Notes to Condensed Consolidated Financial Statements (Unaudited)
Note 1 — Nature of Operations and Basis of Presentation
Organization
Effective May 5, 2022, Distribution Solutions Group, Inc. ("DSG"), a Delaware corporation, changed its corporate name from “Lawson Products, Inc.” to “Distribution Solutions Group, Inc.” 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. ("Lawson"), TestEquity Acquisition, LLC ("TestEquity") and 301 HW Opus Holdings, Inc., conducting business as Gexpro Services ("Gexpro Services"). The complementary distribution operations of Lawson, TestEquity and Gexpro Services were combined for the purpose of creating 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.
Business Combination Background
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 Acquisition, LLC, a Delaware limited liability company and a wholly-owned subsidiary of the TestEquity Equityholder (“TestEquity”), (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
• 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) 301 HW Opus Holdings, Inc., a Delaware corporation and a wholly-owned subsidiary of the Gexpro Services Stockholder (“Gexpro Services”), (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”).
Each outstanding share of TestEquity and Gexpro Services common stock outstanding immediately prior to the closing of the Merger can be derived by converted into approximately 0.3618 shares and 0.7675 shares, respectively, of Company common stock.
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 and under the terms of the TestEquity Merger Agreement, at the closing of the TestEquity Merger, 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 provides that an additional 700,000 shares of DSG common stock (the “TestEquity Holdback Shares”) may be issued to the TestEquity Equityholder or forfeited in accordance with two earnout provisions of the TestEquity Merger Agreement. The amount of TestEquity Holdback Shares issuable under the first earnout opportunity is based on, among other factors, the consummation of a certain additional acquisition by TestEquity during the period beginning after December 29, 2021 and ending 90 days after the Merger Date. If any TestEquity Holdback Shares remain after the calculation of the first earnout opportunity, there is a second earnout opportunity based on, among other factors, the increase in TestEquity EBITDA (as defined in the TestEquity Merger Agreement) in calendar year 2022 over calendar year 2021 subject to the
calculations within the TestEquity Merger Agreement. As of June 30, 2022, 700,000 TestEquity Holdback Shares are expected to be issued under the first earnout opportunity due to the consummation of the certain additional acquisition as referenced in the TestEquity Merger Agreement and were remeasured and reclassified to equity at April 29, 2022 when the additional acquisition was consummated. Refer to Note 11 - Earnout Derivative Liability 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 and under the terms of the Gexpro Services Merger Agreement, at the closing of the Gexpro Services Merger, 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 provides that an additional 1,000,000 shares of DSG common stock (the “Gexpro Services Holdback Shares”) may be issued to the Gexpro Services Stockholder or forfeited in accordance with two earnout provisions of the Gexpro Services Merger Agreement. The amount of Gexpro Services Holdback Shares issuable under the first earnout opportunity is based on, among other factors, the consummation of one or more of three certain additional acquisitions by Gexpro Services during the period beginning after December 29, 2021 and ending 90 days after the Merger Date. If any Gexpro Services Holdback Shares remain after the calculation of the first earnout opportunity, there is a second earnout opportunity based on, among other factors, the increase in Gexpro Services EBITDA (as defined in the Gexpro Services Merger Agreement) in calendar year 2022 over calendar year 2021 subject to the calculations within the Gexpro Services Merger Agreement. As of April 1, 2022, approximately 538,000 Gexpro Services Holdback Shares were expected to be issued under the first earnout opportunity due to the consummation of the certain additional acquisitions which were completed prior to the Merger Date. The fair value of the remaining 462,000 Gexpro Services Holdback Shares available under the second earnout opportunity are included in Earnout derivative liability in the Unaudited Condensed Consolidated Balance Sheets. Final issuance of the Gexpro Services Holdback Shares under the second earnout opportunity is subject to certain terms and conditions as specified in the Gexpro Services Merger Agreement. Refer to Note 11 - Earnout Derivative Liability for information about the earnout derivative liability related to the Gexpro Services Holdback Shares.
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 Merger Date reflect the results of operations and financial position 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.
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 19 - Segment Information.
Lawson sells and distributes specialty products to the industrial, commercial, institutional and government MRO market and uses sales representatives to provide Vendor Managed Inventory ("VMI") services to Lawson's customers. Through The Bolt Supply House business, customers in Western Canada have access to products at 14 branch locations in Alberta, Saskatchewan, Manitoba and British Columbia, Canada. Under its Kent Automotive brand, Lawson provides collision and mechanical repair products to the automotive aftermarket. Lawson ships from several strategically located distribution centers to customers in all 50 states, Puerto Rico, Canada, Mexico, and the Caribbean.
TestEquity is a distributor of test and measurement equipment and solutions, electronic production supplies, and tool kits from its leading manufacturer partners supporting the technology, aerospace, defense, automotive, electronics, education, and medical industries. TestEquity operates primarily through four brands, TestEquity, TEquipment, Jensen Tools and Techni-Tool. TestEquity also designs a full line of environmental test chambers.
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 Original Equipment Manufacturer (OEM) products.
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 as of June 30, 2022 and December 31, 2021 and for the three and six months ended June 30, 2022 and 2021 reflect the results of operations and financial position 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 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 two day difference arising from the different period ends for the quarter ended June 30, 2022 was not material. The Company utilizes the exchange rates in effect at Gexpro Services’ reporting date and the appropriate weighted-average rate for its fiscal reporting period.
The accompanying unaudited condensed consolidated financial statements of DSG have been prepared in accordance with accounting principles generally accepted in the United States ("GAAP") for interim financial information, the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not contain all disclosures required by GAAP for complete consolidated financial statements. These unaudited condensed consolidated financial statements should be read in conjunction with the TestEquity Acquisition, LLC and 301 HW Opus Holdings, Inc. audited consolidated financial statements and accompanying notes included in the Company's Current Report on Form 8-K/A filed with the U.S. Securities and Exchange Commission ("SEC") on June 15, 2022, and the Lawson Products, Inc. audited consolidated financial statements and accompanying notes included in DSG's Annual Report on Form 10-K filed for the year ended December 31, 2021. All normal recurring adjustments have been made that are necessary to fairly state the results of operations for the interim periods. Operating results for the three and six month periods ended June 30, 2022 are not necessarily indicative of the results that may be expected for the year ending December 31, 2022.
Note 2 - Summary of Significant Accounting Policies
Revenue Recognition — The majority of the Company’s revenue is generated through the sale of a broad range of specialized products and components, with revenue recognized upon transfer of control, title and risk of loss, which is generally upon shipment. VMI service revenue represents less than 5% of total revenue and is recognized as the services are performed. The Company offers VMI services only in conjunction with product sales. The Company does not bill product sales and services separately. A portion of selling expenses is allocated to cost of sales for reporting purposes based upon the estimated time spent on such services. A portion of service revenue and cost of service is deferred, as not all services are performed in the same period as billed. The Company includes shipping costs billed to customers in revenue and the related shipping costs in cost of goods and services. The Company accrues for returns based on historical evidence of return rates. The Company has adopted the practical expedient within ASC 340 to recognize incremental costs to obtain a contract, primarily employee related costs, as expense when incurred since the amortization period of the asset that the Company otherwise would have recognized is one year or less. 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.
Cash Equivalents — The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. The carrying amount of the Company’s cash equivalents at June 30, 2022 and December 31, 2021 approximates fair value.
Allowance for Doubtful Accounts — The Company evaluates the collectability of accounts receivable based on a combination of factors. In circumstances where the Company is aware of a specific customer’s inability to meet its financial obligations (e.g., bankruptcy filings, substantial down-grading of credit ratings), a specific reserve for bad debts is recorded against amounts due to reduce the receivable to the amount the Company reasonably believes will be collected. For all other customers, the Company recognizes reserves for bad debts based on the Company’s historical experience of bad debt write-offs as a percent of accounts receivable outstanding. If circumstances change (e.g., higher than expected defaults or an unexpected
material adverse change in a major customer's ability to meet its financial obligations), the estimates of the recoverability of amounts due the Company could be revised.
Inventories — Inventories principally consist of finished goods stated at the lower of cost or net realizable value using the first-in-first-out method for the Lawson and TestEquity segments and weighted average for the Gexpro Services segment. To reduce the cost basis of inventory to a lower of cost or net realizable value, a reserve is recorded for slow-moving and obsolete inventory based on historical experience and monitoring of current inventory activity. Estimates are used to determine the necessity of recording these reserves based on periodic detailed analysis using both qualitative and quantitative factors. As part of this analysis, the Company considers several factors including the inventories length of time on hand, historical sales, product shelf life, product life cycle, product category and product obsolescence.
Property, Plant and Equipment — Property, plant and equipment are stated at cost less accumulated depreciation and amortization. Depreciation expense is computed primarily by the straight-line method for buildings, machinery and equipment, furniture and fixtures and vehicles. The Company estimates useful lives of 10 to 40 years for buildings and improvements, the shorter of the useful life of the assets or term of the underlying leases for leasehold improvements, and 2 to 10 years for machinery and equipment, furniture and fixtures and vehicles. Capitalized software is amortized over estimated useful lives of 3 to 5 years using the straight-line method. The costs of repairs, maintenance and minor renewals are charged to expense as incurred. Amortization of financing and capital leases is included in depreciation expense. When property, plant and equipment are retired, sold, or otherwise disposed of, the asset’s carrying amount and related accumulated depreciation are removed from the accounts and any gain or loss is included in the income from operations.
Rental Equipment — Rental equipment is stated at cost less accumulated depreciation and amortization. Expense is computed primarily by the straight-line method over an estimated useful life of 3 to 7 years. Upon sale or retirement of such assets, the related cost and accumulated depreciation are removed from the Unaudited Condensed Consolidated Balance Sheet, and gains or losses are reflected in the Unaudited Condensed Consolidated Statements of Operations and Comprehensive (Loss) Income. The costs of repairs, maintenance and minor renewals are charged to expense as incurred. When rental equipment is retired, sold, or otherwise disposed of, the asset’s carrying amount and related accumulated depreciation are removed from the Unaudited Condensed Consolidated Balance Sheet and any gain or loss is included in the income from operations.
Cash Value of Life Insurance — The Company invests funds in life insurance policies for certain current and former employees. The cash surrender value of the policies is invested in various investment instruments and is recorded as an asset on our Unaudited Condensed Consolidated Balance Sheets. The Company records these policies at their contractual value. The change in the cash surrender value of the life insurance policies, which is recorded as a component of General and administrative expenses in the Unaudited Condensed Consolidated Statements of Operations and Comprehensive (Loss) Income, is the change in the policies' contractual values.
Deferred Compensation — The Company’s Executive Deferral Plan (“Deferral Plan”) allows certain executives to defer payment of a portion of their earned compensation. The deferred compensation is recorded in an account balance, which is a bookkeeping entry made by the Company to measure the amount due to the participant. The account balance is equal to the participant’s deferred compensation, adjusted for increases and/or decreases in the amount that the participant has designated to one or more bookkeeping portfolios that track the performance of certain mutual funds. The Company adjusts the deferred compensation liability to equal the contractual value of the participants’ account balances. These adjustments are the changes in contractual value of the individual plans and are recorded as a component of General and administrative expenses in the Unaudited Condensed Consolidated Statements of Operations and Comprehensive (Loss) Income.
Stock-Based Compensation — Compensation based on the share value of the Company’s common stock is valued at its fair value at the grant date and the expense is recognized over the vesting period. Fair value is re-measured each reporting period for liability-classified awards that may be redeemable in cash. The Company accounts for forfeitures of stock-based compensation in the period in which they occur.
Goodwill — The Company had $355.4 million of goodwill at June 30, 2022 and $106.1 million of goodwill at December 31, 2021. Goodwill represents the cost of business acquisitions in excess of the fair value of identifiable net tangible and intangible assets acquired. The Company reviews goodwill for potential impairment annually on October 1st, or when an event or other circumstances change that would more likely than not reduce the fair value of the asset below its carrying value.
The first step in the multi-step process to determine if goodwill has been impaired and to what degree is to review the relevant qualitative factors that could cause the fair value of the reporting unit to decrease below the carrying value of the reporting unit. The Company considers factors such as macroeconomic, industry and market conditions, cost factors, overall financial performance and other relevant factors that would affect the individual reporting units. If the Company determines that
it is more likely than not that the fair value of the reporting unit is greater than the carrying value of the reporting unit, then no further impairment testing is needed. If the Company determines that it is more likely than not that the carrying value of the reporting unit is greater than the fair value of the reporting unit, the Company will move to the next step in the process. The Company will estimate the fair value of the reporting unit and compare it to the reporting unit's carrying value. If the carrying value of the reporting unit exceeds its fair value, the Company will record an impairment of goodwill equal to the amount the carrying value of the reporting unit exceeds its fair value, up to the total amount of goodwill previously recognized.
Intangible Assets — The Company's intangible assets primarily consist of trade names and customer relationships. Intangible assets are amortized over a weighted average of 8 to 15 year and 9 to 20 year estimated useful lives for trade names and customer relationships, respectively. The Company amortizes trade name intangible assets on a straight-line basis and customer relationship intangible assets on a basis consistent with their estimated economic benefit.
Impairment of Long-Lived Assets — The Company reviews its long-lived assets, including property, plant and equipment and definite life intangibles, for impairment whenever events or changes in circumstances indicate that the carrying amounts of these assets may not be recoverable. Recoverability is measured by a comparison of the assets carrying amount to their expected future undiscounted net cash flows. If such assets are considered to be impaired, the impairment to be recognized is measured based on the amount by which the carrying amount of the asset exceeds its fair value. No impairments occurred in the first six months of 2022 or during the year ended December 31, 2021.
Income Taxes — Deferred tax assets or liabilities reflect temporary differences between amounts of assets and liabilities for financial and tax reporting. Such amounts are adjusted, as appropriate, to reflect changes in enacted tax rates expected to be in effect when the temporary differences reverse. A valuation allowance is established to offset any deferred tax assets if, based upon the available evidence, it is more likely than not (i.e. greater than 50% likely) that some or all of the deferred tax assets will not be realized. The determination of the amount of a valuation allowance to be provided on recorded deferred tax assets involves estimates regarding (1) the timing and amount of the reversal of taxable temporary differences, (2) expected future taxable income, (3) the impact of tax planning strategies and (4) the ability to carry back deferred tax assets to offset prior taxable income. In assessing the need for a valuation allowance, we consider all available positive and negative evidence, including past operating results, projections of future taxable income and the feasibility of ongoing tax planning strategies. The projections of future taxable income include a number of estimates and assumptions regarding our volume, pricing and costs. Additionally, valuation allowances related to deferred tax assets can be impacted by changes to tax laws. Significant judgment is required in determining income tax provisions as well as deferred tax asset and liability balances, including the estimation of valuation allowances and the evaluation of uncertain tax positions.
Earnings from the Company's foreign subsidiaries are considered to be indefinitely reinvested. A distribution of these non-U.S. earnings in the form of dividends or otherwise would subject the Company to foreign withholding taxes and may subject the Company to U.S. federal and state taxes.
The Company recognizes the benefit of tax positions when a benefit is more likely than not (i.e., greater than 50% likely) to be sustained on its technical merits. Recognized tax benefits are measured at the largest amount that is more likely than not to be sustained, based on cumulative probability, in final settlement of the position. The Company recognizes interest and penalties related to unrecognized tax benefits as a component of Income tax expense in the Unaudited Condensed Consolidated Statements of Operations and Comprehensive (Loss) Income.
Leases — Leases are categorized as either operating or financing leases at commencement of the lease. For both classes of leases, a Right Of Use ("ROU") asset and corresponding lease liability are recognized at commencement of the lease. Operating leases consist of the Company headquarters, distribution and service centers, and Bolt branches. Financing leases consist of equipment such as forklifts and copiers. The value of the lease assets and liabilities are the present value of the total cash payments for each lease. The Company uses its incremental borrowing rate to discount the total cash payments to present value for each lease. The Company reviews each lease to determine if there is a more appropriate discount rate to apply. Upon commencement of the lease, rent expense is recognized on a straight line basis for each operating lease. Each financing lease ROU asset is amortized on a straight line basis over the lease period. TestEquity and the Lawson Partsmaster business have equipment leasing programs for customers. These leases are classified as operating leases. The leased equipment is recognized in Rental equipment, net in the Unaudited Condensed Consolidated Balance Sheets and the leasing revenue is recognized on a straight line basis.
Earnings per Share — Basic earnings per share is computed by dividing net income by the weighted-average number of common shares outstanding during the period. Diluted earnings per share is computed using the weighted-average number of shares of common stock and, if dilutive, common stock equivalents outstanding during the period. Diluted earnings per share reflect the potential dilution from the exercise or conversion of outstanding performance awards, stock options, market stock
units and restricted stock awards into common stock. The dilutive effect of these common stock equivalents is reflected in diluted earnings per share by application of the treasury stock method. Contingently issuable shares are considered outstanding common shares and included in basic EPS as of the date that all necessary conditions have been satisfied (i.e., when issuance of the shares is no longer contingent). For diluted EPS, the contingently issuable shares should be included in the denominator of the diluted EPS calculation as of the beginning of the interim period in which the conditions are satisfied and the earnout arrangements have been resolved.
For the reverse acquisition period prior to April 1, 2022, the Company calculates the basic EPS for each comparative period before the acquisition date presented in the consolidated financial statements by dividing the income of the accounting acquirer attributable to common shareholders in each of those periods by the accounting acquirer’s historical weighted-average number of common shares outstanding. The Company calculates the weighted-average number of common shares outstanding (the denominator of the EPS calculation), including the equity interests issued by the legal acquirer to effect the reverse acquisition, as; the number of common shares outstanding from the beginning of that period to the acquisition date computed on the basis of the weighted-average number of common shares of the accounting acquirer outstanding during the period multiplied by an exchange ratio derived from the shares exchanged at the Merger Date.
For the three and six months ended June 30, 2022 no options to purchase shares of common stock were excluded from the computation of diluted earnings per share because none of the options were in the money.
Foreign Currency — The accounts of foreign subsidiaries are measured using the local currency as the functional currency. All balance sheet amounts are translated into U.S. dollars using the exchange rates in effect at the applicable period end. Components of income or loss are translated using the average exchange rate for each reporting period.
Gains and losses resulting from changes in the exchange rates from translation of the subsidiary accounts in local currency to U.S. dollars are reported as a component of Accumulated other comprehensive income or loss in the Unaudited Condensed Consolidated Balance Sheets. Gains and losses resulting from the effect of exchange rate changes on transactions denominated in currencies other than the functional currency are included as a component of net income or loss upon settlement of the transaction.
Gains and losses resulting from foreign intercompany transactions are included as a component of net income or loss each reporting period unless the transactions are of a long-term-investment nature and settlement is not planned or anticipated in the foreseeable future, in which case the gains and losses are recorded as a component of Accumulated other comprehensive income or loss in the Unaudited Condensed Consolidated Balance Sheets.
Treasury Stock — The Company repurchased 2,756 of its common stock in 2022 from employees upon the vesting of restricted stock to offset the income taxes owed by those employees. The Company accounts for treasury stock using the cost method and includes treasury stock as a component of stockholders’ equity. The cost of the common stock repurchased and held in treasury was $0.08 million in 2022.
Segment Information — The Financial Accounting Standards Board ("FASB") ASC 280, Segment Reporting, establishes standards for reporting information about operating segments. Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker, or decision-making group, in deciding how to allocate resources and in assessing performance.
The Company’s chief operating decision-maker (“CODM”) is the Chief Executive Officer of DSG. The CODM reviews the financial performance and the results of operations of the segments when making decisions about allocating resources and assessing performance of the Company.
The Company has determined it has four operating segments: (i) Lawson, (ii) Gexpro Services, (iii) TestEquity and (iv) All Other. The Company’s three reportable segments include (i) Lawson, (ii) Gexpro Services and (iii) TestEquity. The Company’s CODM reviews the operating results of these reportable segments for the purpose of allocating resources and evaluating financial performance.
There are no intersegment revenues. The reporting segments follow the same accounting policies used in the preparation of the Company’s unaudited condensed consolidated financial statements. Please see Note 19 - Segment Information for further details.
Acquisitions — The Company recognizes identifiable assets acquired and liabilities assumed at their acquisition date fair values. Goodwill as of the acquisition date is measured as the excess of consideration transferred over the net of the acquisition
date fair values of the assets acquired and the liabilities assumed. While the Company uses its best estimates and assumptions for the purchase price allocation process to value assets acquired and liabilities assumed at the acquisition date, the estimates are inherently uncertain and subject to refinement. As a result, during the measurement period, which may be up to one year from the acquisition date, the Company may record adjustments to the assets acquired and liabilities assumed, with the corresponding offset to goodwill.
Fair Value Measurements — The Company applies the guidance in ASC 820, Fair Value Measurements to account for financial assets and liabilities measured on a recurring basis. ASC 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The guidance provides a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The three levels of the fair value hierarchy are described below:
Level 1 - Unadjusted quoted prices for identical assets and liabilities in active markets.
Level 2 - Observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets and liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable market data.
Level 3 - Unobservable inputs that are supported by little or no market activity, may be derived from internally developed methodologies based on management's best estimate of fair value and that are significant to the fair value of the asset or liability
The carrying amount of accounts receivable, accounts payable, accrued expenses and other working capital balances are considered a reasonable estimate of their fair value due to the short-term maturity of these instruments. The carrying amount of debt is also considered to be a reasonable estimate of the fair value based on the nature of the debt and that the debt bears interest at the prevailing market rate for instruments with similar characteristics. The Company’s earnout derivative liability is recorded at fair value on a recurring basis and was estimated using Level 3 inputs.
Earnout Derivative Liability — The Company recorded an earnout derivative liability for the future contingent equity shares related to the TestEquity Holdback Shares and the Gexpro Services Holdback Shares provisions within the Merger Agreements. The contingently issuable shares are not indexed to the common stock of the Company and, therefore, are accounted for as liability classified instruments in accordance with ASC 815-40, Contracts in Entity’s Own Equity, as the events that determine the number of contingently issuable shares required to be released or issued, as the case may be, include events that are not solely indexed to the fair value of common stock of the Company. The contingently issuable shares were initially measured at the Merger Date and are subsequently measured at each reporting date until settled, or when they meet the criteria for equity classification. Changes in the fair value of the earnout derivative liability are recorded as a component of Change in fair value of earnout derivative liability in the Unaudited Condensed Consolidated Statements of Operations and Comprehensive (Loss) Income.
The Company reassesses the classification of these derivative liabilities for earnout arrangements each balance sheet date. If the contingencies are resolved for the issuable shares, the earnout derivative liability is reclassified from the liability to equity as of the date of the event that caused the contingencies were met. The earnout derivative liability is measured at fair value immediately prior to the reclassification to equity. If the earnout derivative liability is reclassified from a liability to equity, gains or losses recorded to account for the liability at fair value during the period that the contract was classified as a liability are not reversed.
The contingently issuable shares are included in the denominator of the basic earnings per share calculation as of the date that all necessary conditions have been satisfied (i.e., when issuance of the shares is no longer contingent). For diluted earnings per share, the contingently issuable shares are included in the denominator of the diluted earnings per share calculation as of the beginning of the interim period in which the conditions are satisfied and the earnout arrangements have been resolved. See Note 15 - Earnings Per Share for further information.
Use of Estimates — Preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported for service revenue, service cost, allowance for doubtful accounts, inventory reserves, goodwill and intangible assets valuation, and income taxes in the unaudited condensed consolidated financial statements and accompanying notes. Actual results could differ from these estimates.
Recent Accounting Pronouncements - Not Yet 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 is effective for smaller reporting companies in fiscal years beginning after December 15, 2023, including interim periods within those fiscal years, and the new guidance will be applied on a prospective basis. The Company is still evaluating the effect the adoption of the new standard will have on its financial statements.
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 is still evaluating the effect the adoption of the new standard will have on its financial statements.
Note 3 - Business Acquisitions
Completion of Mergers
On April 1, 2022, the Mergers were completed via all-stock merger transactions. Pursuant to the Merger Agreements, DSG issued an aggregate of 10.3 million shares of its common stock to the former owners of TestEquity and Gexpro Services. An additional 1.7 million shares of DSG common stock remain potentially issuable upon meeting the conditions of certain earnout provisions. 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 brings together 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 Original Equipment Manufacturer ("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 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 exchanged | | 9,120,167 |
DSG closing price per common stock on March 31, 2022 | | $ | 38.54 | |
Fair value of shares exchanged | | $ | 351,491 | |
| | |
Other consideration(1) | | 1,910 | |
| | |
Total consideration exchanged | | $ | 353,401 | |
(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 fair values were determined based upon a preliminary valuation and the estimates and assumptions used in such valuation are pending completion and subject to change. Certain estimated
values for the acquisition, including the valuation of intangibles and income taxes (including deferred taxes and associated valuation allowances), are not yet finalized, and the preliminary purchase price allocations are subject to change as the Company completes its analysis of the fair value at the date of acquisition. Goodwill generated from the acquisition is not deductible for tax purposes. The Company will continue to obtain information necessary to finalize the fair values, which may differ materially from these preliminary estimates. The final valuation will be completed within the one-year measurement period ending March 31, 2023, and any measurement period adjustments will be applied in the reporting period in which the adjustments are determined.
The preliminary allocation of consideration exchanged to the estimated fair values of assets acquired and liabilities assumed as of the Merger Date is summarized as follows:
| | | | | | | | | | |
(in thousands) | | Total | | |
Current assets | | $ | 148,308 | | | |
Property, plant and equipment | | 57,053 | | | |
Right of use assets | | 17,571 | | | |
Other intangible assets | | 119,060 | | | |
Deferred tax liability, net of deferred tax asset | | (26,237) | | | |
Other assets | | 18,373 | | | |
Current liabilities | | (71,097) | | | |
Long-term obligations | | (25,722) | | | |
Lease and financing obligations | | (29,474) | | | |
Derivative earnout liability | | (43,900) | | | |
| | | | |
Goodwill | | 189,466 | | | |
Total consideration exchanged | | $ | 353,401 | | | |
| | | | |
The preliminary allocation of consideration exchanged to other intangible assets acquired is as follows:
| | | | | | | | | | | | | | |
(in thousands) | | Fair Value | | Estimated Life (in years) |
Customer relationships | | $ | 76,050 | | | 19 |
Trade names | | 43,010 | | | 8 |
Total other intangible assets | | $ | 119,060 | | | |
The Company incurred transaction costs related to the Mergers of $5.8 million and $7.2 million for the three and six months ended June 30, 2022, respectively and $0.4 million and $0.5 million for the three and six months ended June 30, 2021, respectively.
Pro Forma Information
The following table presents estimated unaudited pro forma consolidated financial information for DSG as if the Mergers and other acquisitions disclosed below occurred on January 1, 2021 for the 2022 acquisitions and January 1, 2020 for the 2021 acquisitions. The unaudited pro forma information reflects adjustments including amortization on acquired intangible assets, interest expense, and the related tax effects. This information is presented for informational purposes only and is not necessarily indicative of future results or the results that would have occurred had the Mergers been completed on the date indicated.
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended June 30, | | Six Months Ended June 30, |
(in thousands) | 2022 | | 2021 | | 2022 | | 2021 |
Revenue | $ | 471,280 | | | $ | 299,854 | | | $ | 647,030 | | | $ | 454,895 | |
| | | | | | | |
| | | | | | | |
Net income | 6,056 | | | 8,081 | | | 4,560 | | | 14,431 | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
Other Acquisitions
TestEquity and Gexpro Services acquired other businesses during the first six months of 2022 and year ended December 31, 2021. The consideration exchanged for the acquired businesses included various combinations of cash, sellers notes, and forms of share based payments. 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. Certain estimated values for the acquisitions, including the valuation of intangibles, contingent consideration, and income taxes (including deferred taxes and associated valuation allowances), are not yet finalized, and the preliminary purchase price allocations are subject to change as the Company completes its analysis of the fair value at the date of acquisition. The final valuations will be completed within the one-year measurement periods following the respective acquisition dates, and any adjustments will be recorded in the period in which the adjustments are determined.
During the first six months of 2022, TestEquity acquired Interworld Highway, LLC and National Test Equipment, and Gexpro Services acquired Resolux ApS ("Resolux") and Frontier Technologies Brewton, LLC and Frontier Engineering and Manufacturing Technologies, Inc. ("Frontier"). The purchase consideration for each business acquired and the preliminary 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 | | | | |
Acquisition date | | April 29, 2022 | | January 3, 2022 | | March 31, 2022 | | June 1, 2022 | | Total | | |
Current assets | | $ | 15,018 | | | $ | 8,551 | | | $ | 3,299 | | | $ | 2,186 | | | $ | 29,054 | | | |
Property, plant and equipment | | 313 | | | 459 | | | 1,065 | | | 642 | | | 2,479 | | | |
Right of use assets | | — | | | 1,125 | | | 9,218 | | | — | | | 10,343 | | | |
Other intangible assets: | | | | | | | | | | | | |
Customer relationships | | 6,369 | | | 11,400 | | | 10,000 | | | 1,830 | | | 29,599 | | | |
Trade names | | 4,600 | | | 6,100 | | | 3,300 | | | — | | | 14,000 | | | |
| | | | | | | | | | | | |
Other assets | | 10 | | | 1,745 | | | — | | | — | | | 1,755 | | | |
Accounts payable | | (8,856) | | | (3,058) | | | (1,359) | | | (2,268) | | | (15,541) | | | |
| | | | | | | | | | | | |
Accrued expenses and other liabilities | | — | | | (939) | | | (1,067) | | | (1,169) | | | (3,175) | | | |
Lease obligation | | — | | | (1,125) | | | (9,218) | | | — | | | (10,343) | | | |
| | | | | | | | | | | | |
| | | | | | | | | | | | |
| | | | | | | | | | | | |
Goodwill | | 37,236 | | | 6,498 | | | 10,439 | | | 5,971 | | | 60,144 | | | |
Total purchase consideration exchanged, net of cash acquired | | $ | 54,690 | | | $ | 30,756 | | | $ | 25,677 | | | $ | 7,192 | | | $ | 118,315 | | | |
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. The fair value of the contingent consideration arrangement was classified within Level 3 and was determined using a probability-based scenario analysis approach. As of March 31, 2022 and June 30, 2022, the fair value of the earn-out was $0.9 million and $0.9 million, respectively, with amounts recorded in Accrued expenses and other current liabilities and Other liabilities in the Unaudited Condensed Consolidated Balance Sheets.
During the year ended December 31, 2021, TestEquity acquired MCS Test Group Limited ("MCS"), and Gexpro Services acquired Omni Fasteners Inc. ("Omni"), National Engineered Fasteners ("NEF") and State Industrial Supply ("SIS"). The accounting for the Omni and MCS acquisitions was complete as of June 30, 2022. Certain estimated values for the NEF and SIS acquisitions are preliminary, including goodwill, contingent consideration, and income taxes (including deferred taxes and associated valuation allowances). These values are subject to change as the Company completes its analysis of the fair value at the date of acquisition. The final valuations will be completed within the one-year measurement periods following the respective acquisition dates, and any adjustments will be recorded in the period in which the adjustments are determined.
The purchase consideration for each business acquired during 2021 and the preliminary allocation of the consideration exchanged to the estimated fair values of assets acquired and liabilities assumed is summarized below:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
(in thousands) | | Omni | | NEF(1) | | SIS | | MCS | | | | |
Acquisition date | | June 8, 2021 | | November 1, 2021 | | December 31, 2021 | | July 31, 2021 | | Total | | |
Current assets | | $ | 2,259 | | | $ | 17,882 | | | $ | 3,541 | | | $ | 6,521 | | | $ | 30,203 | | | |
Property, plant and equipment | | 600 | | | 589 | | | 125 | | | — | | | 1,314 | | | |
Right of use assets | | — | | | 1,774 | | | 799 | | | — | | | 2,573 | | | |
Other intangible assets: | | | | | | | | | | | | |
Customer relationships | | 2,530 | | | 5,007 | | | 4,800 | | | 2,621 | | | 14,958 | | | |
Trade names | | 200 | | | 2,503 | | | 1,500 | | | 41 | | | 4,244 | | | |
Other intangible assets | | 9 | | | — | | | 380 | | | — | | | 389 | | | |
Other assets | | — | | | 1,236 | | | 10 | | | — | | | 1,246 | | | |
Accounts payable | | (50) | | | (3,506) | | | (1,464) | | | (2,523) | | | (7,543) | | | |
| | | | | | | | | | | | |
Accrued expenses and other liabilities | | — | | | (3,332) | | | — | | | (685) | | | (4,017) | | | |
Lease obligation | | — | | | (1,774) | | | (799) | | | | | (2,573) | | | |
| | | | | | | | | | | | |
| | | | | | | | | | | | |
| | | | | | | | | | | | |
Goodwill | | 953 | | | — | | | 3,010 | | | 7,245 | | | 11,208 | | | |
Gain on bargain purchase | | — | | | (1,363) | | | — | | | — | | | (1,363) | | | |
Total purchase consideration exchanged, net of cash acquired | | $ | 6,501 | | | $ | 19,016 | | | $ | 11,902 | | | $ | 13,220 | | | $ | 50,639 | | | |
(1)The consideration exchanged in the NEF acquisition included a shared-based payment valued at $2.8 million with the remainder of the payment in cash.
A gain on bargain purchase related to the acquisition of NEF was recognized within Other income (expense), net in the Unaudited Condensed Consolidated Statements of Operations and Comprehensive (Loss) Income in the fourth quarter of 2021. The gain of $1.4 million was calculated as the excess of net assets recognized over the consideration transferred. The bargain purchase was primarily attributable to owners that were highly motivated to sell.
The Company incurred transaction costs related to the other acquisitions of $0.3 million and $1.3 million for the three and six months ended June 30, 2022, respectively and $0.8 million and $1.0 million for the three and six months ended June 30, 2021, respectively.
Other Acquisitions Pro Forma Information - The pro forma information for other acquisitions was included in the estimated unaudited pro forma consolidated financial information for DSG, which is presented above under Pro Forma Information.
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 2022 and 2021. 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.
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
(in thousands) | Three Months Ended June 30, 2022 | | Three Months Ended June 30, 2021 |
| Lawson | | Other Acquisitions | | Total | | Lawson | | Other Acquisitions | | Total |
Revenue | $ | 123,670 | | | $ | 52,739 | | | $ | 176,409 | | | $ | — | | | $ | 468 | | | $ | 468 | |
Net Income | $ | 3,084 | | | $ | 5,316 | | | $ | 8,400 | | | $ | — | | | $ | (335) | | | $ | (335) | |
| | | | | | | | | | | |
| Six Months Ended June 30, 2022 | | Six Months Ended June 30, 2021 |
| Lawson | | Other Acquisitions | | Total | | Lawson | | Other Acquisitions | | Total |
Revenue | $ | 123,670 | | | $ | 75,522 | | | $ | 199,192 | | | $ | — | | | $ | 468 | | | $ | 468 | |
Net Income | $ | 3,084 | | | $ | 8,285 | | | $ | 11,369 | | | $ | — | | | $ | (335) | | | $ | (335) | |
| | | | | | | | | | | |
| | | | | | | | | | | |
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 or not 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 goods 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 goods (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 pre-determined 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 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.
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 are 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 goods 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.
TestEquity Segment
TestEquity’s contracts with customers generally represent a single performance obligation to sell its products. Revenues 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 good 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. Contractual rebate obligations were $0.1 million at June 30, 2022, and are expected to be paid or expire in their entirety during fiscal year ended December 31, 2022.
TestEquity generates revenue from contracts with customers through the sale of new and used electronic test and measurement products. Typically, TestEquity has a purchase order or master service agreement with the customer that specifies the goods and/or services to be provided. TestEquity generally invoices customers as goods are shipped. Fees are typically due and payable 30 days after date of shipment. Generally, customers gain control of the goods 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.
The Company has elected not to disclose the disaggregated components of revenue and cost of sales in its Unaudited Condensed Consolidated Statements of Operations and Comprehensive (Loss) Income and in the related notes to the condensed consolidated financial statements.
Disaggregated 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) | 2022 | | 2021 | | 2022 | | 2021 |
| | | | | | | |
United States | $ | 261,071 | | | $ | 120,020 | | | $ | 386,327 | | | $ | 233,420 | |
Canada | 36,372 | | | 4,145 | | | 46,169 | | | 7,789 | |
Europe | 9,889 | | | 2,517 | | | 17,971 | | | 3,517 | |
Pacific Rim | 5,585 | | | 3,367 | | | 10,624 | | | 6,435 | |
Latin America | 6,949 | | | 2,621 | | | 11,794 | | | 4,821 | |
Other | 1,470 | | | 1,482 | | | 2,536 | | | 2,997 | |
Total revenue | $ | 321,336 | | | $ | 134,152 | | | $ | 475,421 | | | $ | 258,979 | |
Rental Revenues
TestEquity rents new and used electronic test and measurement equipment, to customers in many industries. These leases are classified as operating leases. Rental equipment is included in Rental equipment, net in the Unaudited Condensed Consolidated Balance Sheet, and rental revenues is included in Revenue in the Unaudited Condensed Consolidated Statements of Operations and Comprehensive (Loss) Income. Rental revenues are recognized in the month they are due on the accrual basis of accounting. The unearned portion of rental payments received is accrued as deferred revenue. The TestEquity rental program generated $3.2 million and $2.6 million of revenue for the three months ended June 30, 2022 and 2021, respectively and $6.8 million and $5.4 million of revenue for the six months ended June 30, 2022 and 2021, respectively. The unearned rental revenue related to customer prepayments on equipment leases of $0.4 million at June 30, 2022 and $0.5 million at December 31, 2021, which is included in Accrued expenses and other current liabilities in the Unaudited Condensed Consolidated Balance Sheet, 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. 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. The Torrents machine leasing program generated $1.1
million of revenue for the three months ended June 30, 2022 and $1.1 million of revenue for the six months ended June 30, 2022. The unearned rent revenue of $0.7 million at June 30, 2022 is included as a component of Accrued expenses and other current liabilities in the Unaudited Condensed Consolidated Balance Sheet, is expected to be earned in its entirety during the next twelve months.
Note 5 — Inventories
Inventories, net, consisting of purchased goods and manufactured electronic equipment offered for resale, were as follows:
| | | | | | | | | | | |
| |
(in thousands) | June 30, 2022 | | December 31, 2021 |
Inventories, gross | $ | 259,900 | | | $ | 140,544 | |
Reserve for obsolete and excess inventory | (9,204) | | | (7,827) | |
Inventories, net | $ | 250,696 | | | $ | 132,717 | |
Changes in the reserve for obsolete and excess inventory were as follows:
| | | | | | | | |
(in thousands) | | Amount |
Balance at December 31, 2021 | | $ | (7,827) | |
Additions charged to expense | | (1,694) | |
| | |
Write-offs | | 317 | |
Balance at June 30, 2022 | | $ | (9,204) | |
Note 6 - Property, Plant and Equipment
Components of property, plant and equipment were as follows:
| | | | | | | | | | | |
| |
(in thousands) | June 30, 2022 | | December 31, 2021 |
Land | $ | 9,980 | | | $ | 1,700 | |
Buildings and improvements | 27,254 | | | 2,930 | |
Machinery and equipment | 20,920 | | | 4,389 | |
Capitalized software | 7,529 | | | 3,407 | |
Furniture and fixtures | 7,336 | | | 2,700 | |
Vehicles | 1,465 | | | 798 | |
Construction in progress | 5,531 | | | 12 | |
Total | 80,015 | | | 15,936 | |
Accumulated depreciation and amortization | (15,057) | | | (6,857) | |
Property, plant and equipment, net | $ | 64,958 | | | $ | 9,079 | |
Depreciation expense for property, plant, and equipment was $2.5 million and $0.3 million for the second quarter of 2022 and 2021, respectively and $3.1 million and $0.5 million for the first six months of 2022 and 2021, respectively. Amortization expense for capitalized software was $0.9 million and $0.2 million for the second quarter of 2022 and 2021, respectively and $1.1 million and $0.4 million for the first six months of 2022 and 2021, respectively.
Note 7 - Rental Equipment
Rental equipment, net consisted of the following:
| | | | | | | | | | | |
| |
(in thousands) | June 30, 2022 | | December 31, 2021 |
Rental equipment | $ | 47,863 | | | $ | 46,500 | |
Accumulated depreciation | (21,755) | | | (21,773) | |
Rental equipment, net | $ | 26,108 | | | $ | 24,727 | |
Depreciation expense included in cost of sales for rental equipment was $1.5 million and $1.5 million for the second quarter of 2022 and 2021, respectively and $2.9 million and $3.0 million for the first six months of 2022 and 2021, respectively. Refer to Note 4 - Revenue Recognition for a discussion on the Company's activities as lessor.
Note 8 - 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, 2021 | | $ | — | | | $ | 70,112 | | | $ | 36,033 | | | $ | — | | | $ | 106,145 | |
Acquisitions | | 172,333 | | | 43,207 | | | 16,912 | | | 17,133 | | | 249,585 | |
Impact of foreign exchange rates | | — | | | — | | | — | | | (290) | | | (290) | |
Balance at June 30, 2022 | | $ | 172,333 | | | $ | 113,319 | | | $ | 52,945 | | | $ | 16,843 | | | $ | 355,440 | |
| | | | | | | | | | |
Note 9 - Intangible Assets
The gross carrying amount and accumulated amortization for definite-lived intangible assets were as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| |
| June 30, 2022 | | December 31, 2021 |
(in thousands) | Gross Carrying Amount | | Accumulated Amortization | | Net Carrying Value | | Gross Carrying Amount | | Accumulated Amortization | | Net Carrying Value |
Trade names | $ | 93,355 | | | $ | (12,389) | | | $ | 80,966 | | | $ | 36,304 | | | $ | (8,353) | | | $ | 27,951 | |
Customer relationships | 197,362 | | | (40,524) | | | 156,838 | | | 92,947 | | | (29,269) | | | 63,678 | |
Other (1) | 8,753 | | | (3,631) | | | 5,122 | | | 8,159 | | | (3,180) | | | 4,979 | |
Total | $ | 299,470 | | | $ | (56,544) | | | $ | 242,926 | | | $ | 137,410 | | | $ | (40,802) | | | $ | 96,608 | |
(1) Other primarily consists of non-compete agreements.
Amortization expense for definite-lived intangible assets was $9.7 million and $15.1 million for the three and six months ended June 30, 2022, respectively and $2.5 million and $5.0 million for the three and six months ended June 30, 2021, respectively. Amortization expense related to intangible assets was recorded in General and administrative expenses. The remaining weighted-average useful lives of intangible assets as of June 30, 2022 was 7.0 years for trade names and 14.3 years for customer relationships.
The estimated aggregate amortization expense for the remaining year 2022 and each of the next five years are as follows:
| | | | | | | | |
(in thousands) | | Amortization |
Remaining 2022 | | $ | 17,074 | |
2023 | | 32,994 | |
2024 | | 33,335 | |
2025 | | 30,549 | |
2026 | | 28,134 | |
2027 | | 24,044 | |
Thereafter | | 76,796 | |
Total | | $ | 242,926 | |
Note 10 - 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, 2022 and 2021 were as follows (in thousands):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | |
| | | | Three Months Ended June 30, | | Six Months Ended June 30, |
Lease Type | | Classification | | 2022 | | 2021 | | 2022 | | 2021 |
| | | | | | | | | | |
Operating Lease Expense (1) | | Operating expenses | | $ | 3,896 | | | $ | 1,475 | | | $ | 5,524 | | | $ | 2,868 | |
Financing Lease Amortization | | Operating expenses | | 163 | | | 56 | | | 232 | | | 103 | |
Financing Lease Interest | | Interest expense | | 23 | | | 13 | | | 34 | | | 26 | |
Financing Lease Expense | | | | 186 | | | 69 | | | 266 | | | 129 | |
Net Lease Cost | | | | $ | 4,082 | | | $ | 1,544 | | | $ | 5,790 | | | $ | 2,997 | |
(1) Includes short term lease expense, which is immaterial
The value of net assets and liabilities generated by leasing activity of June 30, 2022 and December 31, 2021 were as follows (in thousands):
| | | | | | | | | | | | | | |
Lease Type | | June 30, 2022 | | December 31, 2021 |
| | | | |
Total ROU operating lease assets (1) | | $ | 45,667 | | | $ | 19,662 | |
Total ROU financing lease assets (2) | | 1,388 | | | — | |
Total lease assets | | $ | 47,055 | | | $ | 19,662 | |
| | | | |
Total current operating lease obligation | | $ | 10,030 | | | $ | 4,641 | |
Total current financing lease obligation | | 457 | | | — | |
Total current lease obligations | | $ | 10,487 | | | $ | 4,641 | |
| | | | |
Total long term operating lease obligation | | $ | 37,886 | | | $ | 16,132 | |
Total long term financing lease obligation | | 766 | | | — | |
Total long term lease obligation | | $ | 38,652 | | | $ | 16,132 | |
(1)Operating lease assets are recorded net of accumulated amortization of $6.4 million as of June 30, 2022 and $2.8 million as of December 31, 2021
(2)Financing lease assets are recorded net of accumulated amortization of $0.1 million as of June 30, 2022 and $0.0 million as of December 31, 2021
The value of lease liabilities generated by leasing activities as of June 30, 2022 were as follows (in thousands):
| | | | | | | | | | | | | | | | | | | | |
Maturity Date of Lease Liabilities | | Operating Leases | | Financing Leases | | Total |
| | | | | | |
Year one | | $ | 8,743 | | | $ | 527 | | | $ | 9,270 | |
Year two | | 10,646 | | | 811 | | | 11,457 | |
Year three | | 8,603 | | | 488 | | | 9,091 | |
Year four | | 6,088 | | | 312 | | | 6,400 | |
Year five | | 5,071 | | | 240 | | | 5,311 | |
Subsequent years | | 14,602 | | | 102 | | | 14,704 | |
Total lease payments | | 53,753 | | | 2,480 | | | 56,233 | |
Less: Interest | | (6,485) | | | (609) | | | (7,094) | |
Present value of lease liabilities | | $ | 47,268 | | | $ | 1,871 | | | $ | 49,139 | |
The weighted average lease terms and interest rates of leases held as of June 30, 2022 were as follows:
| | | | | | | | | | | | | | |
Lease Type | | Weighted Average Term in Years | | Weighted Average Interest Rate |
| | | | |
Operating Leases | | 6.2 | | 7.0% |
Financing Leases | | 3.9 | | 6.4% |
The cash outflows of leasing activity for the six months ended June 30, 2022 were as follows (in thousands):
| | | | | | | | | | | | | | |
Cash Flow Source | | Classification | | Amount |
| | | | |
Operating cash flows from operating leases | | Operating activities | | $ | 5,182 | |
Operating cash flows from financing leases | | Operating activities | | 3 | |
Financing cash flows from financing leases | | Financing activities | | 39 | |
Refer to Note 4 - Revenue Recognition for a discussion on the Company's activities as lessor.
Note 11 - Earnout Derivative Liability
On the Merger Date, the Company recorded an earnout derivative liability for the two earnout provisions within the Merger Agreements. The Company estimated the fair value of the earnout derivative liability based on an aggregate of 1,162,000 additional shares expected to be issued under the two earnout provisions of the Merger Agreements. The aggregate of 1,162,000 shares is comprised of 700,000 shares of DSG common stock that are contingently issuable (or forfeitable) to the TestEquity Equityholder and 462,000 shares of DSG common stock that are contingently issuable (or forfeitable) to the Gexpro Services Stockholder. The additional 538,000 shares of the remaining potential shares of the earnout were not recorded as an earnout derivative liability as the acquisition contingency for these shares was met at the Merger Date.
The Company's earnout derivative liability is classified as a Level 3 instrument and is measured at fair value on a recurring basis. The fair value of the earnout derivative liability was measured using the Monte Carlo simulation valuation model using a distribution of potential outcomes on a monthly basis for the year ended December 31, 2022. Inputs to that model include the expected time to liquidity, the risk-free interest rate over the term, expected volatility based on representative peer companies and the estimated fair value of the underlying class of common stock. The significant unobservable inputs used in the fair value measurement of the earnout derivative liability are the fair value of the underlying stock at the valuation date and the estimated term of the earnout arrangement periods. Generally, increases (decreases) in the fair value of the underlying stock and estimated term would result in a directionally similar impact to the fair value measurement.
The estimated aggregate fair value of the earnout derivative liability recorded on the Merger Date was $43.9 million, with an offsetting entry to additional paid-in capital. As of April 29, 2022, 700,000 of the 1,162,000 shares were reclassified to equity, as the acquisition contingencies had been met. Immediately prior to reclassification, these shares were remeasured to fair value, resulting in a loss of $5.7 million being recorded as a component of Change in fair value of earnout derivative liability in the Unaudited Consolidated Statements of Income and Comprehensive Income.” The earnout opportunity for the remaining 462,000 shares for Gexpro Services expires on December 31, 2022. See Fair Value Measurements in Note 2 - Summary of Significant Accounting Policies for further information.
The change in the fair value of the earnout derivative liability was as follows:
| | | | | | | | |
(in thousands) | | Amount |
Balance at December 31, 2021 | | $ | — | |
Initial recognition on Merger Date | | 43,900 | |
Change in fair value | | 5,693 | |
Reclassifications to equity at fair value | | (26,593) | |
Balance at June 30, 2022 | | $ | 23,000 | |
Note 12 - Accrued Expenses and Other Current Liabilities
Accrued expenses and other current liabilities consisted of the following:
| | | | | | | | | | | |
(in thousand) | June 30, 2022 | | December 31, 2021 |
Accrued stock-based compensation | $ | 10,995 | | | $ | — | |
Accrued compensation | 16,257 | | | 5,997 | |
Accrued and withheld taxes, other than income taxes | 6,063 | | | 880 | |
Accrued income taxes | 2,062 | | | 4,170 | |
Accrued customer rebates | 3,205 | | | 2,657 | |
Accrued severance | 649 | | | — | |
Accrued interest | 1,130 | | | 1,515 | |
Deferred revenue | 1,140 | | | 485 | |
Accrued health benefits | 1,285 | | | 59 | |
Other | 15,524 | | | 7,363 | |
Total accrued expenses and other current liabilities | $ | 58,310 | | | $ | 23,126 | |
Note 13 - Debt
The Company's outstanding long-term debt was comprised of the following:
| | | | | | | | | | | | |
| | |
(in thousands) | June 30, 2022 | | December 31, 2021 | |
Senior secured revolving credit facility | $ | 113,079 | | | $ | — | | |
Senior secured term loan | 246,875 | | | — | | |
Senior secured delayed draw term loan | 50,000 | | | — | | |
Other revolving line of credit | 1,495 | | | — | | |
Previous revolving credit facilities | — | | | 38,707 | | |
Previous term loans | — | | | 190,337 | | |
Total debt | 411,449 | | | 229,044 | | |
Less current portion of long-term debt | (16,495) | | | (134,405) | | |
Less deferred financing costs | (5,675) | | | (1,505) | | |
Total long-term debt | $ | 389,279 | | | $ | 93,134 | | |
Amended and Restated Credit Agreement - April 1, 2022
On April 1, 2022 (the "Closing Date"), DSG and certain of its subsidiaries entered into an Amended and Restated Credit Agreement (the “Amended and Restated Credit Agreement”) by and among DSG, certain subsidiaries of DSG as borrowers or guarantors, the lenders party thereto and JPMorgan Chase Bank, N.A., as administrative agent. Pursuant to the Amended and Restated Credit Agreement, the Company's previous credit agreement was amended and restated in its entirety.
The Amended and Restated Credit Agreement provides for (i) a $200 million senior secured revolving credit facility, with a $25 million letter of credit sub-facility and a $10 million swingline loan sub-facility, (ii) a $250 million senior secured initial term loan facility and (iii) a $50 million senior secured delayed draw term loan facility. In addition, the Amended and Restated Credit Agreement permits the Company to increase the commitments under the Amended and Restated Credit Agreement from time to time by up to $200 million in the aggregate, subject to, among other things, the receipt of additional commitments from existing and/or new lenders and pro forma compliance with the financial covenants in the Amended and Restated Credit Agreement. The revolving credit facility is available to be drawn in U.S. dollars, Canadian dollars and any other additional currencies that may be agreed.
On the Closing Date, the Company borrowed $250 million of initial term loan facility loans and approximately $86 million of revolving credit facility loans under the Amended and Restated Credit Agreement. These borrowings were used to 1) repay all obligations and refinance the Company's previous credit agreement, 2) repay certain existing indebtedness of TestEquity and Gexpro Services and their respective subsidiaries, 3) pay fees and expenses in connection with the Mergers, and 4) finance the working capital needs and general corporate purposes of the Company.
A $2.8 million loss on the extinguishment of debt for remaining unamortized deferred financing costs associated with the previous indebtedness was recorded in the second quarter of 2022 in connection with the payoff. The extinguishment is recorded in Loss on extinguishment of debt in the Unaudited Condensed Consolidated Statements of Operations and Comprehensive (Loss) Income.
The Amended and Restated Credit Agreement requires that the proceeds of any revolving credit facility loans be used for working capital and general corporate purposes (including, without limitation, permitted acquisitions), and requires that the proceeds of any delayed draw term loan facility be used solely to finance the payment of consideration for (i) the potential acquisition by TestEquity of a certain business that had been previously identified to DSG as a potential acquisition candidate by TestEquity prior to the date of the TestEquity Merger Agreement and (ii) other acquisitions permitted under the Amended and Restated Credit Agreement, and for any fees, costs and expenses incurred in connection therewith. On April 29, 2022, the Company borrowed the $50 million available under the delayed draw term loan facility to finance the acquisition of Interworld Highway, LLC made by TestEquity.
As of June 30, 2022, there were $247 million of term loan facility loans outstanding, $50 million of delayed draw term loans outstanding and approximately $113 million of revolving credit facility loans outstanding under the Amended and Restated Credit Agreement. Net of outstanding letters of credit, there was $85.9 million of borrowing availability under the revolving credit facility as of June 30, 2022. The weighted average interest rate from the Closing Date through June 30, 2022 was 3.61%.
The loans under the Amended and Restated Credit Agreement bear interest, at the Company’s option, at a rate equal to (i) the Alternate Base Rate or the Canadian Prime Rate (each as defined in the Amended and Restated Credit Agreement), plus, in each case, an additional margin ranging from 0.0% to 1.75% per annum, depending on the total net leverage ratio of the Company and its restricted subsidiaries as of the most recent determination date under the Amended and Restated Credit Agreement or (ii) the Adjusted Term SOFR Rate or the CDOR Rate (each as defined in the Amended and Restated Credit Agreement), plus, in each case, an additional margin ranging from 1.0% to 2.75% per annum, depending on the total net leverage ratio of the Company and its restricted subsidiaries as of the most recent determination date under the Amended and Restated Credit Agreement. The Amended and Restated Credit Agreement further provides that the additional margin for the period from the Closing Date until the Company’s delivery of its financial statements and compliance certificate for the first full quarter ending after the Closing Date shall be 1.5% per annum for Alternate Base Rate or Canadian Prime Rate loans and 2.5% per annum for all other loans.
Certain closing fees, arrangement fees, administration fees, commitment fees and letter of credit fees are payable to the lenders and the agents under the Amended and Restated Credit Agreement, including a commitment fee on the daily unused amount of the revolving credit facility that will accrue at a rate ranging from 0.15% to 0.35% per annum, depending on the total net leverage ratio of the Company and its restricted subsidiaries as of the most recent determination date under the Amended and Restated Credit Agreement. The Amended and Restated Credit Agreement further provides that such commitment fee for the period from the Closing Date until Lawson’s delivery of its financial statements and compliance certificate for the first full quarter ending after the Closing Date shall accrue at a rate of 0.3% per annum.
In addition, the Amended and Restated Credit Agreement provides that the delayed draw term loan facility shall accrue a ticking fee at a rate ranging from 0.15% to 0.35% per annum, depending on the total net leverage ratio of the Company and its restricted subsidiaries as of the most recent determination date under the Amended and Restated Credit Agreement, and that such ticking fee shall be payable during the period from the Closing Date to the date on which the lenders’ delayed draw term loan facility commitments terminate. The Amended and Restated Credit Agreement further provides that the ticking fee for the period from the Closing Date until the Company’s delivery of its financial statements and compliance certificate for the first full quarter after the Closing Date shall accrue at a rate of 0.3% per annum. The fees outlined above are reported as interest expense and vary depending on the total net leverage ratio as defined in the Amended and Restated Credit Agreement. Fees from the Closing Date through June 30, 2022 were $0.1 million.
In connection with the Amended and Restated Credit Agreement, deferred financing costs of $4.0 million were incurred. Deferred financing costs are amortized over the life of the debt instrument and reported as interest expense. As of June 30, 2022, deferred financing costs net of accumulated amortization were $9.2 million of which $5.7 million are included in Long-term debt, less current portion, net (related to the senior secured term loan and senior secured delayed draw term loan) and $3.5 million are included in Other assets (related to the senior secured revolving credit facility) in the Unaudited Condensed Consolidated Balance Sheets.
Each of the loans under the Amended and Restated Credit Agreement mature on April 1, 2027, at which time all outstanding loans, together with all accrued and unpaid interest, must be repaid and the revolving credit facility commitments will terminate. The Company is required to repay principal on the term loans each quarter in the following amounts (subject to potential adjustment): (i) $3,125,000, in the case of the initial term loan facility, and (ii) an amount equal to 1.25% of the funded delayed draw term loan facility, in the case of the delayed draw term loan facility. The Company is also required to prepay the term loans with the net cash proceeds from any disposition of certain assets (subject to reinvestment rights) or from the incurrence of any unpermitted debt. The Company may borrow, repay and reborrow the revolving loans until April 1, 2027, prepay any of the term loans, and terminate any of the commitments, in whole or in part, at any time without premium or penalty, subject to certain conditions and the reimbursement of certain lender costs in the case of prepayments of certain types of loans.
Subject to certain exceptions as set forth in the Amended and Restated Credit Agreement, the obligations of the Company and its U.S. subsidiaries under the Amended and Restated Credit Agreement are guaranteed by the Company and certain of the Company’s U.S. subsidiaries and the obligations of each of the Company’s Canadian subsidiaries under the Amended and Restated Credit Agreement are guaranteed by the Company and certain of its U.S. and Canadian subsidiaries.
Subject to certain exceptions as set forth in the Amended and Restated Credit Agreement, the obligations under the Amended and Restated Credit Agreement are secured by a first priority security interest in and lien on substantially all assets of the Company, each other borrower and each guarantor.
The Amended and Restated Credit Agreement contains various affirmative covenants, including financial maintenance covenants requiring the Company to maintain compliance with a consolidated minimum interest coverage ratio and a maximum total net leverage ratio, each determined in accordance with the terms of the Amended and Restated Credit Agreement.
The Company was in compliance with all financial covenants as of June 30, 2022.
The Amended and Restated Credit Agreement contains various events of default (subject to exceptions, thresholds and grace periods as set forth in the Amended and Restated Credit Agreement). Under certain circumstances, a default interest rate will apply on all obligations at a rate equal to 2.0% per annum above the applicable interest rate.
Previous Credit Agreements
Gexpro Services - January 3, 2022 Gexpro Services Credit Agreement
On January 3, 2022, prior to the Gexpro Services Merger, Gexpro Services entered into a credit agreement ("2022 Gexpro Services Credit Agreement") with a financial institution under which Gexpro Services obtained an initial $137 million term loan ("2022 Gexpro Services Term Loan"), a $25 million revolving line of credit ("2022 Gexpro Services Revolver") and a delayed $83 million term loan ("2022 Gexpro Services Delayed Term Loan"), together the "2022 Gexpro Services Facilities". The proceeds of the 2022 Gexpro Services Term Loan and 2022 Gexpro Services Delayed Term Loan were used to fund the Resolux acquisition, repay all borrowings under the 2020 Gexpro Services Credit Agreement (as defined below) and seller’s promissory note from SIS acquisition (refer to Note 3 - Business Acquisitions for further details of these acquisitions). In connection with the 2022 Gexpro Services Credit Agreement, deferred financing costs of $7.4 million were incurred.
Gexpro Services - February 24, 2020 Gexpro Services Term Loan Credit Agreement
On February 24, 2020, Gexpro Services entered into a credit agreement ("2020 Gexpro Services Term Loan Credit Agreement") with a financial institution under which Gexpro Services obtained a $60 million term loan ("2020 Gexpro Services Term Loan"). Also on February 24, 2020, Gexpro Services entered into a credit agreement ("2020 Gexpro Services Revolver Credit Agreement" and together with the 2020 Gexpro Services Term Loan Credit Agreement, "2020 Gexpro Services Credit Agreements") with a financial institution under which Gexpro Services obtained a $15 million revolving line of credit ("2020 Gexpro Services Revolver"). Availability of the 2020 Gexpro Services Revolver was reduced by issued and outstanding letters of credit, which were limited to $38.5 million. There were $0.7 million outstanding letters of credit as of December 31, 2021 and $37.7 million outstanding on the 2020 Gexpro Services Revolver. A loss on debt extinguishment of $0.6 million was recorded on January 3, 2022 in connection with the January 3, 2022 Gexpro Services Credit Agreements.
TestEquity - 2017 TestEquity Credit Agreement
On April 28, 2017, TestEquity entered into a credit agreement ("2017 TestEquity Credit Agreement") with a financial institution under which TestEquity obtained a $101 million term loan ("2017 TestEquity Term Loan") and a $15.0 million
revolving line of credit ("2017 TestEquity Revolver"). Availability of the 2017 TestEquity Revolver was reduced by issued and outstanding letters of credit, which were limited to $2.0 million. There were $0.0 million outstanding letters of credit as of December 31, 2021 and $1.0 million outstanding on the revolving line of credit. A loss on debt extinguishment of $0.2 million was recorded on April 1, 2022 in connection with the April 1, 2022 Amended and Restated Credit Agreement executed in connection with the consummation of the Mergers.
Note 14 - Stock-Based Compensation
The Company recorded stock-based compensation expense of $4.0 million and $4.0 million for the three and six months ended June 30, 2022, respectively. A portion of stock-based compensation related to the change in the market value of the Company's common stock. A stock-based compensation liability of $11.0 million as of June 30, 2022 and $0.0 million as of December 31, 2021 was included in Accrued expenses and other current liabilities in the Unaudited Condensed Consolidated Balance Sheets.
Equity Compensation Plans
The Company's Amended and Restated 2009 Equity Compensation Plan (“Equity Plan”) provides for the grant of nonqualified and incentive stock options, stock awards and stock units to officers and employees of the Company. The Equity Plan also provides for the grant of option rights and restricted stock to non-employee directors. As of June 30, 2022, the Company had approximately 164,000 shares of common stock still available under the Equity Plan. Non-employee directors are limited to grants of no more than 20,000 shares of common stock in any calendar year and other than non-employee directors are limited to grants of no more than 125,000 shares of common stock in any calendar year. The Equity Plan is administered by the Compensation Committee of the Board of Directors, or its designee, which as administrator of the plan, has the authority to select plan participants, grant awards, and determine the terms and conditions of the awards.
The Company also has a Stock Performance Rights Plan (“SPR Plan”) that provides for the issuance of Stock Performance Rights (“SPRs”) that allow non-employee directors, officers and key employees to receive cash awards, subject to certain restrictions, equal to the appreciation of the Company's common stock. The SPR Plan is administered by the Compensation Committee of the Board of Directors.
Stock Performance Rights
SPRs entitle the recipient to receive a cash payment equal to the excess of the market value of the Company's common stock over the SPR exercise price when the SPRs are surrendered. Expense, equal to the fair market value of the SPR at the date of grant and remeasured each reporting period, is recorded ratably over the vesting period. Compensation expense is included in Selling, general and administrative expense in the Condensed Consolidated Statements of Operations and Comprehensive (Loss) Income. The outstanding SPRs were granted with approximately a seven year life and vest over one to three years beginning on the first anniversary of the date of the grant. The SPRs are liability classified and included in Accrued expenses and other current liabilities in the Unaudited Condensed Consolidated Balance Sheets.
Restricted Stock Awards
Restricted stock awards ("RSAs") generally vest over a one to three years period beginning on the first anniversary of the date of the grant. Upon vesting, the vested restricted stock awards are exchanged for an equal number of the Company’s common stock. The participants have no voting or dividend rights with the restricted stock awards. The restricted stock awards are valued at the closing price of the common stock on the date of grant and the expense is recorded ratably over the vesting period.
Market Stock Units
Market Stock Units ("MSUs") are exchangeable for between 0% to 150% of the Company's common shares at the end of the vesting period based on the trailing 60 day average closing price of the Company's common stock. The value of the MSUs is determined using a geometric brownian motion model that, based on certain variables, generates a large number of random trials simulating the price of the common stock over the measurement period.
Stock Options
In April 2022, the Company issued 242,000 stock options to key employees that vest through the fifth anniversary from the grant date. The fair value was determined using a Black-Scholes valuation model with a grant date fair value of $2.2 million. Each stock option can be exchanged for one share of the Company’s common stock at the stated exercise price. Upon vesting, stock options are recognized as a component of equity. Unrecognized compensation related to stock options as of June 30, 2022 was $2.1 million.
Performance Awards
Performance Awards ("PAs") are exchangeable for between 0% to 150% of the Company's common shares, or the equivalent amount in cash, based upon the achievement of certain financial performance metrics at the end of the vesting period. The PAs are liability classified and included in Accrued expenses and other current liabilities in the Unaudited Condensed Consolidated Balance Sheets.
Except for the stock options above, no additional stock-based awards were issued during the six months ended June 30, 2022.
Note 15 - Earnings Per Share
As a result of the Mergers discussed in Note 1 - Nature of Operations and Basis of Presentation, all historical per share data and number of shares and numbers of equity awards were retroactively adjusted. The following table provides the computation of basic and diluted earnings per share:
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended June 30, | | Six Months Ended June 30, |
(in thousands, except share and per share data) | 2022 | | 2021 | | 2022 | | 2021 |
| | | | | | | |
Basic income per share: | | | | | | | |
Net (loss) income | $ | (4,715) | | | $ | 461 | | | $ | (7,252) | | | $ | (1,429) | |
Basic weighted average shares outstanding | 20,343,028 | | | 10,251,827 | | | 15,347,943 | | | 10,246,383 | |
Basic (loss) income per share of common stock | $ | (0.23) | | | $ | 0.04 | | | $ | (0.47) | | | $ | (0.14) | |
| | | | | | | |
Diluted income per share: | | | | | | | |
Net (loss) income | $ | (4,715) | | | $ | 461 | | | $ | (7,252) | | | $ | (1,429) | |
Basic weighted average shares outstanding | 20,343,028 | | | 10,251,827 | | | 15,347,943 | | | 10,246,383 | |
Effect of dilutive securities | — | | | 306 | | | — | | | — | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
Diluted weighted average shares outstanding | 20,343,028 | | | 10,558,275 | | | 15,347,943 | | | 10,246,383 | |
Diluted (loss) income per share of common stock | $ | (0.23) | | | $ | 0.04 | | | $ | (0.47) | | | $ | (0.14) | |
Anti-dilutive securities excluded from the calculation of diluted income per share | 464,068 | | | — | | | 359,358 | | | 304,178 | |
Note 16 - Income Taxes
The Company recorded income tax benefit of $3.6 million, a 43.4% effective tax rate for the three months ended June 30, 2022. Income tax expense of $0.6 million, a 54.8% effective tax rate was recorded for the three months ended June 30, 2021. The effective tax rate for the three months ended June 30, 2022 was higher than the U.S. statutory rate primarily due to state taxes, foreign operations, as well as transaction costs and other permanent items.
The Company recorded income tax benefit of $4.6 million, a 38.6% effective tax rate for the six months ended June 30, 2022. Income tax expense of $0.4 million, a 37.5% effective tax rate, was recorded for the six months ended June 30, 2021. The change in the year over year effective tax rate was primarily due to the changes in the valuation allowance in the six months ended June 30, 2021, merger costs incurred in the six months ended June 30, 2022, and the creation of a consolidated group for federal income tax purposes as a result of the completion of the Mergers referenced in Note 3 - Business Acquisitions. Relative to the U.S. statutory rate, the effective tax rate for the six months ended June 30, 2022 was impacted by state taxes, foreign operations, and the expiration of uncertain tax positions, as well as liabilities and transaction expenses related to the Mergers, and discrete tax items related to changes in the uncertain tax positions and prior period true-ups as a result of the completed Mergers.
The Company and its subsidiaries are subject to U.S. federal income tax, as well as income tax of multiple state and foreign jurisdictions. As of June 30, 2022, the Company is subject to U.S. federal income tax examinations for the years 2018 through 2020 and income tax examinations from various other jurisdictions for the years 2015 through 2021.
Earnings from the Company’s foreign subsidiaries are considered to be indefinitely reinvested. A distribution of these non-U.S. earnings in the form of dividends or otherwise may subject the Company to foreign withholding taxes and U.S. federal and state taxes.
Note 17 - Commitments and Contingencies
Shareholder lawsuits
Between January 25, 2022 and March 7, 2022, seven lawsuits were filed in federal district courts against DSG, the members of the DSG board of directors and, in some cases, the TestEquity Equityholder, TestEquity, Merger Sub 1, the Gexpro Services Stockholder, Gexpro Services and Merger Sub 2 in connection with the Mergers. Between February 24, 2022 and April 28, 2022, all of these lawsuits were voluntarily dismissed by the respective plaintiffs. The plaintiffs in these lawsuits have made a demand to DSG for payment of attorneys’ fees and expenses in connection with these lawsuits.
In addition, on each of February 2, 2022, February 14, 2022 and February 15, 2022, purported DSG stockholders made demands pursuant to Section 220 of the Delaware General Corporation Law to inspect certain books and records of DSG (collectively, the “Books and Records Demands”). One stated purpose of the Books and Records Demands is to investigate questions of director disinterestedness and independence and the alleged possibility of wrongdoing, mismanagement and/or material non-disclosure related to the Special Committee’s and the DSG board of directors’ approval of the Mergers. In addition, on March 16, 2022, one of the purported DSG stockholders who previously made a Books and Records Demand filed a lawsuit entitled Robert Garfield v. Lawson Products, Inc., Case No. 2022-0252, in the Court of Chancery of the State of Delaware against DSG (the “Garfield Action”). On March 22, 2022, another of the purported DSG stockholders who previously made a Books and Records Demand filed a lawsuit entitled Jeffrey Edelman v. Lawson Products, Inc., Case No. 2022-0270, in the Court of Chancery of the State of Delaware against DSG (the “Edelman Action”). The Garfield Action and the Edelman Action are collectively referred to as the “Books and Records Actions.” The Books and Records Actions seek to compel inspection of certain books and records of DSG to investigate questions of director disinterestedness and independence and the alleged possibility of wrongdoing, mismanagement and/or material non-disclosure related to the Special Committee’s and the DSG board of directors’ approval of the Mergers. Pursuant to a stipulation approved by the Delaware Court of Chancery on March 24, 2022, the Books and Records Actions were held in abeyance until May 23, 2022. Following the parties’ inability to reach a resolution of the Books and Records Actions, the Delaware Court of Chancery scheduled briefing followed by a trial on July 14, 2022 to adjudicate the Books and Records Actions. At the conclusion of the trial, the Court ruled orally that the stockholders’ demands would be granted only in one respect (production of documents sufficient to show the identities of any guarantors of debt of the acquired companies) and the Court denied the remainder of the stockholders’ requests. The Court’s ruling was memorialized in an order issued on July 20, 2022. DSG and the members of its board of directors disagree with and intend to vigorously defend against the Books and Records Actions and any other claim, if asserted, arising from the Books and Records Demands.
Due to the inherent uncertainties of these matters, DSG is not able to predict either the outcome of these matters on its business, financial condition and results of operations, or a range of reasonably possible losses, if any, at this time. Accordingly, no amounts have been recorded in the condensed consolidated financial statements for these matters.
Environmental matter
In 2012, it was determined a Company owned site in Decatur, Alabama, contained hazardous substances in the soil and groundwater as a result of historical operations prior to the Company's ownership. The Company retained an environmental consulting firm to further investigate the contamination, prepare a remediation plan, and enroll the site in the Alabama Department of Environmental Management (“ADEM”) voluntary cleanup program.
A remediation plan was approved by ADEM in 2018. The plan consists of chemical injections throughout the affected area, as well as subsequent monitoring of the area. The injection process was completed in the first quarter of 2019 and the environmental consulting firm is monitoring the affected area. At June 30, 2022 the Company had less than $0.1 million accrued for potential monitoring costs. The costs for future monitoring are not significant and have been fully accrued. The Company does not expect to capitalize any amounts related to the remediation plan.
Note 18 - Related Party Transactions
Management Services Agreements
Prior to the Mergers, a subsidiary of TestEquity was party to a management agreement with Luther King Capital Management Corporation (“LKCM”) for certain advisory and consulting services (the “TestEquity Management Agreement”), and a subsidiary of Gexpro Services was party to a management agreement with LKCM for certain advisory and consulting services (the “Gexpro Services Management Agreement”). In connection with the closing of the Mergers on April 1, 2022, (i) all of the TestEquity subsidiary’s rights, liabilities and obligations under the TestEquity Management Agreement were novated to, transferred to and assumed by the TestEquity Equityholder, and LKCM released the TestEquity subsidiary from all obligations and claims under the TestEquity Management Agreement, and (ii) all of the Gexpro Services subsidiary’s rights, liabilities and obligations under the Gexpro Services Management Agreement were novated to, transferred to and assumed by the Gexpro Services Stockholder, and LKCM released the Gexpro Services subsidiary from all obligations and claims under the Gexpro Services Management Agreement (collectively, the “Novations”). During the first six months of 2022, expense of $0.5 million was recorded within Selling, general and administrative expenses within the Unaudited Condensed Consolidated Statements of Income and Comprehensive (Loss) Income, reflecting expenses accrued under these management agreements from January 1, 2022 through the April 1, 2022 Merger Date. As of December 31, 2021, $4.8 million was included in Accrued expenses and other current liabilities in the Unaudited Condensed Consolidated Balance Sheets in connection with these management agreements. During the first three months of 2022, expense of $0.5 million was recorded under these management agreements. As of April 1, 2022, the prior obligation of $5.3 million was effectively settled and considered to be a deemed equity contribution by LKCM recorded to additional paid in capital. As a result of the Novations, no additional expense under these management agreements has been incurred subsequent to the Mergers.
TestEquity and Gexpro Services Mergers
Immediately prior to the Mergers, entities affiliated with Luther King Capital Management Corporation (“LKCM”) and J. Bryan King (the Chairman of the DSG board of directors), including private investment partnerships for which LKCM serves as investment manager, owned a majority of the ownership interests in the TestEquity Equityholder (which in turn owned all of the outstanding equity interests of TestEquity as of immediately prior to the completion of the TestEquity Merger). As of the Merger Date, Mr. King was a director of the TestEquity Equityholder. In addition, as of the Merger Date, Mark F. Moon (a member of the DSG board of directors) was a director of, and held a direct or indirect equity interest in, the TestEquity Equityholder.
Immediately prior to the Mergers, entities affiliated with LKCM and Mr. King, including private investment partnerships for which LKCM serves as investment manager, owned a majority of the ownership interests in the Gexpro Services Stockholder (which in turn owned all of the then outstanding stock of Gexpro Services).
Immediately prior to the Mergers, entities affiliated with LKCM and Mr. King owned approximately 48% of the shares of DSG common then stock outstanding.
As a result of and after the consummation of the Mergers, entities affiliated with LKCM and J. Bryan King (the Chairman of the DSG board of directors) owned in the aggregate approximately 14,640,000 shares of DSG common stock as of the Merger Date, which shares represented approximately 75% of the shares of DSG common stock then outstanding after giving effect to the issuance of shares as of the Merger Date in connection with the consummation of the Mergers. Such aggregate share amount does not include any of the up to 700,000 additional shares of DSG common stock or any of the up to 1,000,000 additional shares of DSG common stock potentially issuable to the TestEquity Equityholder and the Gexpro Services Stockholder, respectively, in accordance with the earnout provisions of the TestEquity Merger Agreement and the Gexpro Services Merger Agreement, respectively, summarized in Note 1 - Nature of Operations and Basis of Presentation.
Note 19 – Segment Information
As a result of the Mergers described in Note 1 - Nature of Operations and Basis of Presentation, the Company evaluated its operational, reporting and management structures and identified three reportable segments based on the nature of the products and services and type of customer for those products and services. A description of our reportable segments is as follows:
•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, electronic production supplies, and tool kits from its leading manufacturer partners supporting the technology, aerospace, defense, automotive, electronics, education, and medical industries.
•Gexpro Services is a global supply chain solutions provider, specializing in developing and implementing vendor managed inventory and kitting programs to high-specification manufacturing customers.
In addition to these three reportable segments, the Company also identified an “All Other” category which includes unallocated DSG holding company costs that are not directly attributable to the ongoing operating activities of our reportable segments and the inconsequential results of the Bolt Supply House ("Bolt") non-reportable segment. Revenues within the All Other category represent the results of Bolt. Bolt generates revenue primarily from the sale of MRO products to its walk-up customers and service to its customers through their 14 branch locations. Bolt Supply does not provide VMI services for its customers or provide services in addition to product sales to customers. Revenue is recognized at the time that control of the product has been transferred to the customer which is either upon delivery or shipment depending on the terms of the contract.
Financial information for the Company's reportable segments is presented below. Asset information by operating segment is not presented below since the chief operating decision maker does not review this information by segment.
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| Three Months Ended June 30, | | Six Months Ended June 30, |
(in thousands) | 2022 | | 2021 | | 2022 | | 2021 |
Revenue | | | | | | | |
Lawson (1) | $ | 107,334 | | | $ | — | | | $ | 107,334 | | | $ | — | |
TestEquity | 97,874 | | | 67,856 | | | 170,276 | | | 133,631 | |
Gexpro Services | 99,792 | | | 66,296 | | | 181,475 | | | 125,348 | |
All Other | 16,336 | | | — | | | 16,336 | | | — | |
Total revenue | $ | 321,336 | | | $ | 134,152 | | | $ | 475,421 | | | $ | 258,979 | |
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Operating Income | | | | | | | |
Lawson (1) | $ | (2,562) | | | $ | — | | | $ | (2,562) | | | $ | — | |
TestEquity | 471 | | | 3 | | | (133) | | | (1,362) | |
Gexpro Services | 5,390 | | | 5,465 | | | 8,982 | | | 9,083 | |
All Other | 814 | | | — | | | 814 | | | — | |
Total operating income | $ | 4,113 | | | $ | 5,468 | | | $ | 7,101 | | | $ | 7,721 | |
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(1)Includes the operating results of Lawson only subsequent to the Merger Date of April 1, 2022 and not Lawson operating results prior to the Mergers.