Distribution Solutions Group, Inc.

Good day and welcome to the Distribution Solutions Group first quarter 2024 earnings conference call. At this time, all participants are on a listen-only mode, and a question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. Please note, this conference is being recorded. I will now turn the conference over to your host, Stephen Hoosier, with three-part advisors. Sir, you may begin.

Good morning, everyone, and welcome to the Distribution Solutions Group first quarter 2024 earnings call. Joining me on today's call are DSG's Chairman and Chief Executive Officer, Brian King, and Executive Vice President and Chief Financial Officer, Ron Knudson. In conjunction with today's call, we have provided a financial results slide deck that is posted on the company's website at investor.distributionsolutionsgroup.com. Please note, The statements made on this call and in today's press release contain forward-looking statements concerning goals, beliefs, expectations, strategies, plans, future operating results, and underlying assumptions that are subject to risks and uncertainties that could cause actual results to differ materially from those described. In addition, statements made during this call are based on the company's views as of today. The company anticipates that future developments may cause those views to change, and we may elect to update the forward-looking statements but disclaim no obligation to do so. Management will also refer to non-GAAP measures and reconciliations to the nearest GAAP measures can be found at the end of our earnings release. The earnings release issued earlier today was posted on the investor relations section of our website. A copy of the release has also been included in a current report on 8K filed with the SEC. Lastly, this call is being webcast on the internet via the distribution solutions group investor relations page on our website. A replay of the teleconference will be made available through May 16, 2024. With that, I'd now like to turn the call over to Brian King. Brian?

Thanks, Stephen, and thank you all for joining us to review first quarter 2024. I'll be starting on slide four to review overall financial results. Our 2024 first quarter sales totaled $416 million, up 19.5% on strategic investments inorganic growth compared to the first quarter a year ago. As we signaled on our Q4 2023 call, DSG was up against double-digit comps in the first quarter of 2023 of nearly 14% and faced continued softness in certain end markets, which we will highlight later in the call. Despite those continued pockets of softness, we maintained a positive organic trajectory on a two-year organic basis of 4.7%. which we acknowledge is below our expectation for organic growth that we require from our investment initiatives into the business when we use a longer time horizon lens. Consolidated EBITDA margins enjoyed a sequential improvement from 8.4% in the fourth quarter of 2023 to an adjusted EBITDA margin of 8.7% in the first quarter of 2024, but were below where we expect them to be, partially because of the pockets of in-market softness but also significantly influenced by the internal initiatives that we are executing where there are near-term costs, but where real expense optimization and profitability and efficiency is getting unlocked. We continue to enjoy strong visibility into how those initiatives are reworking significant elements of our cost structure, while visibly improving our value-added offering for our customers and customer-facing colleagues and refining the profitability discipline on that revenue across each of our three DSG verticals. Today, I will reemphasize DSG's overarching goals and longer-term performance milestone objectives, reinforcing our confidence in the huge opportunity in front of us and the material progress we are making, even in the face of some marketplace softness, and the accountability and engagement our collective team embraces. During our 2023 Investor Day last September, we shared that DSG's long-term value creation plans and programs were based on specific commercial growth initiatives and process and structure optimization work streams. These initiatives were and continue to be a bridge for us to grow into structurally higher margins while enjoying stronger organic growth and accelerating returns on invested capital over the next several years. As stated, our five-year goal is to increase total sales to over $3.3 billion, which our plan indicates will be driven about equally from organic and inorganic growth initiatives. And we expect that level of revenue will generate adjusted EBITDA in excess of $450 million and will significantly drive the returns on invested capital profile and earnings per share and free cash flow per share profiles of this highly value-added specialty distribution business. All three of our verticals have a clear path with the assets we own today to deliver EBITDA margins consistent with our corporate objective, although we acknowledge that each of the three verticals currently enjoy a very different fully optimized structural EBITDA margin opportunity. We believe that the two acquisitions we have closed this year to consolidate with Lawson improves EBITDA margins and our return on invested capital. As we shared our detailed initiatives with investors last fall, I think it is important to hold ourselves accountable with our shareholder partners on our progression, acknowledging the pockets of in-market headwinds we have faced while offering discrete data points on the numerous initiatives that are confirming the foundation today for the exciting progression we expect will continue to unfold as we move DSG towards our defined future state. In January, we acquired Emergent Safety Supply, or ESS, under the Lawson Products Banner. ESS is an example consistent with our inorganic investment objective of adding a commercial growth initiative, in this case bolstering our safety offering to our MRO and OEM customers and expanding our existing VMI capabilities inside their facilities to offer a logical product category expansion requested by our customers and Salesforce. We believe it is one that is ubiquitous across our customer base, allowing for an increase in wallet share of existing customers and more earning opportunity and productivity for our sales force, allowing us to add some upgrades and talent depth in key areas of growth, while augmenting and driving more opportunities for cross-selling, not only across our MRO offering, but for our OEM relationships, where we recognize it would enhance our proposed MRO solution when introducing our MRO capabilities and categories to our OEM customer relationships. Safety is a key category where our leadership team strongly believed that investing in an improved offering was an important organic growth accelerating opportunity through our existing relationships and service delivery models. We also announced S&S automotive acquisition yesterday, which I will discuss in a moment. These two highly deliberate inorganic growth acquisitions highlight how we have identified opportunities within our DSG and specialty distribution relationships to engage businesses with product and service capabilities and deep customer relationships and marketplace presence. When combined with our existing network of offerings, this creates an enhanced DSG specialty offering, improving and deepening our value proposition to our customers and allowing for improved sales optimization and cross-sell expansions focusing on our committed lens to driving higher structural returns across DSG, the vertical the acquisition is being acquired into, and higher structural returns on the acquisition itself. Reflecting on our capital allocation around acquisitions over the last 24 months, we are excited about how they significantly enhance each of our verticals' ability to accomplish our profitability objectives and customer engagement vision, as well as drawing together the three verticals into a solutions-focused solution DSG value proposition. Looking across each of our specialty distribution verticals, we continue to progress dialogues with targeted acquisitions that add product or value-added capabilities, driving more scale to transform certain categories or lines of business to accelerate our efforts towards improved marketplace leadership and to generate meaningfully higher levels of free cash flow and returns on invested capital. ESS and S&S Automotive are great examples of strategic acquisitions that benefits our customers, sales teams, and shareholders. The downstream impact of both acquisitions creates more customer engagement, more expertise in targeted product categories, and more solutions and services catered to our combined customers throughout expanded cross-selling opportunities and better sales density. The outcome is positive. with higher productivity and compensation opportunity across each sales force, while driving structurally higher EBITDA margins and returns on our invested capital. These downstream effects can be large and wide, and we believe they work toward creating durable and repeatable results and accelerate the organic growth rate of DSG. Turning to slide five, let's walk through key initiatives and end market trends in each of our business verticals. Our MRO-focused business, Lawson Products, launched an important Salesforce transformation in 2023 with a foundation built on a structure of approximately 900 high-producing and highly motivated field sales reps. We also expanded our inside sales team last fall to approximately 40 individuals from only a few and added 14 technical product specialists. We are in the early innings of this sales optimization program, which includes fine-tuning our investments in working capital, and technology tools to help our sales forces effectiveness and productivity, as well as deliberate lens around designing and optimizing new sales territories as we refocus our attention around driving opportunity for existing field sales reps and recruiting additional reps into a role with enhanced tools and opportunity. We are very pleased with early results, as our productivity measured as sales reps per day increased 8% in quarter one over a year ago, on top of 18% and 15% improvements in the last two quarters of 2023. We continue to analyze and leverage data to optimize our overall Salesforce network, including going live with our CRM tool in the first quarter. as well as an enhanced order entry tablet for our field sales reps to drive ease and productivity around placing customer orders and offering more insights to our salesperson about additional revenue opportunities to grow that customer. This full implementation of Lawson CRM connects our entire sales force into the order management system, greatly improving our visibility into the sales organization and accelerating the ROI of our sales force transformation, addressing our stated goal to improve both the initial and structural earnings available to our sales force and enhance our service levels with our engaged customers, while additionally driving a productivity lift that should improve our selling expense across our total revenue base and elevate our EBITDA margins structurally higher. As I mentioned, we are in the early stages of our progression, with defined milestones that should unfold this year and the next two, and we will continue to hold ourselves accountable, reporting consistently on this key initiative. In addition, Lawson continues to concentrate on product expansion and resources that customers truly value as part of our MRO service delivery intensive VMI offering. We believe this is critical as we refine our product mix and increase our customer density, expertise, value-added tools, and capabilities to engage with new and existing customers. Our process and structure optimization efforts are improving how we go to market at Lawson and effectively utilize people, processes, and products. Lawson had a good first quarter, especially considering we were up against organic comp growth of over 19% reported in prior year quarter. The two-year stack organic growth in the first quarter for Lawson products was nearly 12%. Plus we added a few million dollars of acquired sales from ESS for most of the first quarter. The biggest headwind to sustaining organic revenue growth this quarter was overwhelmingly government, where we have seen a delay in purchase orders, Although we remain confident, the dollars are there to be spent later this year. Yesterday, we announced another acquisition under the Lawson banner, S&S Automotive Group. S&S and our existing Kent Automotive business, which has enjoyed sustained leadership in our organic growth the last few years, operate in large and growing markets in North America, such as auto collision repair and dealership aftermarket businesses. According to the National Automobile Dealers Association, there are 16,835 light vehicle dealerships in the United States. Those dealers wrote 264 million repair orders in 2023 with total part sales of $142 billion. Additionally, only 34% of dealers have auto body shop capabilities. By adding S&S to the Kent offering, we can improve our customer value proposition with more SKUs and services tailored to this large market. Kent focuses primarily on collision repair centers in the U.S. and Canada, where SNS focuses more on auto dealerships in the Midwest, where they have strong density and market share. These business go-to-market models are similar, with both organizations offering value-added, high-touch customer engagement. They each have complementary product leadership, that allows each company to credibly expand their product offering with their existing customers, significantly enhancing the organic growth opportunity. We believe increasing our market density, especially in the Midwest geographies, and leveraging facilities and exceptional localized human capital will immediately increase our Salesforce productivity and improve our margin for our total automotive division. We are confident that combining Kent with S&S will allow us to drive our EBITDA margins for this business above our target margins for DSG and to drive our Kent and S&S returns on invested capital to specialty distribution market leadership levels. Our deliberate structural lift in the return profile and market leadership presence with this acquisition of our automotive repair line of business inside of Lawson is an exceptional example of what we have and expect to continue to accomplish with targeted strategic acquisitions at DSG. As expected, the first quarter returned to double-digit EBITDA margins for JEXPRO services. Although the core business was down slightly compared to the prior year on tough comps, sales grew sequentially by 4.2% compared to the fourth quarter on comparable days. We also experienced strong double-digit sequential and quarter-over-quarter improvements in the sales in the aerospace and defense verticals, Also in the A&D end markets, we are excited about the lift in the number of new projects and services, including new kitting awards and VMI plant production services. We are winning and implementing new program awards faster than expected, which builds our backlog and positions us well for the remainder of 2024 and on to the future. It also offers us confidence about the enhanced value JEXPRO services brings to its customers as part of DSG. and with the value-added capabilities we invested in with our last couple of years of tuck-in acquisitions. And no one is more excited about the Hisco acquisition and its expanded capabilities, product lines, and strong geographic presence in Mexico than the Jexpro Services team, except perhaps Cesar and the Lawson team. Our technology and markets, which were such a drag during 2023 to profitability in the Jexpro Services division, especially in the last half of last year, in the first quarter of 2024 continued to be down compared to a year ago, dragging on EBITDA and EBITDA margin for the division, partly due to the tougher comps in the first part of 2023. However, we are encouraged to see that first quarter sales to our technology customers improved sequentially compared to the third and fourth quarters of 2023, citing an increase in new orders and hopefully messaging, we are past the trough of this semiconductor cycle. Regarding the semiconductor industry, as it was an important element of the profitability that we missed out on for most of last year and some this first quarter, we hear that most companies are signaling trough-level sales in the first quarter, with auto chip sales reporting better than expected results and core industrial sales improving. It's also worth noting that our renewables business is slowly ramping upward with recent sequential improvements between the fourth quarter of 23 and the first quarter of 24. and our customers are reflecting confidence in the progression. Our overall confidence in the OEM business is supported by an increase in gross margins for year-over-year results and sequential margin improvements. On a sales comparison basis, we are past our toughest quarter comparisons of the year and are excited that our project services backlog is growing. We are also excited to see a ramp in our new VMI program wins, market share growth, and wallet share expansion with many long-standing customers. On a sequential basis, all of our end markets are either stabilized or growing, which gives us more confidence year over year, and we expect sequential improvements as 2024 develops. Also starting last year, our project-based businesses from the Frontier, Resilux, and SIS 2022 acquisitions started positioning us as strategic suppliers instead of competitors with those three now business units of JEXPRO services, which with our expanded capabilities and touch points brought by coming together, especially in a market like renewables that is seeing activity from customers precedent to a real revenue recovery from a tough year last year, is allowing us to expand our market share. Those complimentary tuck-in acquisitions enhance the expanded capabilities we now enjoy and will continue to benefit us in 2024 and on. As a refresher, adding those key channel partners offers us a more comprehensive and differentiated solution to a broader customer base, which supports our stated objective around Jexpro Service's margin expansion plan by doing more of the value-added work around the source product versus leaning more on being the leading OEM partner for speccing, sourcing, and managing Class C parts already in the form of a finished good product. The JEXPRO Services business unit also benefits from an expanded investment in e-commerce capabilities, adding several million dollars of incremental revenue from e-commerce orders from established aerospace and defense accounts. As we mentioned last year, JEXPRO Services started the year with a healthy book-to-bill pipeline, growing it as it progressed into 2024. Turning to test equity group, The electronic and specialty production supplies categories remained soft in the first quarter and were impacted by difficult sales comparisons from this time last year, weighing on the OEM as well as the MRO parts of the test equity group. Weakness in sales into wireless communications and semiconductor production also weighed on the OEM and MRO parts of the group. The biggest drag on revenue and profitability, though, for the test equity group continues to be the test and measurement in markets, which became more challenged in late September by what appeared to be an anxiousness around continued spending on capital equipment as the extended interest rate tightening cycle started weighing on business confidence and on capital spending on R&D towards the end of last year. The revenue pressure and marketplace impacts were exacerbated by the product surplus in the channel by some of our suppliers and competitors after a period of supply chain disruption coming out of COVID that delayed delivery on customers' orders and perhaps over-messaged to manufacturers and suppliers about where demand was playing out. A shift in customer behavior caught the channel with too much product on hand. As some tried to push excess product, profitability for most was doubly impacted by weakness in sales and unnatural discounting in temporary pricing activity, which only further stimulates unnatural demand and customer behavior and prolongs the disruptive period in the channel. We thought much of the dynamic was done by the end of the year, but then saw some of this behavior lingering in the first quarter. We certainly believe there was a better backdrop around inventory, pricing, and demand by the end of the quarter than existed throughout the fourth quarter. We believe trends will continue to normalize as the year progresses against weaker comparisons and less rebalancing of inventory in the channel but it's taken longer than expected. While we don't have enough conviction to call an inflection around a reacceleration, there appears to be some stability returning in the customer demand, which with cleaner inventories we expect will help profitability. Since the fourth quarter of 2023, We've identified more synergy opportunities bringing Hisco into the test equity group as we now believe approximately $15 million of cost synergies will be realized during 2024 as we work through integrating Hisco and test equity. Up from the $10 million that we indicated was our estimate at the end of 2023. Real progress is being made, although expenses associated with integration efforts are still flowing through, masking some of the underlying progress to structural margins. Hisco Mexico and Test Equity Mexico, for instance, have been integrated and four facilities have been closed as well as some duplicative warehouse headcount has been relieved. In the U.S. and Canada, another five consolidations have been completed and two more are in process. This footprint rationalization saves over $1.2 million annually. One of the facilities allows us to exit a less optimized owned building that we believe will also release $4.95 million of cash back to the balance sheet as we sell it. Additionally, given the softness of sales in the T&M business, we are actively identifying and accelerating further opportunities for cost rationalization. Adjusted EBITDA for the test equity group improved, but is down versus a year ago. However, gross margins have stabilized despite sales headwinds over the last two quarters, and gross margin initiatives identified during our underwriting across our recent acquisitions are starting to yield a meaningful impact at levels ahead of where we underwrote at this point, masked some by the noisiness of the soft end markets and the continued inventory channel messiness and softness in the test and measurement marketplace. We realize it will take several quarters to see the real run rate benefits of our structural changes to improved overall margins. But as an example, by building the first layer of strategic pricing discipline in the pricing model at Hisco for their small customers, differentiating pricing from their largest customers. We saw gross margins increased by almost 150 basis points across all of Hisco just in the first quarter. Test Equity Group is a big ship to turn, and we're very pleased with the Hisco acquisition, both in how this complementary and strategic acquisition improves the mix shift towards a more reoccurring OEM and MRO offering, as well as enhances the profitability and scale of this industrial technologies business unit with more consumables and lower price points that serve the electronics assembly and lab equipment customers. With HISCO's addition, the steep engagement this business unit now has with JEXPRO services and Lawson is remarkably different as they work together with real added benefits on working to expand their collective engagements with their long-standing customers and new ones that have requested us to bid on contracts with a lens towards a broader DSG set of capabilities. With the HISCO addition, there is now a combined revenue growth initiative populated with a very capable team of sales leadership from each of the three verticals and some of the specialty business unit leaders. There's also significant enthusiasm at Lawson and Jax Pro Services leadership teams around the added footprint that HISCO brings with significant scale throughout North America. Most specifically, offering a platform for our customers requesting JEXPRO services in Lawson to expand their engagements into Mexico. Distribution Solutions Group serves a broad, diverse set of end markets with over 180,000 customers. We deliver and ship from strategically located distribution and service centers to customers throughout North America and Europe, Asia, South America, and the Middle East. Our decentralized operations that maintain brand identity and integrity coupled with an integrated growth platform, offer DSG's customers access to unique, differentiated, high-touch products and solutions, sourcing advantage, and expertise through businesses that leverage best practices to deliver world-class service to our customers every day. With that, I'd like to turn the call to Ron to walk through the financials.