Distribution Solutions Group, Inc. 10-Q

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis of financial condition and results of operations should be read in conjunction with the unaudited condensed consolidated financial statements and related notes included in this Quarterly Report on Form 10-Q, the audited consolidated financial statements, accompanying notes and other information included in our Annual Report on Form 10-K filed for the year ended December 31, 2022 and the Lawson Products, Inc. unaudited condensed consolidated financial statements and accompanying notes included in our Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2022. References to “DSG”, the “Company”, "we", "our" or "us" refer to Distribution Solutions Group, Inc. and all entities consolidated in the accompanying unaudited condensed consolidated financial statements. Overview Organization and Structure Distribution Solutions Group, Inc. ("DSG"), is a multi-platform specialty distribution company providing high touch, value-added distribution solutions to the maintenance, repair and operations ("MRO"), the original equipment manufacturer ("OEM") and the industrial technologies markets. The Mergers that were consummated in April 2022 resulted in the combination of Lawson, TestEquity and Gexpro Services. For a description of the business combination, see Note 1 – Nature of Operations and Basis of Presentation within Item 1. Financial Statements. We manage and report our operating results through three reportable segments: Lawson, TestEquity and Gexpro Services. A summary of our segments is presented below. For additional details about our segments, see Note 16 – Segment Information within Item 1. Financial Statements. Lawson is a distributor of specialty products and services to the industrial, commercial, institutional and government MRO market. TestEquity is a distributor of test and measurement equipment and solutions, electronic production supplies, and tool kits from its leading manufacturer partners supporting the technology, aerospace, defense, automotive, electronics, education, and medical industries. Gexpro Services is a global supply chain solutions provider, specializing in developing and implementing vendor managed inventory ("VMI") and kitting programs to high-specification manufacturing customers. In addition to these three reportable segments, we have an “All Other” category which includes unallocated DSG holding company costs that are not directly attributable to the ongoing operating activities of our reportable segments and the results of a non-reportable segment. DSG Vision and Strategic Focus The complementary distribution operations of Lawson, TestEquity and Gexpro Services were combined in 2022 for the purpose of creating a specialty distribution company enabling each of Lawson, TestEquity and Gexpro Services to maintain their respective high-touch, value-added service delivery models and customer relationships in their specialty distribution businesses under the leadership of their separate business unit management teams. The DSG leadership team provides oversight to these separate leadership teams. This structure enables the combined company to leverage best practices, back-office resources and technologies across the three operating companies to help drive cost synergies and efficiencies. The combined company has the ability to utilize its combined financial resources to accelerate a strategy of expansion through both business acquisitions and organic growth. Organic Growth Strategy We intend to grow our businesses organically by exploring growth opportunities that provide different channels to reach customers, increase revenue and generate positive results. We plan to utilize our company structure to grow organic revenue through collaborative selling across our customer bases and expanding the digital capabilities across our platform. 31 Table of Contents Acquisition Strategy In addition to organic growth, we plan to actively pursue acquisition opportunities complementary to our businesses and that we believe will be financially accretive to our organization. HIS Company, Inc. - Purchase Agreement — On March 30, 2023, DSG entered into a Stock Purchase Agreement (the “Purchase Agreement”), with various parties for the acquisition by DSG, on the terms and subject to the conditions therein, of all of the issued and outstanding capital stock of HIS Company, Inc., a Texas corporation (“Hisco”), a leading distributor of specialty products serving industrial technology applications. The transaction is expected to close in the second quarter of 2023, subject to regulatory and customary closing conditions. For more information about the Hisco acquisition, including DSG’s anticipated financing of a portion of the purchase price for the transaction, refer to Note 3 – Business Acquisitions within Item 1. Financial Statements. Sales Drivers DSG believes that the Purchasing Managers Index ("PMI") published by the Institute for Supply Management is an indicative measure of the relative strength of the economic environment of the industry in which it operates. The PMI is a composite index of economic activity in the U.S. manufacturing sector. DSG believes that a measure of that index above 50 generally indicates expansion of the manufacturing sector while a measure below 50 generally represents contraction. The average monthly PMI wa s 47.1 in the three months ended March 31, 2023 compared to 57.8 in the three months ended March 31, 2022 . Lawson Sales Drivers The North American MRO market is highly fragmented. Lawson competes for business with several national distributors as well as a large number of regional and local distributors. The MRO business is impacted by the overall strength of the manufacturing sector of the U.S. economy. Lawson's revenue is also influenced by the number of sales representatives and their productivity. Lawson plans to continue concentrating its efforts on increasing the productivity and size of its sales team. Additionally, Lawson drives revenue through the expansion of products sold to existing customers as well as attracting new customers and additional ship-to locations. Lawson also uses an inside sales team and an e-commerce site to generate sales. TestEquity Sales Drivers Across both the test and measurement and electronic production supplies businesses, the North American market is highly fragmented with competitors ranging from large global distributors to national and regional distributors. TestEquity management focuses on the internal metric of Sales per Day (“SPD”) and Day Adjust Growth (“DAG”). The SPD calculates and compares TestEquity’s total sales divided by the number of selling days, adjusted for weekends and holidays. A selling day generally represents a business day in which TestEquity ships products to its customers. The DAG represents the percentage increase or decrease in the SPD for a defined period of time. Specifically in respect of its electronic production supplies business, the current semi-conductor chip shortage is negatively impacting TestEquity’s business as such chips are key elements to the electronic production process. TestEquity anticipates that recovery of this important part of its customers’ supply chain will occur in late 2023 and early 2024. Gexpro Services Sales Drivers The global supply chain solutions market is highly fragmented across Gexpro Services' key vertical segments. Gexpro Services’ competitors range from large global distributors and manufacturers to small regional domestic distributors and manufacturers. Gexpro Services revenue is influenced by our OEMs’ production schedules, new product introduction launches, and service project needs. Gexpro Services drives revenue through increasing wallet share with existing customers, customer-led geographic expansion, and new customer development in its six key vertical markets. Additionally, Gexpro Services drives revenue through expansion of its installation and aftermarket services by leveraging its portfolio of recent acquisitions. 32 Table of Contents Supply Chain Disruptions Along with the broader economy, we continue to be affected by rising supplier costs caused by inflation and increased transportation and labor costs . This results in challenges in acquiring and receiving inventory in a timely fashion and fulfilling customer orders . We have instituted various price increases during 2022 and 2023 in response to rising supplier costs, as well as increased transportation and labor costs in order to manage our gross profit margins. Cyber Incident Litigation On February 10, 2022, DSG disclosed that its computer network was the subject of a cyber incident potentially involving unauthorized access to certain confidential information (the “Cyber Incident”). DSG engaged a cybersecurity forensics firm to assist in the investigation of the incident and to assist in securing its computer network. Because of the nature of the information that may have been compromised, DSG was required to notify the parties whose information was potentially compromised of the incident as well as various governmental agencies and has taken other actions, such as offering credit monitoring services. At March 31, 2023 DSG had not incurred material costs as a result of the Cyber Incident and, at this time, is unable to estimate the total cost of any remediation that may be required. On April 4, 2023, a putative class action lawsuit (the “Cyber Incident Suit”) was filed against DSG. For more information about the Cyber Incident Suit, please refer to Note 14 – Commitments and Contingencies within Item 1. Financial Statements. Critical Accounting Policies and Use of Estimates The unaudited condensed consolidated financial statements were prepared in accordance with GAAP. A discussion of our critical accounting policies and estimates is contained within Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations in DSG's Annual Report on Form 10-K for the year ended December 31, 2022. There have been no significant changes to our previously disclosed critical accounting policies and use of estimates. The following provides information on the accounts requiring more significant estimates. Inventory Reserves - Inventories principally consist of finished goods stated at the lower of cost or net realizable value using the first-in-first-out method for the Lawson segment and primarily the weighted average method for the TestEquity and Gexpro Services segments. Most of our products are not exposed to the risk of obsolescence due to technology changes. However, some of our products do have a limited shelf life, and from time to time we add and remove items from our catalogs, brochures or website for marketing and other purposes. To reduce the cost basis of inventory to a lower of cost or net realizable value, a reserve is recorded for slow-moving and obsolete inventory based on historical experience and monitoring of current inventory activity. Estimates are used to determine the necessity of recording these reserves based on periodic detailed analysis using both qualitative and quantitative factors. As part of this analysis, the Company considers several factors including the inventories length of time on hand, historical sales, product shelf life, product life cycle, product category and product obsolescence. In general, depending on the product category, we reserve inventory with low turnover at higher rates than inventory with higher turnover. At March 31, 2023, our inventory reserve was $12.9 million, equal to approximately 4.5% of our gross inventory. A hypothetical change of one hundred basis points to our reserve as a percentage of total inventory would have affected our cost of goods sold by $2.7 million. Income Taxes - Deferred tax assets or liabilities reflect temporary differences between amounts of assets and liabilities for financial and tax reporting. Such amounts are adjusted, as appropriate, to reflect changes in enacted tax rates expected to be in effect when the temporary differences reverse. Significant judgment is required in determining income tax provisions as well as deferred tax asset and liability balances, including the estimation of valuation allowances and the evaluation of uncertain tax positions. Goodwill Impairment - Goodwill represents the cost of business acquisitions in excess of the fair value of identifiable net tangible and intangible assets acquired. The Company reviews goodwill for potential impairment annually on October 1st, or when an event or other circumstances change that would more likely than not reduce the fair value of the asset below its carrying value. The first step in the multi-step process to determine if goodwill has been impaired and to what degree is to review the relevant qualitative factors that could cause the fair value of the reporting unit to decrease below the carrying value of the reporting unit. The Company considers factors such as macroeconomic, industry and market conditions, cost factors, overall 33 Table of Contents financial performance and other relevant factors that would affect the individual reporting units. If the Company determines that it is more likely than not that the fair value of the reporting unit is greater than the carrying value of the reporting unit, then no further impairment testing is needed. If the Company determines that it is more likely than not that the carrying value of the reporting unit is greater than the fair value of the reporting unit, the Company will move to the next step in the process. The Company will estimate the fair value of the reporting unit and compare it to the reporting unit's carrying value. If the carrying value of the reporting unit exceeds its fair value, the Company will record an impairment of goodwill equal to the amount the carrying value of the reporting unit exceeds its fair value, up to the total amount of goodwill previously recognized. Business Combinations - We allocate the purchase price paid for assets acquired and liabilities assumed in connection with our acquisitions based on their estimated fair values at the time of acquisition. This allocation involves a number of assumptions, estimates, and judgments in determining the fair value, as of the acquisition date, of the following: • intangible assets, including the valuation methodology (the relief of royalty method for trade names and multi-period excess earnings method for customer relationships), estimations of future cash flows, discount rates, royalty rates, recurring revenue attributed to customer relationships, and our assumed market segment share, as well as the estimated useful life of intangible assets; • deferred tax assets and liabilities, uncertain tax positions, and tax-related valuation allowances; • inventory; • property, plant and equipment; • pre-existing liabilities or legal claims; and • goodwill as measured as the excess of consideration transferred over the net of the acquisition date fair values of the assets acquired and the liabilities assumed. Our assumptions and estimates are based upon comparable market data and information obtained from our management and the management of the acquired companies. We allocate goodwill to the reporting units of the business that are expected to benefit from the business combination. Factors Affecting Comparability to Prior Periods Our results of operations are not directly comparable to prior results for the periods presented due to the Mergers that were completed on April 1, 2022. The Mergers were accounted for as a reverse merger under the acquisition method of accounting in accordance with the accounting guidance for reverse acquisitions as provided in Accounting Standards Codification 805, Business Combinations ("ASC 805"). Under this guidance, TestEquity and Gexpro Services were treated as a combined entity as the accounting acquirer for financial reporting purposes, and DSG was identified as the accounting acquiree. This determination was primarily made as TestEquity and Gexpro Services were under the common control of an entity that owns a majority of the voting rights of the combined entity, and therefore, only DSG experienced a change in control. Accordingly, the unaudited condensed consolidated financial statements for the three months ended March 31, 2023 and 2022 reflect the results of operations of TestEquity and Gexpro Services on a consolidated basis, and the results of operations of DSG's legacy Lawson business are included only in the unaudited condensed consolidated financial statements for the three months ended March 31, 2023 for activity subsequent to the April 1, 2022 Merger Date. Non-GAAP Financial Measures The Company's management believes that certain non-GAAP financial measures may provide users of this financial information with additional meaningful comparisons between current results and results in prior operating periods. Management believes that these non-GAAP financial measures can provide additional meaningful reflection of underlying trends of the business because they provide a comparison of historical information that excludes certain infrequently occurring, seasonal or non-operational items that impact the overall comparability. These non-GAAP financial measures should be viewed in addition to, and not as an alternative for, the Company's reported results prepared in accordance with GAAP. Non-GAAP Adjusted EBITDA Management believes Adjusted EBITDA is an important measure of the Company's operating performance. We define Adjusted EBITDA as operating income plus depreciation and amortization, stock-based compensation, severance costs, costs related to the execution and integration of the Mergers, amortization of fair value step-up resulting from the Mergers, acquisition related costs (unrelated to the Mergers), and other non-recurring items. The following table provides our calculation of Adjusted EBITDA for the three months ended March 31, 2023 and 2022: 34 Table of Contents Reconciliation of Operating Income to Non-GAAP Adjusted EBITDA (Unaudited) Three Months Ended March 31, (in thousands) 2023 2022 (7) Operating income (loss) $ 16,721 $ 2,988 Depreciation and amortization 15,722 7,589 Stock-based compensation (1) 2,204 — Severance costs (2) 351 456 Merger/integration costs (3) 1,223 1,442 Inventory step-up (4) — 163 Acquisition related costs (5) 2,876 840 Other non-recurring (6) 256 24 Adjusted EBITDA $ 39,353 $ 13,502 (1) Expense primarily for stock-based compensation, of which a portion varies with the Company’s stock price. (2) Includes severance expense from actions taken in 2023 and 2022 not related to a formal restructuring plan. (3) Merger transaction costs related to the negotiation, review and execution of the Merger Agreements relating to the Mergers and subsequent integration costs. (4) Inventory fair value step-up adjustments resulting from the acquisition accounting for additional acquisitions completed by Gexpro Services. (5) Expense for acquisition related costs, unrelated to the Mergers. (6) Other non-recurring costs consist of sales force optimization and other non-recurring items. (7) Includes the operating results of Lawson subsequent, but not prior, to the April 1, 2022 Merger Date in accordance with GAAP accounting guidance for reverse acquisitions. Management uses operating income and Adjusted EBITDA to evaluate the performance of its reportable segments. See Note 16 – Segment Information with in Item 1. Financial Statements for additional information about our reportable segments. The following table provides Adjusted EBITDA by reportable segment: Three Months Ended March 31, (in thousands) 2023 2022 Adjusted EBITDA Lawson (1) $ 18,450 $ — TestEquity 7,659 5,491 Gexpro Services 11,674 8,011 All Other (2) 1,570 — Consolidated Adjusted EBITDA $ 39,353 $ 13,502 (1) Includes the operating results of Lawson subsequent, but not prior, to the April 1, 2022 Merger Date in accordance with GAAP accounting guidance for reverse acquisitions . (2) Includes the operating results of All Other subsequent, but not prior, to the April 1, 2022 Merger Date in accordance with GAAP accounting guidance for reverse acquisitions . Supplemental Information - Lawson Non-GAAP Adjusted Operating Income and Non-GAAP Adjusted EBITDA For management to discuss Lawson's operating results on a comparable basis, Lawson's historical, pre-merger components of operating income have been provided separately in the table below. In addition, Lawson's GAAP results of operations were adjusted to include the results prior to the April 1, 2022 Merger Date in order to reflect the total operating activities attributable to Lawson for each period presented. Management believes this historical information provides the most meaningful basis of comparison for Lawson's operations, is more useful in identifying current business trends, and is important for the user of our financial statements in understanding Lawson's business. Refer to Note 1 – Nature of Operations and Basis of Presentation and Note 3 – Business Acquisitions within Item 1. Financial Statements for information about the Mergers. These non-GAAP amounts are not considered to be prepared in accordance with GAAP, have not been prepared as pro forma results under applicable regulations, may not reflect the actual results we would have achieved had the Mergers occurred at the beginning of 2022, and should not be viewed as a substitute for the results of operations presented in accordance with 35 Table of Contents GAAP. Lawson's historical operating results prior to the Mergers were obtained from the unaudited condensed consolidated financial statements included in DSG's Quarterly Report on Form 10-Q filed for the quarterly period ended March 31, 2022. Lawson Non-GAAP Adjusted Results - Calculation of Supplemental Information (Unaudited) (in thousands) Three Months Ended March 31, 2023 Three Months Ended March 31, 2022 Lawson Operating Income GAAP Results (1) Pre-Merger Results Adjusted Results (2) GAAP Results (1) Pre-Merger Results (3) Adjusted Results (2) Revenue $ 125,280 $ — $ 125,280 $ — $ 104,902 $ 104,902 Cost of goods sold 54,370 — 54,370 — 49,371 49,371 Gross profit 70,910 — 70,910 — 55,531 55,531 Selling, general and administrative expenses 62,665 — 62,665 — 44,435 44,435 Operating income (loss) $ 8,245 $ — $ 8,245 $ — $ 11,096 $ 11,096 Lawson Adjusted EBITDA (4) $ 18,450 $ — $ 18,450 $ — $ 8,042 $ 8,042 (1) Operating income prepared in accordance with GAAP, which includes Lawson’s results of operations subsequent, but not prior, to the April 1, 2022 Merger Date. For the three months ended March 31, 2022, the operating results of Lawson were not included in the Company's GAAP results. See Note 1 – Nature of Operations and Basis of Presentation and Note 3 – Business Acquisitions within Item 1. Financial Statements. (2) Lawson's results of operations adjusted for comparability on a period-over-period basis. These non-GAAP results represent Lawson’s total operating activities for the three months ended March 31, 2023 and 2022 , regardless of the Mergers (that is, they reflect both pre- and post-Merger results of Lawson). (3) Lawson's results of operations for the three months ended March 31, 2022 , which occurred prior to the April 1, 2022 Merger Date, were not included in the Company's GAAP operating results under reverse merger acquisition accounting. See Note 1 – Nature of Operations and Basis of Presentation and Note 3 – Business Acquisitions within Item 1. Financial Statements. (4) Refer to the Non-GAAP Adjusted EBITDA section above for a reconciliation of Adjusted EBITDA to operating income. Composition of Results of Operations The following results of operations for the three months ended March 31, 2023 and 2022 include the accounts of the TestEquity and Gexpro Services combined entity, as the accounting acquirer. The results of DSG's legacy Lawson business have been included only in the results of operations for the three months ended March 31, 2023 for activity subsequent, and not prior, to the April 1, 2022 Merger Date. 36 Table of Contents RESULTS OF OPERATIONS Three Months Ended March 31, 2023 Compared to Three Months Ended March 31, 2022 Consolidated Results of Operations Three Months Ended March 31, 2023 2022 (Dollars in thousands) Amount % of Revenue Amount % of Revenue Revenue Lawson (1) $ 125,280 36.0% $ — —% TestEquity 107,359 30.8% 72,402 47.0% Gexpro Services 101,016 29.0% 81,683 53.0% All Other (2) 14,615 4.2% — —% Total Revenue 348,270 100.0% 154,085 100.0% Cost of goods sold Lawson (1) 54,370 15.6% — —% TestEquity 82,002 23.5% 55,479 36.0% Gexpro Services 70,511 20.2% 57,722 37.5% All Other (2) 8,516 2.4% — —% Total Cost of goods sold 215,399 61.8% 113,201 73.5% Gross profit 132,871 38.2% 40,884 26.5% Selling, general and administrative expenses Lawson (1) 62,665 18.0% — —% TestEquity 25,331 7.3% 17,527 11.4% Gexpro Services 23,131 6.6% 20,369 13.2% All Other (2) 5,023 1.4% — —% Total Selling, general and administrative expenses 116,150 33.4% 37,896 24.6% Operating income (loss) 16,721 4.8% 2,988 1.9% Interest expense (7,670) (2.2)% (6,856) (4.4)% Loss on extinguishment of debt — —% (581) (0.4)% Change in fair value of earnout liabilities (57) —% — —% Other income (expense), net (975) (0.3)% 956 0.6% Income (loss) before income taxes 8,019 2.3% (3,493) (2.3)% Income tax expense (benefit) 2,112 0.6% (956) (0.6)% Net income (loss) $ 5,907 1.7% $ (2,537) (1.6)% (1) Includes the operating results of Lawson subsequent, but not prior, to the April 1, 2022 Merger Date. (2) Includes the operating results of All Other subsequent, but not prior, to the April 1, 2022 Merger Date. Overview of Consolidated Results of Operations Our consolidated results of operations include the financial impact of the Mergers that were completed on April 1, 2022. The increase in gross profit for the first quarter of 2023 compared to the first quarter of 2022 was primarily due to the inclusion of Lawson operations only subsequent, and not prior, to the April 1, 2022 Merger Date. Expenses for the first quarter of 2023 compared to the first quarter of 2022 were impacted by the inclusion of Lawson operations only subsequent, and not prior, to the April 1 2022 Merger Date, and the inclusion of the acquisitions completed in 2022. Refer to Results by Reportable Segment below for a complete discussion of our results of operations. 37 Table of Contents Results by Reportable Segment Lawson Segment Three Months Ended March 31, Change (Dollars in thousands) 2023 2022 Amount % Revenue $ 125,280 $ — $ 125,280 — % Cost of goods sold 54,370 — 54,370 — % Gross profit 70,910 — 70,910 — % Selling, general and administrative expenses 62,665 — 62,665 — % Operating income (loss) $ 8,245 $ — $ 8,245 — % Gross profit margin 56.6 % — % Adjusted EBITDA (1) $ 18,450 $ — $ 18,450 — % (1) Refer to the Non-GAAP Adjusted EBITDA section in Overview for a reconciliation of Adjusted EBITDA to operating income. The increase in revenue, gross profit and operating income for the first quarter of 2023 compared to the first quarter of 2022 was due to the inclusion of Lawson operations beginning on the April 1, 2022 Merger Date and not including any Lawson operations prior to the April 1, 2022 Merger Date. Supplemental Information For management to discuss Lawson's operating results on a comparable basis, Lawson's GAAP results of operations for three months ended March 31, 2022 were adjusted to include its results prior to the April 1, 2022 Merger Date in order to reflect the total operating activities attributable to Lawson for each period presented. These non-GAAP Adjusted Results for the three months ended March 31, 2022 presented in the table below are referred to within this supplemental results of operations discussion as "Adjusted". Three Months Ended March 31, Change from Adjusted 2022 (Dollars in thousands) 2023 Adjusted 2022 (1) Amount % Revenue $ 125,280 $ 104,902 $ 20,378 19.4 % Cost of goods sold 54,370 49,371 4,999 10.1 % Gross profit 70,910 55,531 15,379 27.7 % Selling, general and administrative expenses 62,665 44,435 18,230 41.0 % Operating income (loss) $ 8,245 $ 11,096 $ (2,851) (25.7) % Gross profit margin 56.6 % 52.9 % Adjusted EBITDA (2) $ 18,450 $ 8,042 $ 10,408 129.4 % (1) For comparability purposes, Lawson's GAAP results of operations were adjusted to include the historical results of Lawson prior to the Merger Date. Refer to the section Factors Affecting Comparability to Prior Periods and the non-GAAP measures section Supplemental Information - Lawson Non-GAAP Adjusted Operating Income and Non-GAAP Adjusted EBITDA for more information related to the calculation of adjusted amounts. (2) Refer to the Non-GAAP Adjusted EBITDA section in Overview for a reconciliation of Adjusted EBITDA to operating income. Revenue and Gross Profit Revenue increased $20.4 million, or 19.4%, to $125.3 million in the first quarter of 2023 compared to adjusted revenue of $104.9 million in the first quarter of 2022 . The increase was primarily driven by the realization of price increases enacted throughout 2022 and 2023 to offset rising supplier costs, increased quantity volumes and strengthening sales to Lawson's strategic and governmental customers and automotive end market. 38 Table of Contents Gross profit increased $15.4 million to $70.9 million in the first quarter of 2023 compared to adjusted gross profit of $55.5 million in the prior year quarter primarily as a result of increased sales and the related price increases put in place, lower net freight expense and spreading operating expenses over a higher level of sales. Lawson gross profit as a percent of revenue was 56.6% in the first quarter of 2023 compared to Lawson gross profit as a percent of adjusted revenue of 52.9% in the prior year quarter. The gross margin percentage improvement for the first quarter of 2023 was primarily the result of price increases enacted as the prior year quarter was impacted by increased supplier costs from inflation and supply chain disruptions, offset by a sales shift toward lower margin customers. Selling, General and Administrative Expenses Selling, general and administrative expenses consist of compensation and support for Lawson sales representatives and expenses to operate Lawson's distribution network and overhead expenses. Selling, general and administrative expenses increased to $62.7 million in the first quarter of 2023 compared to the adjusted amount of $44.4 million in the prior year quarter. The increase was primarily driven by higher compensation expense incurred to support increased sales, additional depreciation and amortization as a result of the fair value step-up adjustments resulting from the reverse merger acquisition accounting and stock-based compensation expense offset in part by a stock-based compensation benefit in the first quarter of 2022. Adjusted EBITDA During the three months ended March 31, 2023, Lawson generated Adjusted EBITDA of $18.5 million , an increase of $10.4 million, or 129.4% from the same period a year ago driven by increased revenue and margins. TestEquity Segment Three Months Ended March 31, Change (Dollars in thousands) 2023 2022 Amount % Revenue $ 107,359 $ 72,402 $ 34,957 48.3 % Cost of goods sold 82,002 55,479 26,523 47.8 % Gross profit 25,357 16,923 8,434 49.8 % Selling, general and administrative expenses 25,331 17,527 7,804 44.5 % Operating income (loss) $ 26 $ (604) $ 630 (104.3) % Gross profit margin 23.6 % 23.4 % Adjusted EBITDA (1) $ 7,659 $ 5,491 $ 2,168 39.5 % (1) Refer to the Non-GAAP Adjusted EBITDA section in Overview for a reconciliation of Adjusted EBITDA to operating income. Revenue and Gross Profit Revenue increased $35.0 million, or 48.3%, to $107.4 million in the first quarter of 2023 compared to revenue of $72.4 million in the first quarter of 2022 . The increase was primarily driven by $34.9 million of revenue generated from the acquisitions completed in the second quarter of 2022. Gross profit increased $8.4 million to $25.4 million in the first quarter of 2023 compared to gross profit of $16.9 million in the prior year quarter. The increase was primarily driven by the 2022 acquisitions which generated $7.6 million of additional gross profit in the first quarter of 2023. TestEquity gross profit as a percent of revenue was 23.6% in the first quarter of 2023 compared to 23.4% in the prior year quarter. The gross margin percentage for t he first quarter of 2023 was impacted by an expansion of margins within the existing base business offset by a shift in sales mix from the lower gross margin rates from the 2022 acquisitions. Selling, General and Administrative Expenses Selling, general and administrative expenses consist of compensation and support for TestEquity's sales representatives and expenses to operate TestEquity's distribution network and overhead expenses. 39 Table of Contents Selling, general and administrative expenses increased $7.8 million to $25.3 million in the first quarter of 2023 compared to $17.5 million in the prior year quarter. Approximately $5.2 million of the increased expenses was primarily driven by the 2022 acquisitions and approximately $2.4 million of the increased expenses was driven by increased acquisition expenses in the first quarter of 2023 of $2.7 million in connection with the potential acquisition of Hisco compared to $0.3 million of acquisition expenses in the prior year quarter. Adjusted EBITDA During the three months ended March 31, 2023, TestEquity generated Adjusted EBITDA of $7.7 million, an increase of $2.2 million, or 39.5% from the prior year quarter with approximately $2.4 million driven by the 2022 acquisitions. Gexpro Services Segment Three Months Ended March 31, Change (Dollars in thousands) 2023 2022 Amount % Revenue $ 101,016 $ 81,683 $ 19,333 23.7 % Cost of goods sold 70,511 57,722 12,789 22.2 % Gross profit 30,505 23,961 6,544 27.3 % Selling, general and administrative expenses 23,131 20,369 2,762 13.6 % Operating income (loss) $ 7,374 $ 3,592 $ 3,782 105.3 % Gross profit margin 30.2 % 29.3 % Adjusted EBITDA (1) $ 11,674 $ 8,011 $ 3,663 45.7 % (1) Refer to the Non-GAAP Adjusted EBITDA section in Overview for a reconciliation of Adjusted EBITDA to operating income. Revenue and Gross Profit Revenue increased $19.3 million, or 23.7%, to $101.0 million in the first quarter of 2023 compared to revenue of $81.7 million in the first quarter of 2022 . The increase was primarily driven by $4.0 million of revenue generated from the Frontier acquisition completed at the end of the first quarter of 2022 and 18.7% organic growth in the base business t hrough an expansion of products and services to existing customers as well as the addition of new customers. Gross profit increased $6.5 million to $30.5 million in the first quarter of 2023 compared to gross profit of $24.0 million in the prior year quarter. Gexpro Services gross profit as a percent of revenue was 30.2% in the first quarter of 2023 compared to 29.3% in the prior year quarter. The gross profit increase was driven by the 2022 acquisitions, an improvement in the global supply chain and sales price increases enacted. Selling, General and Administrative Expenses Selling, general and administrative expenses consist of sales and marketing expenses primarily relating to compensation, costs associated with supporting Gexpro Services’ service facilities, overhead expenses within finance, legal, human resources and information technology, and other costs required to operate Gexpro Services’ business and service customers. Selling, general, and administrative expenses increased to $23.1 million in the first quarter of 2023 compared to $20.4 million in the prior year quarter. The increase of $2.8 million was primarily driven by $1.7 million of additional expenses from the 2022 acquisitions. The remainder of the increase was due primarily to additional compensation and product fulfillment costs to support organic growth. Adjusted EBITDA During the three months ended March 31, 2023, Gexpro Services generated Adjusted EBITDA of $11.7 million , an increase of $3.7 million, or 45.7%, from the same period a year ago primarily driven by increases in revenue and margins. 40 Table of Contents Consolidated Non-operating Income and Expense Three Months Ended March 31, Change (Dollars in thousands) 2023 2022 Amount % Interest expense $ (7,670) $ (6,856) $ (814) 11.9 % Change in fair value of earnout liabilities $ (57) $ — $ (57) N/M Other income (expense), net $ (975) $ 956 $ (1,931) N/M Income tax expense (benefit) $ 2,112 $ (956) $ 3,068 N/M N/M Not meaningful Interest Expense Interest expense increased $0.8 million in the first quarter of 2023 compared to the prior year quarter . The increase was due to higher outstanding borrowings as a result of the debt refinancing related to the Mergers, offset partially by a lower interest rate on the outstanding borrowings as a result of the debt refinancing related to the Mergers. Change in Fair Value of Earnout Liability The $0.1 million expense in the first quarter of 2023 related to the change in fair value of the earnout liability associated with the Frontier earnout. Other Income (Expense), Net Other expense, net increased $1.9 million in the first quarter of 2023 compared to the prior year quarter primarily due to the inclusion of Lawson operations subsequent to the April 1, 2022 Merger Date. Income Tax Expense (Benefit) Income tax expense was $2.1 million, a 26.3% effective tax rate for the three months ended March 31, 2023 compared to income tax expense of $1.0 million and a 27.4% effective tax rate for the three months ended March 31, 2022. The change in the year over year effective tax rate was primarily due to the effect of lower transaction costs in 2023 compared to 2022. LIQUIDITY AND CAPITAL RESOURCES Cash and cash equivalents were $31.1 million on March 31, 2023 compared to $24.6 million on December 31, 2022. The Company believes its current balances of cash and cash equivalents, availability under its Amended and Restated Credit Agreement and cash flows from operations will be sufficient to meet its liquidity needs for the next twelve months. As of March 31, 2023, liquidity for the Company was $100.9 million comprised of $31.1 million of cash and cash equivalents and $69.8 million of bo rrowing availability remaining, net of outstanding letters of credit, under the Amended and Restated Credit Agreement. Our primary short-term and long-term liquidity and capital resource needs are to finance operating expenses, working capital, capital expenditures, potential business acquisitions, strategic initiatives and general corporate purposes. Our current debt obligations under the Amended and Restated Credit Agreement mature in April 2027. Principal payments on the Amended and Restated Credit Agreement for the next twelve months are $15.0 million. Refer to Note 9 – Debt within Item 1. Financial Statements for additional information related to our debt obligations. Access to debt capital markets has historically provided the Company with sources of liquidity, beyond normal operating cash flows. We do not anticipate having difficulty in obtaining financing from those markets in the future, however, we cannot provide assurance that events beyond our control will not have a material adverse impact on our liquidity. 41 Table of Contents Sources and Uses of Cash The following table presents a summary of our cash flows: (in thousands) March 31, 2023 March 31, 2022 Change Net cash provided by (used in) operating activities $ 13,858 $ (13,532) $ 27,390 Net cash provided by (used in) investing activities $ (5,094) $ (57,573) $ 52,479 Net cash provided by (used in) financing activities $ (2,394) $ 68,795 $ (71,189) Cash Provided by (Used in) Operating Activities Net cash provided by operations for the three months ended March 31, 2023 was $13.9 million primarily due to net income including non-cash items, partially offset by investments in trade working capital to support higher sales and other net cash flow items. Net cash used in operations for the three months ended March 31, 2022 was $13.5 million, primarily due to increases in trade working capital and other net cash flow items. Cash Provided by (Used in) Investing Activities Net cash used in investing activities for the three months ended March 31, 2023 was $5.1 million, primarily due to purchases of property, plant and equipment and rental equipment which was partially offset by the sale of rental equipment. Net cash used in investing activities for the three months ended March 31, 2022 was $57.6 million, primarily due to the other acquisitions completed during the first three months of 2023 by Gexpro Services as described in Note 3 – Business Acquisitions within Item 1. Financial Statements. Cash Provided by (Used in) Financing Activities Net cash used in financing activities for the three months ended March 31, 2023 was $2.4 million, primarily due to principal payments on the term loans partially offset by net proceeds on the revolving credit facility. Net cash provided by financing activities for the three months ended March 31, 2022 was $68.8 million, primarily due to net proceeds on term loans and revolving credit facilities as a result of the January 3, 2022 Gexpro Services refinancing that was used to fund the Resolux acquisition and repay previous indebtedness. Financing and Capital Requirements Credit Facility On April 1, 2022, DSG entered into the Amended and Restated Credit Agreement, which includes a $200 million senior secured revolving credit facility, a $250 million senior secured initial term loan facility and a $50 million senior secured delayed draw term loan facility. Refer to Note 9 – Debt within Item 1. Financial Statements for a description of the Amended and Restated Credit Agreement. On March 31, 2023, we had $415.9 million in outstanding borrowings and $69.8 million of bo rrowing availability remaining, net of outstanding letters of credit, under the senior secured revolving credit facility. As of March 31, 2023, we were in compliance with all financial covenants under our Amended and Restated Credit Agreement. While we were in compliance with our financial covenants as of March 31, 2023, failure to meet the covenant requirements of the Amended and Restated Credit Agreement in future quarters could lead to higher financing costs and increased restrictions, reduce or eliminate our ability to borrow funds, or accelerate the payment of our indebtedness and could have a material adverse effect on our business, financial condition and results of operations. 42 Table of Contents Purchase Commitments As of March 31, 2023, we had contractual commitments to purchase approximately $174 million of product from our suppliers and contractors over the next twelve months. Capital Expenditures During the three months ended March 31, 2023, t otal capital expenditures for property, plant and equipment and rental equipment were $6.9 million excluding proceeds from the sale of rental equipment. The company expects to spend approxi mately $14 million to $16 million for capital expenditures during the remainder of 2023 to support ongoing operations. Stock Repurchase Program The Company's Board of Directors previously authorized a stock repurchase program that permits the Company to repurchase its common stock. The timing and the amount of any repurchases will be determined by management under parameters established by the Board of Directors and depend on various factors including an evaluation of our stock price, corporate and regulatory requirements, capital availability and other market conditions. The Company had $7.6 million of remaining availability for stock repurchases under the program as of March 31, 2023. See Note 11 – Stock Repurchase Program with in Item 1. Financial Statements for further information. HIS Company, Inc. - Purchase Agreem ent On March 30, 2023, the Company agreed to purchase Hisco for $269.1 million at closing, with a potential additional earn-out payment of up to $12.6 million, subject to Hisco achieving certain performance targets. DSG also agreed to pay $37.5 million in cash or DSG common stock in retention bonuses to certain Hisco employees that remain employed with Hisco or its affiliates for twelve or more months after the closing of the Hisco Transaction. The completion of the Hisco Transaction is subject to regulatory and customary closing conditions. DSG intends to finance a portion of the purchase price through a combination of (i) the incurrence of additional indebtedness pursuant to DSG's Amended and Restated Credit Agreement dated April 1, 2022 by and among DSG, certain subsidiaries of DSG as borrowers or guarantors, the lenders party thereto and JPMorgan Chase Bank, N.A., as administrative agent; and (ii) the issuance of additional shares of DSG common stock pursuant to the Rights Offering to existing holders of DSG common stock as of the record date therefor. The Rights Offering is expected to raise an aggregate amount of approximately $100 million and will be conducted pursuant to DSG's effective registration statement on Form S-3. The subscription rights will be transferable but will not be listed for trading on any stock exchange or market. Luther King Capital Management and its affiliates currently own approximately 77% of DSG’s outstanding stock and have indicated an intention to fully subscribe for their pro rata portion in the Rights Offering, as well as for their pro rata portion of any rights remaining unsubscribed at the completion of the subscription period. 43 Table of Contents ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK ITEM 3 of Part I has been omitted from this report.