UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | ||||||||
For the quarterly period ended June 30, 2023
or
| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | ||||||||
For the transition period from to
Commission file Number: 0-10546
(Exact name of registrant as specified in its charter)
| (State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | |||||||||||||
| (Address of principal executive offices) | (Zip Code) | |||||||||||||
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
| Title of each class | Trading Symbol | Name of each exchange on which registered | ||||||||||||
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No ¨
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ý No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
| Large accelerated filer | ¨ | ☒ | |||||||||
| Non-accelerated filer | ¨ | Smaller reporting company | |||||||||
| Emerging growth company | |||||||||||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No ý
As of July 24, 2023, 23,349,735 shares of common stock, $1.00 par value, were outstanding.
1
TABLE OF CONTENTS
| Page # | ||||||||
Condensed Consolidated Balance Sheets as of June 30, 2023 (Unaudited) and December 31, 2022 | ||||||||
Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) for the Three and Six Months Ended June 30, 2023 and 2022 (Unaudited) | ||||||||
Item 1. | ||||||||
2
CAUTIONARY STATEMENT REGARDING FORWARD LOOKING STATEMENTS
This Quarterly Report on Form 10-Q contains certain “forward-looking statements” that involve risks and uncertainties. Terms such as “aim,” “anticipate,” “believe,” “contemplates,” “continues,” “could,” “ensure,” “estimate,” “expect,” “forecasts,” “if,” “intend,” “likely,” “may,” “might,” “objective,” “outlook,” “plan,” “positioned,” “potential,” “predict,” “probable,” “project,” “shall,” “should,” “strategy,” “will,” “would,” and variations of them and other words and terms of similar meaning and expression (and the negatives of such words and terms) are intended to identify forward-looking statements. Forward-looking statements can also be identified by the fact that they do not relate strictly to historical or current facts. These statements are not guarantees of future performance and involve risks, uncertainties and assumptions that are difficult to predict. These statements are based on management’s current expectations, intentions or beliefs as of the date they are made and are subject to a number of factors, assumptions and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements. Factors that could cause or contribute to such differences or that might otherwise impact our business, financial condition and results of operations include:
•inventory obsolescence;
•work stoppages and other disruptions at transportation centers or shipping ports;
•the reliance of TestEquity Acquisition, LLC ("TestEquity") on a significant supplier for a significant amount of its product inventory;
•changes in our customers, product mix and pricing strategy;
•disruptions of our information and communication systems;
•cyber-attacks or other information security incidents;
•the inability to successfully recruit, integrate and retain productive sales representatives;
•difficulties in integrating the business operations of TestEquity and 301 HW Opus Holdings, Inc., which conducts business as Gexpro Services ("Gexpro Services"), with our legacy Lawson Products, Inc. operations, and/or the failure to successfully combine those operations within our expected timetable;
•failure to retain talented employees, managers and executives;
•the inability of management to successfully implement changes in operating processes;
•various risks involved in any pursuit or completion by us of additional acquisitions;
•competition in the markets in which we operate;
•potential impairment charges for goodwill and other intangible assets;
•changes that affect governmental and other tax-supported entities;
•our significant amount of indebtedness;
•failure to adequately fund our operating and working capital needs through cash generated from operations and borrowings available under our credit facility;
•failure to meet the covenant requirements of our credit facility;
•government efforts to combat inflation, along with other interest rate pressures, could lead to higher financing costs;
•declines in the market price of our common stock (the "DSG common stock");
•the significant influence of Luther King Capital Management Corporation ("LKCM") over the Company in light of its ownership percentage;
•any sales of shares of DSG common stock held by entities affiliated with LKCM or the possibility of any such sales;
•violations of environmental protection regulations;
•changes in tax matters;
•risks arising from our international operations;
•potential limitations on our ability to use our net operating losses and certain other tax attributes generated prior to the Mergers (as defined below);
•public health emergencies;
•business uncertainties as a result of the Mergers;
•stockholder litigation relating to the Mergers;
•TestEquity and/or Gexpro Services may not have in place the financial organization, reporting and internal controls necessary for a public company;
•a downturn in the economy or in certain sectors of the economy;
•changes in energy costs, tariffs, transportation costs and the cost of raw materials used in our products, and other inflationary pressures;
•supply chain constraints, inflationary pressure and labor shortages;
•foreign currency exchange rate changes; and
•the other factors discussed in the “Risk Factors” section of our Annual Report on Form 10-K for the fiscal year ended December 31, 2022 and the “Risk Factors” section of this Quarterly Report on Form 10-Q.
3
We undertake no obligation to update or revise any forward-looking statement contained herein, whether to reflect events or circumstances after the date on which such statement is made or to reflect the occurrence of unanticipated events or otherwise, except as may be required under applicable law.
4
PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
Distribution Solutions Group, Inc.
Condensed Consolidated Balance Sheets
(Dollars in thousands, except share data)
(Unaudited)
| June 30, 2023 | December 31, 2022 | ||||||||||
| ASSETS | |||||||||||
| Current assets: | |||||||||||
| Cash and cash equivalents | $ | $ | |||||||||
| Restricted cash | |||||||||||
Accounts receivable, less allowances of $ | |||||||||||
| Inventories, net | |||||||||||
| Prepaid expenses and other current assets | |||||||||||
| Total current assets | |||||||||||
| Property, plant and equipment, net | |||||||||||
| Rental equipment, net | |||||||||||
| Goodwill | |||||||||||
| Deferred tax asset | |||||||||||
| Intangible assets, net | |||||||||||
| Cash value of life insurance | |||||||||||
| Right of use operating lease assets | |||||||||||
| Other assets | |||||||||||
| Total assets | $ | $ | |||||||||
| LIABILITIES AND STOCKHOLDERS’ EQUITY | |||||||||||
| Current liabilities: | |||||||||||
| Accounts payable | $ | $ | |||||||||
| Current portion of long-term debt | |||||||||||
| Current portion of lease liabilities | |||||||||||
| Accrued expenses and other current liabilities | |||||||||||
| Total current liabilities | |||||||||||
| Long-term debt, less current portion, net | |||||||||||
| Lease liabilities | |||||||||||
| Deferred tax liability | |||||||||||
| Other liabilities | |||||||||||
| Total liabilities | |||||||||||
| Commitments and contingencies (Note 14) | |||||||||||
| Stockholders’ equity: | |||||||||||
Preferred stock, $ | |||||||||||
Authorized - | |||||||||||
Common stock, $ | |||||||||||
Authorized - Issued - Outstanding - | |||||||||||
| Capital in excess of par value | |||||||||||
| Retained deficit | ( | ( | |||||||||
Treasury stock – | ( | ( | |||||||||
| Accumulated other comprehensive (loss) income | ( | ( | |||||||||
| Total stockholders’ equity | |||||||||||
| Total liabilities and stockholders’ equity | $ | $ | |||||||||
See notes to Condensed Consolidated Financial Statements (Unaudited)
5
Distribution Solutions Group, Inc.
Condensed Consolidated Statements of Operations and Comprehensive Income (Loss)
(Dollars in thousands, except per share data)
(Unaudited)
| Three Months Ended June 30, | Six Months Ended June 30, | ||||||||||||||||||||||
| 2023 | 2022 | 2023 | 2022 | ||||||||||||||||||||
| Revenue | $ | $ | $ | $ | |||||||||||||||||||
| Cost of goods sold | |||||||||||||||||||||||
| Gross profit | |||||||||||||||||||||||
| Selling, general and administrative expenses | |||||||||||||||||||||||
| Operating income (loss) | |||||||||||||||||||||||
| Interest expense | ( | ( | ( | ( | |||||||||||||||||||
| Loss on extinguishment of debt | ( | ( | |||||||||||||||||||||
| Change in fair value of earnout liabilities | ( | ( | ( | ||||||||||||||||||||
| Other income (expense), net | ( | ( | ( | ||||||||||||||||||||
| Income (loss) before income taxes | ( | ( | |||||||||||||||||||||
| Income tax expense (benefit) | ( | ( | |||||||||||||||||||||
| Net income (loss) | $ | $ | ( | $ | $ | ( | |||||||||||||||||
| Basic income (loss) per share of common stock | $ | $ | ( | $ | $ | ( | |||||||||||||||||
| Diluted income (loss) per share of common stock | $ | $ | ( | $ | $ | ( | |||||||||||||||||
| Comprehensive income (loss) | |||||||||||||||||||||||
| Net income (loss) | $ | $ | ( | $ | $ | ( | |||||||||||||||||
| Other comprehensive income (loss), net of tax: | |||||||||||||||||||||||
| Foreign currency translation adjustment | ( | ( | |||||||||||||||||||||
| Other | ( | ( | |||||||||||||||||||||
| Comprehensive income (loss) | $ | $ | ( | $ | $ | ( | |||||||||||||||||
See notes to Condensed Consolidated Financial Statements (Unaudited)
6
Distribution Solutions Group, Inc.
Condensed Consolidated Statements of Changes in Stockholders’ Equity
(Dollars in thousands, except share data)
(Unaudited)
| Common Stock | Capital in Excess of Par Value | Accumulated Other Comprehensive Income (Loss) | Total Stockholders' Equity | ||||||||||||||||||||||||||||||||||||||
| Outstanding Shares | $ | Retained Deficit | Treasury Stock | ||||||||||||||||||||||||||||||||||||||
| Balance at January 1, 2023 | $ | $ | $ | ( | $ | ( | $ | ( | $ | ||||||||||||||||||||||||||||||||
| Net income (loss) | — | — | — | — | — | ||||||||||||||||||||||||||||||||||||
| Foreign currency translation adjustment | — | — | — | — | — | ||||||||||||||||||||||||||||||||||||
| Stock-based compensation | — | — | — | — | — | ||||||||||||||||||||||||||||||||||||
| Stock-based compensation liability paid in shares | — | — | — | — | — | ||||||||||||||||||||||||||||||||||||
| Shares issued | ( | — | — | — | |||||||||||||||||||||||||||||||||||||
| Shares issued - earnout | ( | — | — | — | |||||||||||||||||||||||||||||||||||||
| Tax withholdings related to net share settlements of stock-based compensation awards | ( | ( | — | ( | — | ( | |||||||||||||||||||||||||||||||||||
| Other | — | — | ( | — | ( | ||||||||||||||||||||||||||||||||||||
| Balance at March 31, 2023 | $ | $ | $ | ( | $ | ( | $ | ( | $ | ||||||||||||||||||||||||||||||||
| Net income (loss) | — | — | — | — | — | ||||||||||||||||||||||||||||||||||||
| Foreign currency translation adjustment | — | — | — | — | — | ||||||||||||||||||||||||||||||||||||
| Stock-based compensation | — | — | — | — | — | ||||||||||||||||||||||||||||||||||||
Issuance of common stock in rights offering, net of offering costs of $ | — | — | — | ||||||||||||||||||||||||||||||||||||||
| Shares issued | ( | — | — | — | |||||||||||||||||||||||||||||||||||||
| Tax withholdings related to net share settlements of stock-based compensation awards | ( | ( | — | ( | — | ( | |||||||||||||||||||||||||||||||||||
| Other | — | — | — | — | ( | ||||||||||||||||||||||||||||||||||||
| Balance at June 30, 2023 | $ | $ | $ | ( | $ | ( | $ | ( | $ | ||||||||||||||||||||||||||||||||
See notes to Condensed Consolidated Financial Statements (Unaudited)
7
Distribution Solutions Group, Inc.
Condensed Consolidated Statements of Changes in Stockholders’ Equity
(Dollars in thousands)
(Unaudited)
| Common Stock | Capital in Excess of Par Value | Accumulated Other Comprehensive Income (Loss) | Total Stockholders' Equity | ||||||||||||||||||||||||||||||||||||||
| Outstanding Shares | $ | Retained Deficit | Treasury Stock | ||||||||||||||||||||||||||||||||||||||
| Balance at January 1, 2022 | $ | $ | $ | ( | $ | ( | $ | $ | |||||||||||||||||||||||||||||||||
| Net income (loss) | — | — | — | ( | — | — | ( | ||||||||||||||||||||||||||||||||||
| Foreign currency translation adjustment | — | — | — | — | — | ||||||||||||||||||||||||||||||||||||
| Shares issued | ( | — | — | — | |||||||||||||||||||||||||||||||||||||
| Tax withholdings related to net share settlements of stock-based compensation awards | ( | — | — | ( | — | ||||||||||||||||||||||||||||||||||||
| Other | — | — | ( | — | — | — | ( | ||||||||||||||||||||||||||||||||||
| Balance at March 31, 2022 | $ | $ | $ | ( | $ | ( | $ | $ | |||||||||||||||||||||||||||||||||
| Net income (loss) | — | — | — | ( | — | — | ( | ||||||||||||||||||||||||||||||||||
| Foreign currency translation adjustment | — | — | — | — | — | ( | ( | ||||||||||||||||||||||||||||||||||
| Stock-based compensation | — | — | — | — | — | ||||||||||||||||||||||||||||||||||||
| Shares issued | ( | — | — | — | |||||||||||||||||||||||||||||||||||||
| Deemed consideration for reverse acquisition | — | — | — | ||||||||||||||||||||||||||||||||||||||
| Reclassification of issuable shares from earnout derivative liability | — | — | — | — | — | ||||||||||||||||||||||||||||||||||||
| Fair value adjustment of stock-based compensation awards | — | — | — | — | — | ||||||||||||||||||||||||||||||||||||
| Tax withholdings related to net share settlements of stock-based compensation awards | ( | — | — | — | ( | — | ( | ||||||||||||||||||||||||||||||||||
| Settlement of related party liability | — | — | — | — | — | ||||||||||||||||||||||||||||||||||||
| Other | — | — | ( | — | — | — | ( | ||||||||||||||||||||||||||||||||||
| Balance at June 30, 2022 | $ | $ | $ | ( | $ | ( | $ | ( | $ | ||||||||||||||||||||||||||||||||
See notes to Condensed Consolidated Financial Statements (Unaudited)
8
Distribution Solutions Group, Inc.
Condensed Consolidated Statements of Cash Flows
(Dollars in thousands)
(Unaudited)
| Six Months Ended June 30, | |||||||||||
| 2023 | 2022 | ||||||||||
| Operating activities | |||||||||||
| Net income (loss) | $ | $ | ( | ||||||||
| Adjustments to reconcile to net cash used in operating activities: | |||||||||||
| Depreciation and amortization | |||||||||||
| Amortization of debt issue costs | |||||||||||
| Extinguishment of debt | |||||||||||
| Stock-based compensation | |||||||||||
| Deferred income taxes | ( | ||||||||||
| Change in fair value of earnout liabilities | |||||||||||
| Gain on sale of rental equipment | ( | ( | |||||||||
| Loss on sale of property, plant and equipment | |||||||||||
| Charge for step-up of acquired inventory | |||||||||||
| Net realizable value and reserve adjustment for obsolete and excess inventory | |||||||||||
| Bad debt expense | |||||||||||
| Changes in operating assets and liabilities, net of acquisitions: | |||||||||||
| Accounts receivable | ( | ( | |||||||||
| Inventories | ( | ||||||||||
| Prepaid expenses and other current assets | ( | ( | |||||||||
| Accounts payable | ( | ( | |||||||||
| Accrued expenses and other current liabilities | ( | ||||||||||
| Other changes in operating assets and liabilities | ( | ||||||||||
| Net cash provided by (used in) operating activities | ( | ||||||||||
| Investing activities | |||||||||||
| Purchases of property, plant and equipment | ( | ( | |||||||||
| Business acquisitions, net of cash acquired | ( | ( | |||||||||
| Purchases of rental equipment | ( | ( | |||||||||
| Proceeds from sale of rental equipment | |||||||||||
| Net cash provided by (used in) investing activities | ( | ( | |||||||||
| Financing activities | |||||||||||
| Proceeds from revolving lines of credit | |||||||||||
| Payments on revolving lines of credit | ( | ( | |||||||||
| Proceeds from term loans | |||||||||||
| Payments on term loans | ( | ( | |||||||||
| Deferred financing costs | ( | ( | |||||||||
Proceeds from rights offering, net of offering costs of $ | |||||||||||
| Shares repurchased held in treasury | ( | ( | |||||||||
| Payment of financing lease principal | ( | ( | |||||||||
| Payment of earnout | ( | ||||||||||
| Net cash provided by (used in) financing activities | |||||||||||
| Effect of exchange rate changes on cash and cash equivalents | |||||||||||
| Increase (decrease) in cash, cash equivalents and restricted cash | |||||||||||
| Cash, cash equivalents and restricted cash at beginning of period | |||||||||||
| Cash, cash equivalents and restricted cash at end of period | $ | $ | |||||||||
| Cash and cash equivalents | $ | $ | |||||||||
| Restricted cash | |||||||||||
| Total cash, cash equivalents and restricted cash | $ | $ | |||||||||
See notes to Condensed Consolidated Financial Statements (Unaudited)
9
Distribution Solutions Group, Inc.
Condensed Consolidated Statements of Cash Flows (Continued)
(Dollars in thousands)
(Unaudited)
| Six Months Ended June 30, | |||||||||||
| 2023 | 2022 | ||||||||||
| Supplemental disclosure of cash flow information | |||||||||||
| Net cash paid for income taxes | $ | $ | |||||||||
| Net cash paid for interest | $ | $ | |||||||||
| Non-cash activities: | |||||||||||
| Fair value of common stock exchanged for reverse acquisition | $ | $ | |||||||||
| Settlement of related party obligations | $ | $ | |||||||||
| Additions of property, plant and equipment included in accounts payable | $ | $ | |||||||||
| Right of use assets obtained in exchange for finance lease liabilities | $ | $ | |||||||||
| Right of use assets obtained in exchange for operating lease liabilities | $ | $ | |||||||||
See notes to Condensed Consolidated Financial Statements (Unaudited)
10
Notes to Condensed Consolidated Financial Statements (Unaudited)
Note 1 – Nature of Operations and Basis of Presentation
Organization
Distribution Solutions Group, Inc., a Delaware corporation ("DSG"), is a global specialty distribution company providing value-added distribution solutions to the maintenance, repair and operations ("MRO"), original equipment manufacturer ("OEM") and industrial technology markets. DSG has three principal operating companies: Lawson Products, Inc., an Illinois corporation ("Lawson"), TestEquity Acquisition, LLC, a Delaware limited liability company ("TestEquity"), and 301 HW Opus Holdings, Inc., a Delaware corporation conducting business as Gexpro Services ("Gexpro Services"). The complementary distribution operations of Lawson, TestEquity and Gexpro Services were combined on April 1, 2022 to create a specialty distribution company. A summary of the Mergers (as defined below), including the legal entities party to the transactions and the stock consideration, is presented below.
Unless the context requires otherwise, references in this Quarterly Report on Form 10-Q to “DSG”, the “Company”, "we", "our" or "us" refer to the holding company, Distribution Solutions Group, Inc., and all entities consolidated in the accompanying unaudited condensed consolidated financial statements.
Recent Events
HIS Company, Inc. Acquisition
On March 30, 2023, DSG entered into a Stock Purchase Agreement (the “Purchase Agreement”), with various parties for the acquisition of all of the issued and outstanding capital stock of HIS Company, Inc., a Texas corporation (“Hisco,” and the "Hisco Transaction"), a distributor of specialty products serving industrial technology applications. DSG completed the Hisco Transaction on June 8, 2023. The total purchase consideration exchanged for the Hisco Transaction was $270.4 million, net of cash, at closing, with a potential additional earn-out payment subject to Hisco achieving certain performance targets. DSG will also 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 at least twelve months after the closing of the Hisco Transaction. In connection with the Hisco Transaction, DSG combined the operations of TestEquity and Hisco. DSG funded the Hisco Transaction using a combination of its amended and restated credit facility and proceeds raised from the Rights Offering (as defined below) with existing stockholders, both discussed below. Refer to Note 3 – Business Acquisitions for further details about Hisco and the Hisco Transaction.
Debt Amendment
On June 8, 2023, the Company and certain of its subsidiaries entered into the First Amendment to Amended and Restated Credit Agreement (the “First Amendment”), which amended the Amended and Restated Credit Agreement, dated as of April 1, 2022 (as amended by the First Amendment, the “2023 Credit Agreement”), by and among the Company, certain subsidiaries of the Company as borrowers or guarantors, the lenders party thereto and JPMorgan Chase Bank, N.A., as administrative agent. The First Amendment provides for a $305 million incremental term loan and for the Company to increase the commitments from time to time by up to $200 million in the aggregate, subject to, among other things, receipt of additional commitments from existing and/or new lenders and pro forma compliance with certain financial covenants. Refer to Note 9 – Debt for additional information about the 2023 Credit Agreement.
Rights Offering
On May 30, 2023, the Company issued 2,222,222 shares of DSG common stock for approximately $100 million pursuant to a subscription rights offering (the "Rights Offering"). The Rights Offering provided one transferable subscription right for each share of DSG common stock held by holders of DSG common stock on record as of the close of business on May 1, 2023. Each subscription right entitled the holder to purchase 0.105 shares of DSG common stock at a subscription price of $45.00 per share. The subscription rights were transferable, but were not listed for trading on any stock exchange or market. In addition, holders of subscription rights who fully exercised their subscription rights were entitled to oversubscribe for additional shares of DSG common stock, subject to proration. Refer to Note 11 – Stockholders' Equity for additional information about the Rights Offering.
11
Combination with TestEquity and Gexpro Services
On December 29, 2021, DSG entered into:
• an Agreement and Plan of Merger (the “TestEquity Merger Agreement”) by and among (i) LKCM TE Investors, LLC, a Delaware limited liability company (the “TestEquity Equityholder”), (ii) TestEquity, which was a wholly-owned subsidiary of the TestEquity Equityholder, (iii) DSG and (iv) Tide Sub, LLC, a Delaware limited liability company and a wholly-owned subsidiary of DSG (“Merger Sub 1”), pursuant to the terms and subject to the conditions of which the parties agreed, among other things, that Merger Sub 1 would merge with and into TestEquity, with TestEquity surviving the merger as a wholly-owned subsidiary of DSG (the “TestEquity Merger”); and
• an Agreement and Plan of Merger (the “Gexpro Services Merger Agreement” and, together with the TestEquity Merger Agreement, the “Merger Agreements”) by and among (i) 301 HW Opus Investors, LLC, a Delaware limited liability company (the “Gexpro Services Stockholder”), (ii) Gexpro Services, which was a wholly-owned subsidiary of the Gexpro Services Stockholder, (iii) DSG and (iv) Gulf Sub, Inc., a Delaware corporation and a wholly-owned subsidiary of DSG (“Merger Sub 2”), pursuant to the terms and subject to the conditions of which the parties agreed, among other things, that Merger Sub 2 would merge with and into Gexpro Services, with Gexpro Services surviving the merger as a wholly-owned subsidiary of DSG (the “Gexpro Services Merger” and, together with the TestEquity Merger, the “Mergers”).
At the closing of the Mergers, each outstanding share of TestEquity and Gexpro Services common stock outstanding immediately prior to the closing of the Mergers was converted into approximately 0.3618 shares and 0.7675 shares, respectively, of DSG common stock, based on the ratio of outstanding shares of each entity immediately prior to the Mergers to the number of shares of DSG common stock acquired in the Mergers.
Completion of the TestEquity Merger
On April 1, 2022 (the "Merger Date"), the TestEquity Merger was consummated pursuant to the TestEquity Merger Agreement. In accordance with the TestEquity Merger Agreement, Merger Sub 1 merged with and into TestEquity, with TestEquity surviving as a wholly-owned subsidiary of DSG.
In accordance with and under the terms of the TestEquity Merger Agreement, in connection with the closing of the TestEquity Merger on the Merger Date, DSG: (i) issued to the TestEquity Equityholder 3,300,000 shares of DSG common stock, (ii) on behalf of TestEquity, paid certain indebtedness of TestEquity and (iii) on behalf of TestEquity, paid certain transaction expenses of TestEquity.
The TestEquity Merger Agreement provided that up to an additional 700,000 shares of DSG common stock would be potentially issuable to the TestEquity Equityholder in accordance with, and subject to the terms and conditions of, the earnout provisions of the TestEquity Merger Agreement. On March 20, 2023, DSG issued 700,000 shares of DSG common stock to the TestEquity Equityholder (the "TestEquity Holdback Shares") pursuant to the terms of the earnout provisions of the TestEquity Merger Agreement. The TestEquity Holdback Shares issued represented the maximum number of additional shares that could be issued under the TestEquity Merger Agreement, and no further shares are available for issuance, and no additional shares will be issued, in connection with the TestEquity Merger Agreement. Refer to Note 8 – Earnout Liabilities for information about the earnout derivative liability related to the TestEquity Holdback Shares.
Completion of the Gexpro Services Merger
On the Merger Date, the Gexpro Services Merger was consummated pursuant to the Gexpro Services Merger Agreement. In accordance with the Gexpro Services Merger Agreement, Merger Sub 2 merged with and into Gexpro Services, with Gexpro Services surviving as a wholly-owned subsidiary of DSG.
In accordance with and under the terms of the Gexpro Services Merger Agreement, in connection with the closing of the Gexpro Services Merger on the Merger Date, DSG: (i) issued to the Gexpro Services Stockholder 7,000,000 shares of DSG common stock, (ii) on behalf of Gexpro Services, paid certain indebtedness of Gexpro Services and (iii) on behalf of Gexpro Services, paid certain specified transaction expenses of Gexpro Services.
The Gexpro Services Merger Agreement provided that up to an additional 1,000,000 shares of DSG common stock would be potentially issuable to the Gexpro Services Stockholder in accordance with, and subject to the terms and conditions of, the earnout provisions of the Gexpro Services Merger Agreement. On March 20, 2023, DSG issued 1,000,000 shares of DSG
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common stock to the Gexpro Services Stockholder (the “Gexpro Services Holdback Shares”) pursuant to the terms of the earnout provisions of the Gexpro Services Merger Agreement. The Gexpro Services Holdback Shares issued represented the maximum number of additional shares that could be issued under the Gexpro Services Merger Agreement, and no further shares are available for issuance, and no additional shares will be issued, in connection with the Gexpro Services Merger Agreement.
As of April 1, 2022, approximately 538,000 of the Gexpro Services Holdback Shares had been expected to be issued under the first earnout opportunity in the Gexpro Services Merger Agreement based on certain earnout metrics related to the consummation of certain additional acquisitions which were completed prior to the Merger Date. Under the Gexpro Services Merger Agreement, if any Gexpro Services Holdback Shares remained after the calculation of the first earnout opportunity, there was a second earnout opportunity under the Gexpro Services Merger Agreement based on certain earnout performance metrics. On March 20, 2023, all 1,000,000 Gexpro Services Holdback Shares were issued under the earnout opportunities. The incremental 462,000 Gexpro Services Holdback Shares that were issued in excess of the 538,000 Gexpro Services Holdback Shares that were originally expected to be issued had been remeasured at fair value immediately prior to and reclassified to equity at December 31, 2022. Refer to Note 8 – Earnout Liabilities for information about the earnout derivative liability related to the Gexpro Services Holdback Shares.
Accounting for the Mergers
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. Accordingly, periods prior to the April 1, 2022 Merger Date 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 only included subsequent to the April 1, 2022 Merger Date.
For more information about the Mergers, refer to Note 3 – Business Acquisitions.
Nature of Operations
A summary of the nature of operations for each of DSG's operating companies is presented below. Information regarding DSG's reportable segments is presented in Note 16 – Segment Information.
Lawson is a distributor of specialty products and services to the industrial, commercial, institutional and government maintenance, repair and operations market.
TestEquity is a distributor of test and measurement equipment and solutions, industrial and electronic production supplies, vendor managed inventory programs, converting, fabrication and adhesive solutions from its leading manufacturer partners supporting the technology, aerospace, defense, automotive, electronics, education, automotive 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.
Basis of Presentation and Consolidation
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 ("ASC") 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 six months ended June 30, 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 only included subsequent to the April 1, 2022 Merger Date. The combined operations of all three entities are included in the unaudited condensed consolidated financial statements for the three and six months ended June 30, 2023 and the three months ended June 30, 2022. The unaudited condensed consolidated financial statements as of June 30, 2023 and December 31, 2022 reflect the financial position of TestEquity, Gexpro Services and DSG's legacy Lawson business on a consolidated basis.
The Company and its consolidated subsidiaries, except for Gexpro Services, operate on a calendar year-end. Gexpro Services operates on a calendar year-end for annual reporting purposes. However, quarterly financial statements for Gexpro Services are prepared on financial close dates that may differ from that of the Company. The consolidated financial statement impact of the one day difference arising from the different period ends for the quarter ended June 30, 2023 was not material.
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Note 2 – Summary of Significant Accounting Policies
There were no significant changes to the Company's accounting policies from those disclosed in DSG's Annual Report on Form 10-K for the year ended December 31, 2022. See Note 2 of the 2022 consolidated financial statements included in DSG's Annual Report on Form 10-K for the year ended December 31, 2022 for further details of the Company's significant accounting policies.
Accounting Pronouncements - Adopted
In June 2016, the FASB issued ASU 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which revises the requirements for how an entity should measure credit losses on financial instruments. The pronouncement was effective for smaller reporting companies in fiscal years beginning after December 15, 2022, including interim periods within those fiscal years, and the new guidance will be applied on a prospective basis. The Company adopted this guidance on January 1, 2023. The adoption had no material impact on the Company's financial condition, results of operations or cash flows.
In October 2021, the FASB issued ASU 2021-08, Business Combinations (Topic 805): Accounting for Contract Assets and Contract Liabilities from Contracts with Customers, which requires an entity to apply Topic 606 to recognize and measure contract assets and contract liabilities in a business combination. The pronouncement is effective in fiscal years beginning after December 15, 2022 and early adoption is permitted. The Company adopted this guidance on January 1, 2023. The adoption had no impact on the Company's financial condition, results of operations or cash flows and will be applied to business combinations on or after the adoption date.
Note 3 – Business Acquisitions
Combination with TestEquity and Gexpro Services
On April 1, 2022, the Mergers with TestEquity and Gexpro Services were completed via all-stock merger transactions. Pursuant to the Merger Agreements, DSG issued an aggregate of 10.3 million shares of DSG common stock on April 1, 2022 to the former owners of TestEquity and Gexpro Services. On March 20, 2023, an additional 1.7 million shares of DSG common stock were issued. Refer to Note 1 – Nature of Operations and Basis of Presentation for further information regarding the Mergers.
The business combination of Lawson, TestEquity and Gexpro Services combines three value-added complementary distribution businesses. Lawson is a distributor of products and services to the industrial, commercial, institutional, and governmental MRO marketplace. TestEquity is a distributor of parts and services to the industrial, commercial, institutional and governmental electronics manufacturing and test and measurement market. Gexpro Services is a provider of supply chain solutions, specializing in developing and implementing VMI and kitting programs to high-specification manufacturing customers. Gexpro Services provides critical products and services to customers throughout the lifecycle of highly technical OEM products. Refer to Note 1 – Nature of Operations and Basis of Presentation for more information on the nature of operations for these businesses.
The Mergers were accounted for as a reverse merger under the acquisition method of accounting for business combinations, whereby TestEquity and Gexpro Services were identified as the accounting acquirers and were treated as a combined entity for financial reporting purposes, and DSG was identified as the accounting acquiree. Accordingly, under the
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acquisition method of accounting, the purchase price was allocated to DSG's tangible and identifiable intangible assets acquired and liabilities assumed, based on their estimated acquisition-date fair values. These estimates were determined through established and generally accepted valuation techniques.
Allocation of Consideration Exchanged
Under the acquisition method of accounting, the estimated consideration exchanged was calculated as follows:
| (in thousands, except share data) | April 1, 2022 | |||||||
| Number of DSG common shares | ||||||||
| DSG common stock closing price per share on March 31, 2022 | $ | |||||||
| Fair value of shares exchanged | $ | |||||||
Other consideration(1) | ||||||||
| Total consideration exchanged | $ | |||||||
(1)Fair value adjustment of stock-based compensation awards.
Due to the publicly traded nature of shares of DSG common stock, the equity issuance of shares of DSG common stock based on this value was considered to be a more reliable measurement of the fair market value of the transaction compared to the equity interests of the accounting acquirer.
The allocation of consideration exchanged to the tangible and identifiable intangible assets acquired and liabilities assumed was based on estimated fair values as of the Merger Date. The accounting for the Mergers was complete as of December 31, 2022. Goodwill generated from the Mergers is no t deductible for tax purposes.
The following table summarizes the allocation of consideration exchanged to the estimated fair values of assets acquired and liabilities assumed at the Merger Date after applying measurement period adjustments:
| (in thousands) | Final Purchase Price Allocation | |||||||
| Current assets | $ | |||||||
| Property, plant and equipment | ||||||||
| Right of use assets | ||||||||
| Other intangible assets | ||||||||
| Deferred tax liability, net of deferred tax asset | ( | |||||||
| Other assets | ||||||||
| Current liabilities | ( | |||||||
| Long-term obligations | ( | |||||||
| Lease and financing obligations | ( | |||||||
| Derivative earnout liability | ( | |||||||
| Goodwill | ||||||||
| Total consideration exchanged | $ | |||||||
| (in thousands) | Fair Value | Estimated Life (in years) | ||||||||||||
| Customer relationships | $ | |||||||||||||
| Trade names | ||||||||||||||
| Total other intangible assets | $ | |||||||||||||
Other Acquisitions
DSG and its operating companies acquired other businesses during the first six months of 2023 and the year ended December 31, 2022. The acquisitions were accounted for under ASC 805, the acquisition method of accounting. For each acquisition, the allocation of consideration exchanged to the assets acquired and liabilities assumed was based on estimated acquisition-date fair values.
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Purchase of HIS Company, Inc.
On June 8, 2023, DSG acquired all of the issued and outstanding capital stock of Hisco, a distributor of specialty products serving industrial technology applications, pursuant to the Purchase Agreement dated March 30, 2023. In connection with this transaction, DSG combined the operations of TestEquity and Hisco further expanding the product and service offerings at TestEquity, as well as all of our operating businesses under DSG.
Hisco operates in 38 locations across North America, including its Precision Converting facilities that provide value-added fabrication and its Adhesive Materials Group that provides an array of custom repackaging solutions. Hisco offers customers a broad range of products, including adhesives, chemicals and tapes, as well as specialty materials such as electrostatic discharge, thermal management materials and static shielding bags. Hisco also offers vendor-managed inventory and RFID programs with specialized warehousing for chemical management, logistics services and cold storage.
The total purchase consideration exchanged for the Hisco Transaction was $270.4 million, net of cash, with a potential additional earn-out payment subject to Hisco achieving certain performance targets. Refer to Note 8 – Earnout Liabilities for additional information on the earn-out. DSG will also 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 at least twelve months after the closing of the Hisco Transaction. For the three and six months ended June 30, 2023, $2.3
DSG funded the Hisco Transaction using a combination of its 2023 Credit Agreement and proceeds raised from the Rights Offering. Refer to Note 9 – Debt for information about the 2023 Credit Agreement and Note 11 – Stockholders' Equity for details on the Rights Offering.
The following table summarizes the allocation of consideration exchanged to the estimated fair values of assets acquired and liabilities assumed, including the allocation to other intangible assets acquired:
| (in thousands) | Hisco | |||||||
| Acquisition date | June 8, 2023 | |||||||
| Current assets | $ | |||||||
| Property, plant and equipment | ||||||||
| Right of use assets | ||||||||
| Other intangible assets: | ||||||||
| Customer relationships | ||||||||
| Trade names | ||||||||
| Deferred tax liability, net of deferred tax asset | ( | |||||||
| Other assets | ||||||||
| Accounts payable | ( | |||||||
| Lease liabilities | ( | |||||||
| Accrued expenses and other liabilities | ( | |||||||
| Goodwill | ||||||||
| Total purchase consideration exchanged, net of cash acquired | $ | |||||||
| Cash consideration | $ | |||||||
| Deferred consideration | ||||||||
| Contingent consideration | ||||||||
| Total purchase consideration exchanged, net of cash acquired | $ | |||||||
Certain estimated values for the Hisco Transaction, including the valuation of intangibles, property, plant and equipment, contingent consideration, and income taxes (including deferred taxes and associated valuation allowances), are not yet finalized, and the preliminary purchase price allocation is subject to change as the Company completes its analysis of the fair value at the date of acquisition. The final valuation will be completed within the one-year measurement period following the acquisition date, and any adjustments will be recorded in the period in which the adjustments are determined.
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The customer relationships and trade names intangibles assets have estimated useful lives of 12 years and 8 years, respectively. As a result of the Hisco Transaction, the Company recorded tax deductible goodwill of $39.8 million in 2023 that may result in a tax benefit in future periods and is primarily attributable to the benefits we expect to derive from expected synergies including expanded product and service offerings and cross-selling opportunities.
Purchases of Other Companies in 2022
During the year ended December 31, 2022, TestEquity acquired Interworld Highway, LLC, National Test Equipment, and Instrumex, and Gexpro Services acquired Resolux ApS ("Resolux") and Frontier Technologies Brewton, LLC and Frontier Engineering and Manufacturing Technologies, Inc. ("Frontier"). The consideration exchanged for these acquired businesses included various combinations of cash and sellers' notes. The accounting for the Interworld Highway, LLC, Resolux, Frontier and National Test Equipment acquisitions was complete within the one-year measurement periods following the respective acquisition dates. Certain estimated values for the Instrumex acquisition, including working capital and other liability adjustments, are not yet finalized, and the preliminary purchase price allocation is subject to change as the Company completes its analysis of the fair value at the date of acquisition. The final valuation will be completed within the one-year measurement period following the acquisition date, and any adjustments will be recorded in the period in which the adjustments are determined. The purchase consideration for each business acquired and the allocation of the consideration exchanged to the estimated fair values of assets acquired and liabilities assumed is summarized below:
| (in thousands) | Interworld Highway, LLC | Resolux | Frontier | National Test Equipment | Instrumex | |||||||||||||||||||||||||||||||||
| Acquisition date | April 29, 2022 | January 3, 2022 | March 31, 2022 | June 1, 2022 | December 1, 2022 | Total | ||||||||||||||||||||||||||||||||
| Current assets | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||||||||||
| Property, plant and equipment | ||||||||||||||||||||||||||||||||||||||
| Right of use assets | ||||||||||||||||||||||||||||||||||||||
| Other intangible assets: | ||||||||||||||||||||||||||||||||||||||
| Customer relationships | ||||||||||||||||||||||||||||||||||||||
| Trade names | ||||||||||||||||||||||||||||||||||||||
| Other assets | ||||||||||||||||||||||||||||||||||||||
| Accounts payable | ( | ( | ( | ( | ( | ( | ||||||||||||||||||||||||||||||||
| Current portion of long term debt | ( | ( | ||||||||||||||||||||||||||||||||||||
| Accrued expenses and other liabilities | ( | ( | ( | ( | ( | |||||||||||||||||||||||||||||||||
| Lease liabilities | ( | ( | ( | |||||||||||||||||||||||||||||||||||
| Goodwill | ||||||||||||||||||||||||||||||||||||||
| Total purchase consideration exchanged, net of cash acquired | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||||||||||
| Cash consideration | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||||||||||
| Seller's notes | ||||||||||||||||||||||||||||||||||||||
| Total purchase consideration exchanged, net of cash acquired | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||||||||||
The consideration for the Frontier acquisition includes a potential earn-out payment up to $3.0 million based upon the achievement of certain milestones and relative thresholds during the earn out measurement period which ends on December 31, 2024. Refer to Note 8 – Earnout Liabilities for additional information on the earn-out.
As a result of acquisitions completed in 2022, the Company recorded tax deductible goodwill of $53.6 million in 2022 that may result in a tax benefit in future periods.
The pro forma information for other acquisitions was included in the estimated unaudited pro forma consolidated financial information for DSG, which is presented below under Unaudited Pro Forma Information.
Unaudited Pro Forma Information
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informational purposes only and is not necessarily indicative of future results or the results that would have occurred had the Mergers and other acquisitions been completed on the date indicated.
| Three Months Ended June 30, | Six Months Ended June 30, | ||||||||||||||||||||||
| (in thousands) | 2023 | 2022 | 2023 | 2022 | |||||||||||||||||||
| Revenue | $ | $ | $ | $ | |||||||||||||||||||
| Net income | $ | $ | ( | $ | $ | ||||||||||||||||||
Actual Results of Business Acquisitions
The following table presents actual results attributable to our business combinations that were included in the unaudited condensed consolidated financial statements for the second quarter and first six months of 2023 and 2022. The results of DSG's legacy Lawson business are included only subsequent to the April 1, 2022 Merger Date, and the results for other acquisitions are only included subsequent to their respective acquisition dates provided above.
| Three Months Ended June 30, 2023 | Three Months Ended June 30, 2022 | ||||||||||||||||||||||||||||||||||
| (in thousands) | Lawson | Other Acquisitions | Total | Lawson | Other Acquisitions | Total | |||||||||||||||||||||||||||||
| Revenue | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||||
| Net Income | $ | $ | ( | $ | ( | $ | $ | $ | |||||||||||||||||||||||||||
| Six Months Ended June 30, 2023 | Six Months Ended June 30, 2022 | ||||||||||||||||||||||||||||||||||
| Lawson | Other Acquisitions | Total | Lawson | Other Acquisitions | Total | ||||||||||||||||||||||||||||||
| Revenue | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||||
| Net Income | $ | $ | ( | $ | ( | $ | $ | $ | |||||||||||||||||||||||||||
The Company incurred transaction costs related to the Mergers and other completed and contemplated acquisitions of $5.1 million and $9.2 million for the three and six months ended June 30, 2023, respectively, and $6.1 million and $8.6 million for the three and six months ended June 30, 2022, respectively, which are included in Selling, general and administrative expenses in the Unaudited Condensed Consolidated Statements of Operations and Comprehensive Income (Loss).
Note 4 – Revenue Recognition
Under the definition of a contract as defined by ASC 606, the Company considers contracts to be created at the time an order to purchase product and services is agreed upon regardless of whether there is a written contract. Revenue from customers is recognized when obligations under the terms of a contract are satisfied; this generally occurs with the delivery of products or services. Revenue from customers is measured as the amount of consideration the Company expects to receive in exchange for the delivery of products or services. Contracts may last from one month to one year or more and may have renewal terms that extend indefinitely at the option of either party. Price is typically based on market conditions, competition, changes in the industry and product availability. Volumes fluctuate primarily as a result of customer demand and product availability. Consistent with the way the Company manages its businesses, the Company refers to sales under service agreements, which includes both products (such as parts, equipment and equipment upgrades) and related services (such as monitoring, maintenance and repairs) as sales of “services,” which is an important part of the Company’s operations. The Company has no significant financing components in its contracts with customers. The Company records revenue net of certain taxes, such as sales taxes, that are assessed by governmental authorities on the Company’s customers.
The Company also operates as a lessor and recognizes lease revenue on a straight-line basis over the life of each lease. The Company has adopted the practical expedient not to separate the non-lease components that would be within the scope of ASC 606 from the associated lease component as the relevant criteria under ASC 842 are met.
The Company does not incur significant costs to obtain contracts. Incidental items that are immaterial in the context of the contract are recognized as expenses. Sales of products and services to customers are invoiced and settled on a monthly basis. ASC 606 requires an entity to present a contract liability in instances where the customer is entitled to a volume rebate based on purchases made during the period. The Company is not usually subject to obligations for warranties, rebates, returns or refunds except in the case of rebates for select customers if predetermined purchase thresholds are met as discussed for the TestEquity segment below. The Company does not typically receive payment in advance of satisfying its obligations under the terms of its
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sales contracts with customers; therefore, liabilities related to such payment are not significant to the Company. Accounts receivable represents the Company’s unconditional right to receive consideration from its customers.
Lawson Segment
The Lawson segment has two distinct performance obligations offered to its customers: a product performance obligation and a service performance obligation, and accordingly, two separate revenue streams. Although Lawson has identified that it offers its customers both a product and a service obligation, the customer only receives one invoice per transaction with no price allocation between these obligations. Lawson does not price its offerings based on any allocation between these obligations.
Lawson generates revenue primarily from the sale of MRO products to its customers. Revenue related to product sales is recognized at the time that control of the product has been transferred to the customer; either at the time the product is shipped or the time the product has been received by the customer. Lawson does not commit to long-term contracts to sell customers a certain minimum quantity of products.
Lawson offers a VMI service proposition to its customers. A portion of these services, primarily related to stocking of product and maintenance of the MRO inventory, is provided over a short period of time after control of the purchased product has been transferred to the customer. Since certain obligations pursuant to the VMI service agreement have not been provided at the time the control of the product transfers to the customer, that portion of expected consideration is deferred until the time that those services have been provided and the related performance obligations have been satisfied.
TestEquity Segment
TestEquity’s contracts with customers generally represent a single performance obligation to sell its products. Revenue from contracts with customers reflect the transaction prices for contracts reduced by variable consideration. TestEquity provides a rebate to select customers if pre-determined purchase thresholds are met. The rebate consideration is not in exchange for a distinct product or service. Variable consideration is estimated using the expected-value method considering all reasonably available information, including TestEquity’s historical experience and current expectations, and is reflected in the transaction price when sales are recorded. Sales returns are generally accepted by TestEquity; however, sales returns are not material to the Company’s operations. TestEquity provides an assurance type warranty which is not sold separately and does not represent a separate performance obligation.
TestEquity generates revenue from contracts with customers through the sale of new and used electronic test and measurement products, industrial and electronic production supplies, and adhesive solutions. Typically, TestEquity has a purchase order or master service agreement with the customer that specifies the products and/or services to be provided. TestEquity generally invoices customers as products are shipped. Payment terms on invoiced amounts are typically due and payable 30 days after the date of shipment. Generally, customers gain control of the products upon providing the product to the carrier, or when services are completed. For the majority of transactions, TestEquity recognizes revenue at the time of shipment, when control passes to the customer. For consigned inventory, revenue is recognized when inventory is removed from TestEquity’s stock location and control passes to the customer.
Gexpro Services Segment
Gexpro Services’ contracts with customers generally represent a single performance obligation to sell its products. Revenue from sales of Gexpro Services’ products is recognized upon transfer of control to the customer, which is typically when the product has been shipped from its distribution facilities. The transaction price is the amount of consideration to which Gexpro Services expects to be entitled in exchange for transferring products to the customer. Revenue is recorded based on the transaction price, which includes fixed consideration and an estimate of variable consideration such as, early payment/volume discounts and rebates. The amount of variable consideration included in the transaction price is constrained and is included only to the extent it is probable that a significant reversal of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is subsequently resolved.
Gexpro Services’ products are marketed and sold primarily to original equipment manufacturers globally. Sales of products are subject to economic conditions and may fluctuate based on changes in the industry, trade policies and financial markets. Payment terms on invoiced amounts range from 10 to 120 days. In instances where the timing of revenue recognition differs from the timing of the right to invoice, the Company has determined that a significant financing component does not exist.
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Disaggregated consolidated revenue by geographic area (based on the location to which the product is shipped to):
| Three Months Ended June 30, | Six Months Ended June 30, | ||||||||||||||||||||||
| (in thousands) | 2023 | 2022 | 2023 | 2022 | |||||||||||||||||||
| United States | $ | $ | $ | $ | |||||||||||||||||||
| Canada | |||||||||||||||||||||||
| Europe | |||||||||||||||||||||||
| Pacific Rim | |||||||||||||||||||||||
| Latin America | |||||||||||||||||||||||
| Other | |||||||||||||||||||||||
| Total revenue | $ | $ | $ | $ | |||||||||||||||||||
Rental Revenue
TestEquity rents new and used electronic test and measurement equipment to customers in multiple industries. These leases are classified as operating leases under ASC 842. Rental equipment is included in Rental equipment, net in the Unaudited Condensed Consolidated Balance Sheet, and rental revenue is included in Revenue in the Unaudited Condensed Consolidated Statements of Operations and Comprehensive Income (Loss). The unearned rental revenue related to customer prepayments on equipment leases of $0.3 million at June 30, 2023 and $0.3 million at December 31, 2022 was included in Accrued expenses and other current liabilities in the Unaudited Condensed Consolidated Balance Sheet and is expected to be earned in its entirety during the next twelve months.
Lawson leases parts washer machines to customers through its Torrents leasing program. These leases are classified as operating leases under ASC 842. The leased machines are included in Rental equipment, net, in the Unaudited Condensed Consolidated Balance Sheet, and the leasing revenue is recognized on a straight-line basis and is included in Revenue in the Unaudited Condensed Consolidated Statements of Operations and Comprehensive Income (Loss). The unearned rental revenue related to customer prepayments on equipment leases was nominal at June 30, 2023 and December 31, 2022.
Rental revenue from operating leases:
| Three Months Ended June 30, | Six Months Ended June 30, | ||||||||||||||||||||||
| (in thousands) | 2023 | 2022 | 2023 | 2022 | |||||||||||||||||||
| Revenue from operating leases | $ | $ | $ | $ | |||||||||||||||||||
Note 5 – Supplemental Financial Statement Information
Restricted Cash
The Company has agreed to maintain restricted cash of $20.6 million under agreements with outside parties. An escrow account of $12.5 million was established in conjunction with the Hisco Transaction, to be released upon Hisco meeting certain working capital and other post closing requirements as of the one year post-acquisition date. The Company is restricted from withdrawing this balance without the prior consent of the sellers. The remaining balance of $8.1 million of restricted cash represents collateral for certain borrowings under the 2023 Credit Agreement, and the Company is restricted from withdrawing this balance without the prior consent of the respective lenders.
Inventories, net
Inventories, net, consisting of purchased products and manufactured electronic equipment offered for resale, were as follows:
| (in thousands) | June 30, 2023 | December 31, 2022 | |||||||||
| Inventories, gross | $ | $ | |||||||||
| Reserve for obsolete and excess inventory | ( | ( | |||||||||
| Inventories, net | $ | $ | |||||||||
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Property, Plant and Equipment, net
Components of property, plant and equipment were as follows:
| (in thousands) | June 30, 2023 | December 31, 2022 | |||||||||
| Land | $ | $ | |||||||||
| Buildings and improvements | |||||||||||
| Machinery and equipment | |||||||||||
| Capitalized software | |||||||||||
| Furniture and fixtures | |||||||||||
| Vehicles | |||||||||||
Construction in progress(1) | |||||||||||
| Total | |||||||||||
| Accumulated depreciation and amortization | ( | ( | |||||||||
| Property, plant and equipment, net | $ | $ | |||||||||
(1)Construction in progress primarily related to upgrades to certain of the Company's distribution facilities that we expect to place in service in the next 12 months.
Depreciation expense for property, plant and equipment was $2.5 million and $2.5 million for the second quarter of 2023 and 2022, respectively, and $6.0 million and $3.1 million for the first six months of 2023 and 2022, respectively. Amortization expense for capitalized software was $0.8 million and $0.9 million for the second quarter of 2023 and 2022, respectively, and $1.5 million and $1.1 million for the first six months of 2023 and 2022, respectively.
Rental Equipment, net
Rental equipment, net consisted of the following:
| (in thousands) | June 30, 2023 | December 31, 2022 | |||||||||
| Rental equipment | $ | $ | |||||||||
| Accumulated depreciation | ( | ( | |||||||||
| Rental equipment, net | $ | $ | |||||||||
Depreciation expense included in cost of sales for rental equipment was $1.9 million and $1.5 million for the second quarter of 2023 and 2022, respectively and $4.2 million and $2.9 million for the first six months of 2023 and 2022, respectively. Refer to Note 4 – Revenue Recognition for a discussion on the Company's activities as lessor.
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Accrued Expenses and Other Current Liabilities
Accrued expenses and other current liabilities consisted of the following:
| (in thousand) | June 30, 2023 | December 31, 2022 | |||||||||
| Accrued compensation | $ | $ | |||||||||
| Deferred acquisition payments and accrued earnout liabilities | |||||||||||
| Accrued and withheld taxes, other than income taxes | |||||||||||
| Accrued customer rebates | |||||||||||
| Accrued stock-based compensation | |||||||||||
| Accrued interest | |||||||||||
| Accrued severance and acquisition related retention bonus | |||||||||||
| Accrued health benefits | |||||||||||
| Deferred revenue | |||||||||||
| Accrued income taxes | |||||||||||
| Other | |||||||||||
| Total accrued expenses and other current liabilities | $ | $ | |||||||||
Other Liabilities
| (in thousand) | June 30, 2023 | December 31, 2022 | |||||||||
| Security bonus plan | $ | $ | |||||||||
| Deferred compensation | |||||||||||
| Other | |||||||||||
| Total other liabilities | $ | $ | |||||||||
Note 6 – Goodwill and Intangible Assets
Goodwill
Changes in the carrying amount of goodwill by segment were as follows:
| (in thousands) | Lawson | TestEquity | Gexpro Services | All Other | Total | |||||||||||||||||||||||||||
| Balance at December 31, 2022 | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||
| Acquisitions | ||||||||||||||||||||||||||||||||
| Impact of foreign exchange rates | ||||||||||||||||||||||||||||||||
| Balance at June 30, 2023 | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||
Intangible Assets
The gross carrying amount and accumulated amortization for definite-lived intangible assets were as follows:
| June 30, 2023 | December 31, 2022 | ||||||||||||||||||||||||||||||||||
| (in thousands) | Gross Carrying Amount | Accumulated Amortization | Net Carrying Value | Gross Carrying Amount | Accumulated Amortization | Net Carrying Value | |||||||||||||||||||||||||||||
| Trade names | $ | $ | ( | $ | $ | $ | ( | $ | |||||||||||||||||||||||||||
| Customer relationships | ( | ( | |||||||||||||||||||||||||||||||||
Other (1) | ( | ( | |||||||||||||||||||||||||||||||||
| Total | $ | $ | ( | $ | $ | $ | ( | $ | |||||||||||||||||||||||||||
22
Amortization expense for definite-lived intangible assets was $9.4 million and $18.6 million for the three and six months ended June 30, 2023, respectively, and $9.9 million and $15.3 million for the three and six months ended June 30, 2022, respectively. Amortization expense related to intangible assets was recorded in Selling, general and administrative expenses.
The estimated aggregate amortization expense for the remaining year 2023 and each of the next five years are as follows:
| (in thousands) | Amortization | |||||||
| Remaining 2023 | $ | |||||||
| 2024 | ||||||||
| 2025 | ||||||||
| 2026 | ||||||||
| 2027 | ||||||||
| 2028 | ||||||||
| Thereafter | ||||||||
| Total | $ | |||||||
Note 7 – Leases
Activities as Lessee
The Company leases property used for warehousing, distribution centers, office space, branch locations, equipment and vehicles. The expenses generated by leasing activity for the three and six months ended June 30, 2023 and 2022 were as follows (in thousands):
| Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||||||||||||||||||
| Lease Type | Classification | 2023 | 2022 | 2023 | 2022 | |||||||||||||||||||||||||||
Operating Lease Expense (1) | Operating expenses | $ | $ | $ | $ | |||||||||||||||||||||||||||
| Financing Lease Amortization | Operating expenses | |||||||||||||||||||||||||||||||