DSGR - NASDAQ

Greetings and welcome to the Distribution Solutions Group Second Quarter 2023 Earnings Conference Call. [Operator Instructions] Please note, this conference is being recorded. I will now turn the conference over to your host, Mr. Steven Hooser. You may begin.

Good morning, ladies and gentlemen and welcome to the Distribution Solutions Group second quarter 2023 earnings call. In conjunction with today's call, we have provided a Q2 earnings presentation that has been posted on the company's IR website at investor.dstributionsolutionsgroup.com. Please note that statements made on this call and in the press release contain forward-looking statements concerning goals, beliefs, expectations, strategies, plans, future operating results and underlying assumptions that are subject to risks and uncertainties that could cause actual results to differ materially from those described. In addition, statements made during this call are based on the company's views as of today. The company anticipates that future developments may cause those views to change and we may elect to update the forward-looking statements made today but disclaim any obligation to do so. Management will also refer to non-GAAP measures and reconciliations to the nearest GAAP measures can be found at the end of the earnings release. The earnings press release issued earlier today was also posted on the Investor Relations section of the website. A copy of the release has also been included in the current report on Form 8-K filed with the SEC. This call is also being webcast on the Internet via the Distribution Solutions Group Investor Relations page on the company's website. A replay of the teleconference will be available through August 17, 2023. I will now turn the call over to Bryan King, DSG's Chairman and Chief Executive Officer. Bryan?

Thanks, Steven and thank you all for joining to review our second quarter results. Joining me for today's call is Ron Knutson, DSG's Executive Vice President and Chief Financial Officer. Distribution Solutions Group delivered strong 2023 first half results, anchored by our industry leadership positions, our broad portfolio of products, value-added services and mission-critical solutions and the benefits we are starting to unlock with our significantly improved scale, coupled with our talented team's relentless focus on execution. Starting on Slide 4 of the second quarter earnings presentation. We again delivered strong quarterly sales up almost 18% in the second quarter which included organic growth of 5%. Second quarter adjusted earnings per share were -- was $0.52, up over 40% from the comparable prior year earnings per share. We also generated adjusted EBITDA in excess of $40 million or a margin of 10.6% in the quarter. This quarter represents the fifth consecutive year-over-year quarterly EBITDA margin expansion. We are extremely pleased with how the teams have executed, especially in a dynamic operating environment with a lot of initiatives that are requiring investment of internal and external resources in the first half of 2023 to accelerate unlocking future value to the shareholders. Later, we will provide more commentary on important sales and cost initiatives we are currently working on, along with our discussion of the operating unit performance for the second quarter. We are excited that DSG has successfully established itself as a leader in the end markets we serve. We are positioned well to leverage our high-touch service delivery model and deepen customer relationships with our increasing breadth of value-added products and services. We are thrilled to have closed on the Hisco acquisition on June 8 and are successfully integrating processes and the team to create a unified and streamlined single platform with test equity. We fully expect to realize expanded sales productivity and meaningful cost synergies. We continue to grow significant wallet share across DSG and are identifying key cross-selling opportunities with solid contract wins through our growing business pipeline and Hisco only expands these growth engagements. I applaud the strong collegiality and respectfulness across the collective expertise and DSG of our leadership teams we have assembled and how they have prioritized and aligned their common goals across how our verticals can best leverage the total spend and capabilities at DSG to successfully improve and expand our products and services within our intimate customer engagement model, allowing me to see quite discretely how it will continue to translate into an acceleration in building shareholder value for all of us. In conjunction with these efforts and as a reality following many of our investments, I also expect shareholders to benefit in coming quarters and for years to come from the investments being made in process improvements underway that will accelerate free cash flow and specifically for free cash flow conversion in the back half of 2023 and 2024 to significantly improve. While we remain guarded about our current rate environment and how it could weigh on our customers, business activity remained solid through July, very consistent with our first half of the year. Our sales organizations continue to engage the marketplace using customer-centric experiences that deliver quality products and smart, efficient solutions that reinforce our value proposition to our important end markets. We are actively monitoring the demand environment and marketplace forces in each of our channels. We are leveraging DSG's strong customer relationships and focus on a customized customer experience to expand our engagement, especially getting traction with large strategic accounts. We are confident this is strengthening the company's organic growth trajectory and reducing resistance to our cross-selling efforts as we reinforce our customer-centric priority and offer more value-added capabilities in each of our verticals. Moving to Slide 5. Let me briefly provide business updates on initiatives for each of our verticals. First, Lawson Products is a leader in the MRO distribution of C-Parts offering vendor-managed inventory services. During the second quarter of 2023, Lawson continued to make significant operational and financial progress. I'm pleased with how well the team managed pricing, freight recoveries and organic growth within its customer base. Also during the second quarter, the Lawson team successfully aligned the sales organization to better serve our customers with key strategic field and inside sales personnel shifts. We believe critical initiatives like positioning our field sales team to become more productive with our high-touch, high demand customers generates greater customer lifetime value. We are confident that this more balanced approach will drive sustained long-term growth and engagement with customers. Under Cesar's leadership, we took the first steps this quarter. We also continue to make strategic investments by enhancing our supply chain technology to support our customers and progressing on our digital road map. We are working diligently on the CRM go-live with enhanced mobile capabilities at Lawson. The company's investment in lead generation capabilities and CRM tools is expected to roll out in a few months. Our goal is to better enable our sales reps across all sales channels to be more productive, serve customers more efficiently, be better equipped for cross-sell opportunities and ultimately drive higher compensation for our high-performing growing sales force. Secondly, Gexpro Services is a leader in the supply chain solutions of largely C-Parts, specializing in VMI programs for high-spec OEM customers. Gexpro Services delivered strong quarter results, both sequentially and versus the prior year quarter. Customers continue to be interested in our renewables value proposition that combines expanded electrical, mechanical and hardware product offerings with kitting supply chain services. We've accelerated our leadership position as a value-added channel partner for major OEMs, helping them with solutions, not only on the OEM side but across the growing demand around the retrofit and upgrade cycle for the installed base. We've seen recovery in the aerospace and defense vertical and industrial power demand remains very solid. Importantly, Gexpro services value creation initiatives this year include getting additional synergies out of our acquisitions, expanded kitting and project services and successfully launching our e-commerce platform with a focus initially on tech and aerospace and defense customers. We are also working through an expanded pipeline of opportunities where our customers are engaging us as partners to offer solutions around additional product and service capabilities. Our goal is to continue to win OEM programs where we are intensely embedded with a customer as the provider of choice. Our collaborative approach and the benefits seen through strategic combinations and bolt-on acquisitions significantly increases our resources, footprint and collective expertise and offerings. Thirdly, moving to test equity. Vendor managed inventory solutions continue to show sustained strong double-digit strength in the second quarter. We've seen pressure in the technology and R&D sectors which we believe are impacted by higher cost of capital and capital expenditure delays. Our teams are learning that projects are not being cancelled. However, they are being pushed out for several months. As we mentioned last quarter, we continue to see increases in rental bookings and refurbishment as market dynamics change. Significant progress has been made on reducing our lead times for chambers by over 50%, allowing us to work through our backlog of historic orders by the fourth quarter. We will begin shipping many models just in time from current stock in early 2024 which should drive expanded margins. Digital sales were up 8% in the second quarter, with growth primarily from the new test equity and tea equipment e-commerce sites. We're in the process of optimizing people, processes and technologies as we integrate Hisco with test equity. So in addition to acquisition-related costs, we also recorded about $2 million of restructuring expenses that Ron will cover more in a few moments. We will continue to capture cost synergies and production efficiencies, resulting in improved delivery times and lower shipping costs. Regarding Hisco, we are accelerating our work to build a higher structural margin profile and are encouraged by early results. In addition, the Hisco team quickly embraced and is successfully engaging in established DSG cross-selling efforts. We expect this to have a meaningful impact on the overall profitability and cash flow generation for DSG beginning this year. With that, I would like to turn the call over to Ron to walk through the financials. Ron?

Thank you, Bryan and good morning, everyone. Turning to Slide 7. We're excited this morning to share with you our strong second quarter results of Distribution Solutions Group. Let me summarize Q2 results. On a combined basis, we reported strong top line and bottom-line results over a year ago. As Bryan mentioned, we reported total sales growth of 17.6% with organic sales growing 4.8% through both price and volume expansion. The second quarter results reflect continued growth in margin dollars. GAAP reported income improved threefold with Q2 adjusted EBITDA exceeding $40 million, a first since bringing DSG together over a year ago. Our positive momentum and movement in cash flows generated from operations continued with our focus on working capital improvements. I'll now walk through some of the specific numbers on a combined basis, of which most of this is on Page 7 of our presentation. First, consolidated revenue for the second quarter was $378 million, revenue increased 17.6% or $56.7 million over the second quarter of 2022, driven by organic growth plus approximately $43.4 million coming from acquisitions, of which $28 million was from Hisco. Second, reported GAAP operating income was $13.8 million compared to $4.1 million a year ago quarter. On an adjusted basis, excluding merger-related costs, acquisition costs, stock-based compensation, severance and other nonrecurring items, adjusted EBITDA improved by nearly 27% or $8.5 million to $40.1 million or 10.6% of revenues. While the percentage is down slightly from Q1, approximately 40 bps of the decline was related to including the initial 3 weeks of Hisco which we did anticipate. And third, we reported GAAP diluted earnings per share of $0.14 for the quarter compared to a loss of $0.23 a year ago. On an adjusted basis, diluted EPS was $0.52 for the quarter versus $0.36 for a year ago quarter. Turning to Slide 8, let me now comment briefly on each of the businesses. Starting with Lawson, sales were $119.1 million for the quarter. Please note that this does not include Bolt Supply as they are included in all other reporting segment. The Lawson segment average daily sales, or ADS grew 11% organically over the second quarter of 2022. The increase over a year ago was driven by strong performance within the strategic business, up nearly 25%; Kent Automotive up 21%, the core business up nearly 2.5% and government up 22%. During the quarter, unit volume increased approximately 2.5% versus a year ago. Lawson's growth during the quarter was achieved through increased share of wallet with existing customers and new customer relationships, in particular, within strategic or large accounts in our Kent Automotive business. During the quarter, Lawson continued to build out its infrastructure to help our field sales reps become more productive. This included investments in additional account managers to help grow the strategic and government businesses inside sales reps to assist with smaller accounts, conversions, implementation individuals, technical specialists and we are 3 to 4 months away from rolling out our CRM tool. We're excited about these overdue investments to help the long-term growth of our field sales representatives as they expand their book of business. Lawson continues to realize steady improvements in its gross margin percentage. While we're up against some mix shift headwinds as our largest customers have been growing faster and we continue to see expansion given price realization, lower net freight costs and leveraging our costs over a higher sales base. Lawson's adjusted EBITDA improved to $16.1 million compared to adjusted EBITDA of $9.4 million a year ago quarter, primarily driven by the sales and gross margin improvements, partially offset by increased compensation on higher sales. Lawson's adjusted EBITDA as a percent of sales was 13.5% in the quarter versus 8.8% a year ago quarter. You may recall that Lawson got out of the gate with an extremely strong start in Q1 with its strongest quarter that we've seen. During the second quarter, we launched our initiative to better service our customers, depending upon their needs and size through additional channel offerings which should improve the effectiveness and long-term efficiency of our sales force. That, combined with some of the infrastructure investments that I previously mentioned brought down the percentage sequentially slightly. However, we are well positioned to grow the company and a long-term margin profile. In the first half of the year, Lawson nearly doubled its adjusted EBITDA going from $17.4 million to $34.6 million and is well positioned with these investments to grow the company on an accelerated basis. Turning to Gexpro Services on Slide 9. Total sales were $108.3 million for the second quarter of 2023, an increase of $8.5 million over the second quarter of 2022, all from organic growth. Approximately 4.4% came from volume with the rest from price. The increase in aggregate sales was primarily driven by new customers and the expansion of existing customer relationships. Profitability improved, although mix shift was a headwind as softer sales to the semiconductor end market were more than offset with nice growth in aerospace and defense and industrial power markets. 5 of the 6 verticals delivered year-over-year sales growth. Gexpro Services continues to expand its relationships with existing customers and attract new customers through its value creation offerings, including VMI, kitting, project management services and the ability to deliver world-class support to the OEM production cycle. Gexpro Services works extremely close with its customer base to ensure they have the necessary product and services and to simplify the supply chain and improve total cost of ownership for their customers. Gexpro Services adjusted EBITDA expanded to $13.1 million or 12.1% of sales as compared to $11.9 million or 11.9% for the year ago quarter and 11.6% in the first quarter of 2023. Gexpro Services continues to make incremental improvements in their margin profile in managing through varying end market cycles. Lastly, I'll turn to test equity on Slide 10. Sales for the quarter grew $38.2 million or 39% to $136.1 million, primarily driven by the recent acquisitions. During 2022, test equity closed on 3 acquisitions, key equipment and national test equipment in the second quarter and Instrumex in Q4. And in the second quarter of 2023, we closed on Hisco. Of the $38.2 million sales increase for the quarter, $43.4 million was generated from these acquisitions and of that, approximately $28 million came from Hisco. Organic sales were down 7% versus a year ago with a decrease in test and measurement sales and a softening of the EPS sales, as Bryan previously commented on. The test and measurement piece of the business is more closely tied to customer capital projects. Our sense is that our performance is consistent with others in our space and that these projects are delayed and not cancelled. We anticipate volumes will pick back up in late 2023 and into early 2024. On an adjusted EBITDA basis, the second quarter ended at 7% of sales or $9.5 million, representing an increase of $900,000 over a year ago quarter with the softening of T&M sales and with the benefit of thinking how Hisco's resources will begin to be leveraged as folded in through the integration plan later this year and next, the legacy test equity business had more flexibility to remove nearly $4 million of annual costs out of the company which commenced in June. Moving on to Slide 11. During the quarter, we expanded our committed credit facility from $500 million to $805 million. We were able to accomplish this in a very difficult bank market which validates the support of our strategy from our existing bank group, plus 4 additional banks that joined our credit facility. Additionally, we also issued $100 million of additional stock to existing shareholders through a common stock rights offering. These 2 actions allowed us to close on the Hisco transaction, pay down our revolver, manage our overall financial leverage within the guided range and increase our capacity for future acquisitions. From an access to capital, we have approximately $44.2 million of unrestricted cash and $189.6 million available under our existing credit facility. As part of that facility, we also have an additional $200 million accordion feature. We ended the quarter at a net debt leverage ratio of 3.1x, primarily on increased earnings and taking on debt for the Hisco acquisition. So even with multiple acquisitions over the past 15 months, we've been able to deleverage the company and improve our scale and offering to accelerate further deleveraging and support additional inorganic growth. For reference, at the time of the April 1, 2022 merger date, our net debt leverage was 3.6x. This progress is consistent with our intention to prudently manage our debt levels and our leverage in the 3 to 4x range. Our positive movement in cash flows generated from operations continued during the quarter with our focus on working capital improvements. Net capital expenditures, inclusive of rental equipment, was $5.7 million for the quarter and we expect full year CapEx to be in the range of $16 million to $22 million, most of which is a discretionary investment to grow rental assets which also supports used T&M equipment sales. Before I turn the call back to Bryan, I wanted to reiterate how pleased we are with the company's strong financial performance for the quarter. We generated over $40 million in adjusted EBITDA for the quarter, a significant increase over a year ago and also up over a very tough first quarter comparison. We're also very excited that in conjunction with the Hisco closing during the quarter, we expanded our credit facility, providing us more fire power to continue on our growth strategy. All of the businesses continue to execute on their planned initiatives for 2023. We will continue to prudently manage our balance sheet and financial position as we monitor current market trends. Thank you to the operating teams at Lawson Products, Gexpro Services and test equity for their continued focus and commitment to deliver these great results and welcome to the entire Hisco team. I'll now turn the call back over to Bryan.

Thank you, Ron. Let's turn to Slide 12. We believe it is important, especially as U.S. and global markets evolve and change quickly to discuss with investors our approach to capital deployment. DSG's allocation of capital is focused on a disciplined balance between investing in growth, both in our core businesses as well as in strategic acquisitions that fit our model with a prudent approach to working capital intensity, leverage and occasionally through opportunistic share buybacks. Our goal is to continue to scale the DSG platform into an even more enduring well-positioned specialty distributor with key differentiators that uniquely benefit from utilizing our high-touch, value-added distribution solutions, services and customizable capabilities that customers clearly recognize and celebrate. Since we have built this business as an asset-light structure, we have planned for organic and inorganic growth through deliberate working capital investments as well as strategic acquisitions that are aligned with our commitment to accelerating shareholder value. Our targeted leverage will continue to be in the 3% to 4% range. And at the end of the second quarter, just 3 weeks post-closing of Hisco our leverage is 3.1x. At the end of the quarter, we had approximately $476 million of net working capital with accelerating cash flow. Our investment in working capital over the last year facilitated our focus to drive organic growth that drives accelerating profitability for our shareholders. Finally, we continue to seek the highest return on invested capital opportunities with an obsessive commitment to build incremental shareholder value for the benefit of all of us. We understand and appreciate why there continues to be interest in DSG from investors. It is easy to see the long-term compounding effects of owning a leading specialty distribution company with the scale and breadth of our products and solutions. Turning to Slide 13. Our principal goal at DSG remains focused on improving our overall return profile by building and maintaining profitable scale as a specialty distribution business. Second quarter results accomplished our profitability objectives while balancing significant investments in the business. We know that adding Hisco will accelerate advancing many of our current initiatives and longer-term goals. We continue to be selective with our robust acquisition pipeline as we carefully analyze opportunities that fit our focused value accelerating criteria. I'd like to thank all our DSG associates who are working to optimize and streamline operations, better serve our customers and position the company to maximize its full potential. We believe that decisions and actions today from our team generates accelerated shareholder value. Before I open it up for questions, I would like to let you know that we are hosting an Investor Day on September 28 in Fort Worth. We plan to share key operational initiatives and will include a showcase our show and tell featuring Watson products, Gexpro services and test equity so that investors can better understand each of the unique products and solutions. We will audio webcast elements at Investor Day but believe you may get the most benefit by attending the event live and get to know the mini DSG and LKCM-Headwater team members that are working and engaging daily across countless works streams to build shareholder value. If you've not registered yet, please reach out to our IR team for more details. Thank you for your time today. And now, operator, we would like to take questions from analysts and investors.

[Operator Instructions] Your first question is coming from Kevin Steinke of Barrington Research.

I wanted to start off by asking about the organic growth and the breakdown of price versus volume is kind of roughly half and price and half volume the way to think about that 5% organic growth in the second quarter? Or if not, can you give me the breakdown there?

Yes, Kevin, this is Ron. I can jump in on that one. So it varied a little bit by each of the 3 individual companies. If you look at Lawson's organic growth of 11%, about 2.5 points of that was volume and the rest being price, Gexpro services of the 8.5% organic growth kind of split 50-50, a little bit north of 4% on price and it's same on volume. And then on the test equity side, organic, we mentioned that they were down about 7%. About 2% of that was price and down the offset to that was lower volume. So all in, if you kind of take the weighted average between the 3 operating companies, kind of flattish, maybe up just slightly in volume and then with price being the remainder of that. So hopefully, that breakdown by company is more specific than maybe what you asked but hopefully, that answers your question.

Well, that's great. Yes. No, that's perfect. And I know you touched on that in some of the segment discussion as well. But okay, great. So I think you mentioned in your prepared comments that business activity has remained solid in July. Should we think about similar type volume trends on the organic side continue into July? And have we largely lapped the benefit of the price increases that you've been implementing?

Yes. I'll jump in on that one as well. So I would say that we'll start lapping some of the increases that we put in place more so in the second half of the year, in particular on the Lawson business, more of that -- of those changes took place in the second half of 2022. So we're -- I would say we're in the early stages of starting to lap some of those. And I think the pricing piece for test and Gexpro was probably a little bit more dynamic throughout 2022. So I think that's probably a little bit more consistent. But on the Lawson side, we're probably lapping some tougher numbers in the second half of the year. And as we think about just overall what we've seen so far here in the month of July, flattish to kind of where we were in the second quarter, flattish to down just a little bit. We continue to see a little bit of softening yet within some of the end markets. But again, it kind of varies a little bit by operating company as to where we're seeing that. And there's -- you end up with some kind of some strange dynamics based upon how the calendars fall. So that impacts our average daily sales, especially Gexpro services which has basically a 5-week July. Typically, we see a little bit of compression in the average daily sales number. So but kind of flattish as I think about where we're at today versus the reported numbers in Q2 on a consolidated basis.

Ron, I just -- I'd love to give him a little more detail on -- so the lapping, Lawson, Ron, why don't you give him more specifics on where we did on loss and we had specific spots where we did take pricing actions last year. And they weren't in July last year. So it was later in the year. So to specifically answer your question, July did have both as it related to loss and had both the benefit of some volumes and had some benefit of pricing. We're going to see -- I think it was September. Was it late August or September that we had a specific price action initiative in Lawson.

It was just.

So that way you've got specifically some support from us in terms of actually kind of where those skating spots were. We had a lot less ability last year to on the longer cycle pieces of Gexpro services to be able to take price action on those contracts until later. So to kind of give context around Gexpro services, we were -- it was later in the course of the year. And in some cases, it was really rolling through those contracts as they reset through the inflationary pressures that we had last year that we started to get the benefit of some pricing actions there. And then as we moved into this year, it became a little bit more dynamic on price action. So it was less of on a single day, a point of price action taken. I started to kind of become more dynamically blended into what we were seeing in those particular SKUs on the sourcing side. And so what it becomes less clean, if you will, to be able to kind of point to specific points in time as we move back into 2023. And so that's -- I'm hopeful that, that gives you some context. On the sales side, the softening that we saw on test equity, I think that the context there that I would offer is, first of all, we're really glad that we've bought Hisco because Hisco offers what longer term we want out of that business unit which is to have a lot more MRO and OEM kind of repeat activities as opposed to test equity itself, the legacy business that we've enjoyed for the last number of years did have 2/3 of its revenue of the legacy business was tied towards test and measurement equipment or bench sales and really what I would characterize as more of a capital spend from the customers. On that piece of it, we've got active dialogues going with the customers. And there's -- we've seen some sliding in their interest to kind of either replace or expand their equipment needs. But -- and we think that we're going to see a renewed level of order flow there but that's the area that we've had the most softness across all of our DSG platform which is in those -- that kind of 2/3 of the historic test equity piece that was tied to more capital spend. And we -- now there were some pieces of that that's been interesting that have been more favorable to kind of, I guess, equally, one has been kind of pressure on gross margins. The other has been to the benefit of. We have seen a shift as people deferred or delayed their purchases on equipment. They have asked for more rental equipment access. And that obviously has historically come with a higher gross margin associated with it. It does influence how we have to think about investing dollars into our rental fleet. And then one of the things that I spoke to specifically on test and measurement that's been a real drag for -- on the test equity side on the capital spend side that's been a drag to us but has actually had a little bit more support in the top line. It's been a drag to margins and revenue over the last several years has been our chamber side. And we will lap some orders that we got over a year ago where we were in a different cost of goods sold environment that we had locked into pricing. And we finally get out from that burden here in the fourth quarter, having worked through the backlog. We have expanded our contract manufacturing capabilities for those that support us on our -- on the chamber side and it allows us to start accelerating the revenue out of our chambers again because we've had a large backlog there and it allows us to get back to a much healthier margin.

I'm just wondering how we should think about adjusted EBITDA margins. As we look to the second half and beyond, I think you mentioned, Ron, that 40 basis points sequentially of the margin versus the first quarter, the 40-basis point headwind just from inclusion of Hisco and he also talked about plans to improve Hisco margins. I mean we started to run in some tougher comps, I guess, in the second half year year-over-year. Should we think about just layering in Hisco being largely offset by organic margin expansion? Or how quickly can you start to improve the Hisco margins? Just any color on margin direction would be helpful.

Yes, I can start. Sure, Bryan. Yes, I'll start with that. So yes, you're -- Kevin, you're spot on the Hisco impact on the sequential margins from Q1 to Q2. And we did anticipate that when we announced the Hisco transaction, we knew that it would bring down the overall margin on a shorter-term basis. But clearly, our expectation is that when we work through the integration process which we were well underway as we sit today, that those margins will -- that they'll really come up to the margin profile of overall DSG. So the interesting part in the second quarter was they were only in for 3 weeks, right? So we have to think about bringing them in for the full quarter here in Q3 and Q4. So whether or not it's going to be entirely offset by margin expansion from the other entities is a bit of a tough question to answer without giving specific guidance here over the last 6 months of the year. What I would say is that we have very specific objectives around and action items around the integration of Hisco. We did comment on some of the cost actions that test equity has already taken around that to how that will help right away here starting in the third quarter. And Gexpro Services just continues to deliver. When we start thinking about even their end market cycling a bit, they have a great ability to be able to focus on those end markets where they can pick up growth. And we saw -- and we continue to see incremental margin expansion there on the organic basis as well as on the Lawson side. So -- it -- so hopefully, that helps without giving you -- without giving you a specific percentage that we're going after here in Q3 and Q4 but that might give you a little bit of context just in terms of some of the actions we're taking.

Yes, Ron, let me -- I'm going to dovetail onto that and just kind of as it relates to Hisco. There -- one thing I want to flag is that we've got an earn-out element to the Hisco transaction that's at the end of this quarter or if it is October, I guess, Ron, is that right?

Yes, October.

October. So there are elements to making sure that they are able to have clean numbers for that opportunity which include -- really was set around some real growth in profitability as well as their targets. And right now, we would expect that, that will be a tough reach for them to hit. But we -- and we've got a great relationship with that management team. So we want to make sure that we give them every opportunity to kind of get through October with their stewardship of kind of the margin profile there. So it's easier for us to take those actions that we took in the month of June looking forward to how the businesses are getting integrated on the test equity side itself. And so that's why when we call out the $4 million of actions that we took on the test equity side and we didn't call out actions that we've played that the management team of Hisco is has looked at as the 2 businesses come together, we wanted to make sure that we wanted them to have every opportunity and we would love for them to hit the earnout. There are gross margin initiatives that are across that total vertical now that we will see during the third and fourth quarter, some as it relates to the test equity side and more opportunity going forward as it relates to the Hisco side. There are -- when we think about longer-term structural margin opportunities for the whole business and when we speak about how Hisco allows the whole business to have a structurally higher margin, there's 2 real levers there. One is the fact that Hisco with test equity allows test equity and Hisco together to get to a higher structural margin than where test equity would have been by itself and it gets there faster, like this action that allowed us to take on the test equity side. We had targeted to get test equity to double-digit EBITDA margin at the end of the year or before the end of the year. And that's without Hisco as part of it. And that's been the operating objective that, that team has been moving towards for the last 18 months. We continue to feel confident that they are marching us that direction. There's also the stabilization, if you will and kind of the repeat volumes that you get out of OEM and MRO that are now 2/3 plus of the revenue, especially with revenue being softer and tested measurement in the kind of benches and some of the capital spend on the test equity side. That's really where we've seen, just like we called out the 8% growth in the digital side of test equity during the last quarter. So that part's been growing. The consumables have been growing but the softness has been on the capital spending side. Now, that whole division is much more levered to that. And that ought to allow us to optimize both the cost structure and the way that we approach margins to pull that up. The value-added capabilities that Hisco has are allowing some opportunities to look back at Gexpro Services and at Lawson, where we have -- Lawson's got the highest structural margin profile because of the contribution margin that it enjoys. But there's opportunities that we are seeing on pulling some of the capabilities of Hisco back across the Gexpro services in the test or the Watson side. And then there are some capabilities that expo Services has on the value-added side that are allowing us to look across the test equity Hisco platform. And those are on the margin side. And additionally, we have seen very good traction with the Hisco team out of the gate. They've been great key players and they've seen an assigned real opportunity to being able to cross-sell some of -- specifically the capabilities the Gexpro services and Lawson half into their customers on the -- where they're more deeply embedded and also the geographic expansion that we've been able to grow with the Hisco transaction south of the border.

Your next question is coming from Ken Newman of KeyBanc Capital Markets.

So Ron, you gave some pretty good answers, very, very detailed answers here for a lot of my questions I was going to ask. So, maybe I'll just ask one here on [ph].

Ken, its 30 years of being asking the questions that you're asking. Yes, given that I've been on the other side of these calls for so many years, it's hard for me to resist, not trying to offer some color that I'll probably get in trouble with my team afterwards.

Well, for my question, we are hearing more this earnings season about customers revising orders as lead times are improving, especially in some of these electrical components that maybe you guys touch a bit with tax equity and Gexpro. Curious if you're seeing that today? And how do you view that impacting demand at all in coming quarters?

Ron, well, there's 2 ways to answer that question. One is to specifically talk about how lead times have influenced our own purchases and then also some of the actions that we took a year ago were 18 months ago -- or I guess, 15 months ago when we were concerned about lead times. And so over the last 2 years, we certainly increased the working capital intensity in our businesses across the business, across our verticals and we've got the benefit today of being able to take a more take a posture on our working capital investment that should allow us, specifically in opportunities that we've identified to lean up our working capital investment over the next 3 to 6 months, maybe 9 months to kind of get through it or so. So we -- that's where I called out free cash flow. We had good free cash flow conversion in this last quarter. I think that we'll have better at some point in time over the next 6 to 9 months. We've got initiatives to really go back and look at where we took some actions on inventory stocking levels because we were worried about strong inflationary pressure as well as lead times and freight costs. And there's a lot of money that we've tied up in working capital that we think we might be able to release over the next 6 to 9 months. That's one part of it. That also is it related to Gexpro services specifically had an impact. It's kind of the old game of telephone or the kind of where one person tells you and the story kind of gets amplified and it gets to the next person or maybe it's kind of fishing stories, if you will. But the challenge has been that our customers have re-laid with a lot of anxiety production levels that then got narrated back to and through purchasing. And now that there's less of a concern from their end, we're getting to the heart of exactly what their production levels are and it's allowing us to be more exacting in our -- because there's less anxiety on there and that we're going to not have adequate inventory to support their OEM needs. And specifically, the risk associated with a bunch of our customers of us paying out for -- out of stock on a small piece good that would slow down a major manufacturing line. There's just not that level of flexibility on our side and so we understand why they popped some of their forecasting to us.

And Bryan, clarify my question here. I'm more concerned about your -- of the demand that you're seeing, are customers pulling back on orders because it used to take, call it, 3 months for product widget and now it takes back to normal 3 weeks. And so they don't have to order out as far. Are you seeing that today?

Yes, that's been something that we've talked about over the last 6 months and I think I even alluded to it on the last call was whether or not we were going to see some destocking at our customer level that would have some influence on our own order levels that we were seeing. And I think that some of that's going, is absolutely taking place. If it was happening, we were seeing it happen some in the last quarter because we're not seeing right now an acceleration in it. But I had said this and I think certainly, I said it to some of the investors but I think I said it in the last quarter's earnings call that I been calling out for 3 to 6 months for our team to be anticipating that we were going to see some destocking at the customer level because they are concerns about lead times and availability were so peaked a year ago that they stocked deeper themselves. And so we're saying on the public side, we're seeing some of our customers look like they're working inventory levels down on working capital. And we think some of that's been playing out as a kind of a bit of a dampener on our own performance over the last 3 months or maybe even longer. But we aren't seeing a steepening of that yet this quarter because we didn't see any more of that happening, we don't think during the month of July. Any more is more than what we saw in the second quarter. But yes, we have had a lot of internal conversations about how much of that was taking place and so I think it's a very fair call out on your part. Ron is any more color on that? You may have some more specific areas where we're seeing it or where we might have seen it.

Yes. The only piece I would add to that, Bryan, is on the Lawson side, Ken, we're a short-cycle business. So it's a little difficult for our customers to build up. They really don't have to have a buildup of stock. And so we just -- I mean, we turned quickly with our customers. So probably a less impact of that on the Lawson side of the business. Generally, for Gexpro Services, long-term agreements that we have with customers on the Gexpro Services side. And so I agree with Bryan, there's certainly not any further pullback than probably what we just see as part of the normal process and Gexpro Services is so well connected to the production cycle that we probably saw a little bit of a bump probably last year. But again, it's not a huge movement, I would call it, dramatically impacting our results from quarter-to-quarter.

And Ron, I would even just kind of thinking about what I said and reflecting on it and hearing you say it sometimes so helpful. Gexpro Services has got those long-term contracts and we are required to hold that inventory. So if anything, that inventory has been on our balance sheet. And now what's happening is because they're pulling it as they need it. And so they aren't carrying any real buffer on their end, we're carrying the buffer on our end. And that's where I'm talking about us being able to work our own inventory levels down that we've been carrying for our customers as their anxiousness has kind of buffered a little bit. So that should actually translate back into cash for us. On test equity, there are some shelf-life elements there on some of the products that they order from us. And so we have not seen it specifically in our conversations on test equity be something that we've been concerned about. I continue to be concerned about it. It's a question I'm asking consistently but the answer I've gotten back on the test side has been that we are -- have not been seeing that. So those are those two. And then the short cycle side of Lawson, I think Ron answered very well. So I wouldn't offer any more color there.

We appear to have no further questions in the queue. I'm now going to hand back over to Bryan for any closing remarks.

Thank you. Appreciate it, operator. We appreciate everybody participating today and your support on what we're doing with test -- with -- across DSG. The businesses are coming together very nicely. As we alluded to earlier and I think it's important to process. We've got a lot of moving parts. We made some decisions that we wanted to invest in the business and we called out some of those investments during the second quarter and we're very pleased with how those are impacting where we think we're headed with the business from a structural margin and from a long-term value for the shareholders going forward. We look forward to talking in a lot more detail and having more of a forum discussion this -- at the end of September on our Investor Day and we would encourage any investors or any analysts that are interested in DSG to come to Foot Worth and participate with us in that day. Thank you very much and we appreciate your time. Have a good balance of the summer.