCPA”) and the UK Bribery Act 2010 (the “UKBA”). The U.S., U.K. and other foreign agencies and authorities have a broad range of civil and criminal penalties they may seek to impose against companies for violations of export controls, the FCPA, the UKBA, and other laws, rules, sanctions, embargoes and regulations, including those established by the Office of Foreign Assets Control (“OFAC”). Any violation of these legal requirements, even if prohibited by Lawson’s policies, procedures and controls, could subject the Combined Company to criminal or civil enforcement actions, penalties for non-compliance or otherwise have an adverse effect on its business and reputation.
Litigation relating to the Transactions could prevent or delay the closing of the Transactions and/or result in the payment of damages following the closing of the Transactions.
Lawson and members of the Lawson board of directors are and may in the future be parties, among others, to litigation related to the Merger Agreements and the Transactions. Among other remedies, the stockholders in the pending litigation seek, and other stockholders could seek, damages and/or seek to enjoin the Transactions. The outcome of any legal proceedings are difficult to predict and any such lawsuits could prevent or delay the closing of the Transactions and/or result in substantial costs to Lawson. The existence of litigation relating to the Transactions may also create uncertainty relating to the Transactions and may be costly and distracting to management. Further, the defense or settlement of any lawsuit or claim that remains unresolved at the time the Mergers are completed may adversely affect the Combined Company’s business, financial condition, results of operations and cash flows. See Note 15 - Commitments and Contingencies to our consolidated financial statements, included in Part II. Item 8. Financial Statements and Supplementary Data, for a description of certain of our pending legal proceedings relating to the Transactions, which are incorporated herein by reference.
If any pending or future lawsuit challenging the Transactions is successful in obtaining an injunction preventing the parties to the Merger Agreements from consummating the Transactions, such injunction may delay or prevent the consummation of the Transactions.
As a result of the Transactions, Lawson’s ability to use its net operating losses and certain other tax attributes generated prior to the Transactions may be subject to limitation.
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As a result of the Transactions, Lawson’s ability to use its net operating losses and certain other tax attributes generated prior to the Transactions may be subject to limitation.
TestEquity and Gexpro Services are private companies and may not have in place the financial organization, reporting and internal controls necessary for a public company.
TestEquity and Gexpro Services are private companies and may not have in place the financial organization, reporting and controls which are required for a U.S. public company. The cost of implementing this type of financial organization, reporting and controls in respect of TestEquity and Gexpro Services and integrating their financial reporting processes with those of Lawson may be significant. Furthermore, if the limitations in TestEquity’s or Gexpro Services’ financial organization, reporting and controls, or any failure to effectively integrate their financial reporting processes with those of Lawson, cause the Combined Company to miss an SEC reporting deadline or otherwise not comply with an applicable law or regulation, the Combined Company might, among other things, have a material weakness in its internal controls or violate its indebtedness covenants.
Risk Factors Relating to the Debt Financing Expected to be Incurred in Connection with the Mergers
The Combined Company is expected to have a significant amount of indebtedness, which could adversely affect the Combined Company’s business, financial condition, and results of operations following the Transactions.
Lawson expects that the Combined Company will have a significant amount of indebtedness after the completion of the Transactions, which is expected to include new indebtedness under the anticipated arrangements described in the section ent itled “Debt Financing Commitment Letter” in Part I. Item 1. Business. In addition, Lawson would have the ability to incur a significant amount of additional indebtedness. The Combined Company’s indebtedness could have significant consequences on the Combined Company’s future operations, including:
• events of default if the Combined Company fails to comply with the financial and other covenants contained in the agreements governing the Combined Company’s debt instruments, which could result in all of the debt becoming immediately due and payable or require the Combined Company to negotiate an amendment to financial or other covenants that could cause the Combined Company to incur additional fees and expenses;
• reducing the availability of the Combined Company’s cash flow to fund working capital, capital expenditures, investments, acquisitions and other general corporate purposes, and limiting the Combined Company’s ability to obtain additional financing for these purposes;
• limiting the Combined Company’s flexibility in planning for, or reacting to, and increasing the Combined Company’s vulnerability to, changes in its business, the industries in which the Combined Company operates, and the overall economy;
• limiting the Combined Company’s ability to buy back common stock or pay dividends;
• placing the Combined Company at a competitive disadvantage compared to any of the Combined Company’s competitors that have less debt or are less leveraged; and
• increasing the Combined Company’s vulnerability to the impact of adverse economic and industry conditions.
The Combined Company’s ability to meet its payment and other obligations under its debt instruments will depend on the Combined Company’s ability to generate significant cash flow in the future. This, to some extent, is subject to general economic, financial, competitive, legislative and regulatory factors as well as other factors that are beyond the Combined Company’s control. Lawson cannot assure that the Combined Company will generate cash flow from operations, or that future borrowings will be available to the Combined Company, in an amount sufficient to enable the Combined Company to meet its indebtedness obligations and to fund other liquidity needs following the completion of the Transactions.
Failure to adequately fund the Combined Company’s operating and working capital needs through cash generated from operations and cash available through the Combined Company’s financing arrangements could negatively impact the Combined Company’s ability to invest in its business and maintain its capital structure.
The Combined Company’s business will require investment in working capital and fixed assets. Lawson expects the Combined Company to fund these investments from cash generated from operations and funds available from the Combined
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Company’s anticipated new financing arrangements. Failure to generate sufficient cash flow from operations or from such anticipated new financing arrangements could cause the Combined Company to have insufficient funds to operate its business. Adequate funds may not be available when needed or may not be available on favorable terms.
Failure to meet the covenant requirements of the Combined Company’s financing arrangements could lead to higher financing costs and increased restrictions and reduce or eliminate the Combined Company’s ability to borrow funds.
Lawson expects that the Combined Company’s anticipated new financing arrangements will contain financial and other restrictive covenants. These covenants could adversely affect the Combined Company by limiting its financial and operating flexibility as well as its ability to plan for and react to market conditions and to meet its capital needs. Failure to meet these covenant requirements could lead to higher financing costs and increased restrictions, reduce or eliminate the Combined Company’s ability to borrow funds, or accelerate the payment of the Combined Company’s indebtedness. TestEquity has been in default of certain debt covenants of its term loan and revolving line of credit agreements. In connection therewith, on September 6, 2019, February 28, 2020, March 27, 2020, October 9, 2020 and June 30, 2021, TestEquity entered into forbearance agreements with its lender. Such term loan and revolving line of credit agreements are expected to be terminated in connection with the closing of the TestEquity Merger.
If the Combined Company requires more liquidity than is expected to be available to it under its financing arrangements, the Combined Company may need to raise additional funds through debt or equity offerings which may not be available when needed or may not be available on terms favorable to the Combined Company. Should funding be insufficient at any time in the future, the Combined Company may be unable to develop or enhance its products or services, take advantage of business opportunities or respond to competitive pressures, any of which could have a material adverse effect on the Combined Company’s business, financial condition and results of operations.
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ITEM 1B. UNRESOLVED STAFF COMMENTS.
None.