Distribution Solutions Group, Inc. (DSGR) FY 2022 MD&A

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

The following discussion and analysis of financial condition and results of operations should be read in conjunction with the consolidated financial statements and related notes included in this Annual Report on Form 10-K, 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 and the Lawson Products, Inc. unaudited condensed consolidated financial statements and accompanying notes included in DSG’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2022.

References to “DSG”, the “Company”, "we", "our" or "us" refer to Distribution Solutions Group, Inc. and all entities consolidated in the accompanying consolidated financial statements.

Overview

DSG is a multi-platform specialty distribution company providing high touch, value-added distribution solutions to the maintenance, repair & operations (“MRO”), the original equipment manufacturer (“OEM”) and the industrial technologies markets. The Mergers that were consummated in April 2022 resulted in the combination of Lawson Products, Inc. ("Lawson"), TestEquity Acquisition, LLC ("TestEquity") and 301 HW Opus Holdings, Inc., conducting business as Gexpro Services ("Gexpro Services"). For a description of the business combination, refer to Item 1. Business and Note 1 – Nature of Operations and Basis of Presentation in Item 8. Financial Statements.

We manage and report our operating results through three reportable segments: Lawson, TestEquity and Gexpro Services. A summary of our segments is presented below. For additional details about our segments, see Item 1. Business and Note 14 – Segment Information in Item 8. Financial Statements.

Lawson is a distributor of specialty products and services to the industrial, commercial, institutional and government MRO market.

TestEquity is a distributor of test and measurement equipment and solutions, electronic production supplies, and tool kits from its leading manufacturer partners supporting the technology, aerospace, defense, automotive, electronics, education, and medical industries.

Gexpro Services is a global supply chain solutions provider, specializing in developing and implementing VMI and kitting programs to high-specification manufacturing customers.

In addition to these three reportable segments, we have an “All Other” category which includes unallocated DSG holding company costs that are not directly attributable to the ongoing operating activities of our reportable segments and the inconsequential results of a non-reportable segment.

Sales Drivers

DSG believes that the Purchasing Managers Index ("PMI") published by the Institute for Supply Management is an indicative measure of the relative strength of the economic environment of the industry in which we operate. The PMI is a composite index of economic activity in the U.S. manufacturing sector. We believe that a measure of that index above 50 generally indicates expansion of the manufacturing sector while a measure below 50 generally represents contraction. The average monthly PMI was 53.5 in the year ended December 31, 2022 compared to 60.7 in the year ended December 31, 2021.

Lawson Sales Drivers

The North American MRO market is highly fragmented. Lawson competes for business with several national distributors as well as a large number of regional and local distributors. The MRO business is impacted by the overall strength of the manufacturing sector of the U.S. economy.

Lawson's revenue is also influenced by the number of sales representatives and their productivity. Lawson plans to continue concentrating its efforts on increasing the productivity and size of its sales team. Additionally, Lawson drives revenue through the expansion of products sold to existing customers as well as attracting new customers and additional ship-to locations. Lawson also uses an inside sales team and an e-commerce site to generate sales.

TestEquity Sales Drivers

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Across both the test and measurement and electronic production supplies businesses, the North American market is highly fragmented with competitors ranging from large global distributors to national and regional distributors.

TestEquity management focuses on the internal metric of Sales per Day (“SPD”) and Day Adjust Growth (“DAG”). The SPD calculates and compares TestEquity’s total sales divided by the number of selling days, adjusted for weekends and holidays. A selling day generally represents a business day in which TestEquity ships products to its customers. The DAG represents the percentage increase or decrease in the SPD for a defined period of time.

Specifically in respect of its electronic production supplies business, the current semi-conductor chip shortage, primarily due to the COVID-19 pandemic, is negatively impacting TestEquity’s business as such chips are key elements to the electronic production process. TestEquity anticipates that recovery of this important part of its customers’ supply chain will occur in 2023.

Gexpro Services Sales Drivers

The global supply chain solutions market is highly fragmented across Gexpro Services' key vertical segments. Gexpro Services’ competitors range from large global distributors and manufacturers to small regional domestic distributors and manufacturers. Gexpro Services revenue is influenced by our OEMs’ production schedules, new product introduction launches, and service project needs.

Gexpro Services drives revenue through increasing wallet share with existing customers, customer-led geographic expansion, and new customer development in its six key vertical markets. Additionally, Gexpro Services drives revenue through expansion of its installation and aftermarket services by leveraging its portfolio of recent acquisitions.

Key Factors Affecting our Results of Operations and Financial Condition

Supply Chain Disruptions

Along with the broader economy, we continue to be affected by rising supplier costs caused by inflation and increased transportation and labor costs. This results in challenges in acquiring and receiving inventory in a timely fashion and fulfilling customer orders, which offset some of the sales gains we recorded in 2022 compared to 2021. The supply chain disruptions have also led to higher product costs which have contributed to lower gross profit margins as a percentage of sales in certain pieces of our business. We have instituted various price increases during 2021 and 2022 in response to rising supplier costs, as well as increased transportation and labor costs.

Factors Affecting Comparability to Prior Periods

Our results of operations are not directly comparable to prior results for the periods presented due to the Mergers that were completed on April 1, 2022. The Mergers were accounted for as a reverse merger under the acquisition method of accounting in accordance with the accounting guidance for reverse acquisitions as provided in Accounting Standards Codification 805, Business Combinations ("ASC 805"). Under this guidance, TestEquity and Gexpro Services were treated as a combined entity as the accounting acquirer for financial reporting purposes, and DSG was identified as the accounting acquiree. This determination was primarily made as TestEquity and Gexpro Services were under the common control of an entity that owns a majority of the voting rights of the combined entity, and therefore, only DSG experienced a change in control. Accordingly, the consolidated financial statements as of December 31, 2022 and December 31, 2021 and for the years ended December 31, 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 included only subsequent, and not prior, to the April 1, 2022 Merger Date.

Non-GAAP Financial Measures

The Company's management believes that certain non-GAAP financial measures may provide users of this financial information with additional meaningful comparisons between current results and results in prior operating periods. Management believes that these non-GAAP financial measures can provide additional meaningful reflection of underlying trends of the business because they provide a comparison of historical information that excludes certain infrequently

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occurring, seasonal or non-operational items that impact the overall comparability. These non-GAAP financial measures should be viewed in addition to, and not as an alternative for, the Company's reported results prepared in accordance with GAAP.

Non-GAAP Adjusted EBITDA

Management believes Adjusted EBITDA is an important measure of the Company's operating performance. We define Adjusted EBITDA as operating income plus depreciation and amortization, stock-based compensation, severance costs, costs related to the execution of the Mergers, adjustments recorded to reduce inventory related to certain discontinued products, amortization of fair value step-up resulting from the Mergers, acquisition related costs (unrelated to the Mergers), and other non-recurring items. The following table provides our calculation of Adjusted EBITDA for the year ended December 31, 2022 and 2021:

Reconciliation of Operating Income to Non-GAAP Adjusted EBITDA (Unaudited)

(1)    Expense primarily for stock-based compensation, of which a portion varies with the Company’s stock price.

(2)    Includes severance expense from actions taken in 2022 and 2021, not related to a formal restructuring plan.

(3)    Merger transaction costs related to the negotiation, review and execution of the Merger Agreements relating to the Mergers and subsequent integration costs.

(4)    Inventory net realizable value adjustment recorded to reduce inventory related to discontinued products where the anticipated net realizable value was lower than the cost reflected in our records.

(5)    Inventory fair value step-up adjustments resulting from the reverse merger acquisition accounting for Lawson and acquisition accounting for additional acquisitions completed by Gexpro Services.

(6)    Expense for acquisition related costs, unrelated to the Mergers.

(7)    Other non-recurring costs consists of sales force optimization and other non-recurring items.

(8)    Includes the operating results of Lawson subsequent, but not prior, to the April 1, 2022 Merger Date in accordance with GAAP accounting guidance for reverse acquisitions.

Management uses operating income and Adjusted EBITDA to evaluate the performance of its reportable segments. See Note 14 – Segment Information of our consolidated financial statements within Item 8. Financial Statements for additional information about our reportable segments. The following table provides Adjusted EBITDA by reportable segment:

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(1)    Includes the operating results of Lawson subsequent, but not prior, to the April 1, 2022 Merger Date in accordance with GAAP accounting guidance for reverse acquisitions.

(2)    Includes the operating results of All Other subsequent, but not prior, to the April 1, 2022 Merger Date in accordance with GAAP accounting guidance for reverse acquisitions.

Supplemental Information - Lawson Non-GAAP Adjusted Operating Income and Non-GAAP Adjusted EBITDA

For management to discuss Lawson's operating results on a comparable basis, Lawson's historical, pre-merger components of operating income have been provided separately in the table below. In addition, Lawson's GAAP results of operations were adjusted to include the results prior to the Merger Date in order to reflect the total operating activities attributable to Lawson for each period presented. Management believes this historical information provides the most meaningful basis of comparison for Lawson's operations, is more useful in identifying current business trends, and is important for the user of our financial statements in understanding Lawson's business. Refer to Note 1 – Nature of Operations and Basis of Presentation and Note 3 – Business Acquisitions within Item 8. Financial Statements for information about the Mergers.

These non-GAAP amounts are not considered to be prepared in accordance with GAAP, have not been prepared as pro forma results under applicable regulations, may not reflect the actual results we would have achieved had the Mergers occurred at the beginning of 2021, and should not be viewed as a substitute for the results of operations presented in accordance with GAAP. Lawson's historical operating results prior to the Mergers were obtained from the consolidated financial statements included in DSG's Annual Report on Form 10-K filed for the year ended December 31, 2021 and the unaudited condensed consolidated financial statements included in DSG's Quarterly Report on Form 10-Q filed for the quarterly period ended March 31, 2022.

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(1)    Operating income prepared in accordance with GAAP, which includes Lawson’s results of operations subsequent, but not prior, to the April 1, 2022 Merger Date. For the year ended December 31, 2021, the operating results of Lawson were not included in the Company's GAAP results. See Note 1 – Nature of Operations and Basis of Presentation and Note 3 – Business Acquisitions within Item 8. Financial Statements.

(2)    Lawson's results of operations for the three months ended March 31, 2022, which occurred prior to the April 1, 2022 Merger Date, were not included in the Company's GAAP operating results under reverse merger acquisition accounting.

(3)    Lawson's results of operations adjusted for comparability on a period-over-period basis. These non-GAAP results represent Lawson’s total operating activities for the year ended December 31, 2022 and 2021, regardless of the Mergers (that is, they reflect both pre- and post-Merger results of Lawson).

(4)    Lawson's results of operations for the year ended December 31, 2021, which occurred prior to the April 1, 2022 Merger Date, were not included in the Company's GAAP operating results under reverse merger acquisition accounting. See Note 1 – Nature of Operations and Basis of Presentation and Note 3 – Business Acquisitions within Item 8. Financial Statements.

(5)    Refer to the Non-GAAP Adjusted EBITDA section above for a reconciliation of Adjusted EBITDA to operating income.

Composition of Results of Operations

The following results of operations for the years ended December 31, 2022 and 2021 include the accounts of the TestEquity and Gexpro Services combined entity, as the accounting acquirer, and include the results of Lawson only subsequent, and not prior, to the April 1, 2022 Merger Date.

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RESULTS OF OPERATIONS FOR 2022 AS COMPARED TO 2021

Consolidated Results of Operations

(1) Includes the operating results of Lawson subsequent, but not prior, to the Merger Date of April 1, 2022.

(2)    Includes the operating results of All Other subsequent, but not prior, to the April 1, 2022 Merger Date.

Overview of Consolidated Results of Operations

Our consolidated results of operations include the financial impact of the Mergers that were completed on April 1, 2022. The increase in gross profit for 2022 compared to 2021 was primarily due to the inclusion of Lawson operations only subsequent, and not prior, to the Merger Date. Expenses for 2022 were impacted by the inclusion of Lawson operations only subsequent, and not prior, to the Merger Date, the 2021 and 2022 acquisitions, and Merger related costs.

Refer to Results by Reportable Segment below for a complete discussion of our results of operations.

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Results by Reportable Segment

Lawson Segment

(1)Refer to the Non-GAAP Adjusted EBITDA section in Overview for a reconciliation of Adjusted EBITDA to operating income.

The increase in revenue, gross profit and operating income for 2022 compared to 2021 was due to the inclusion of Lawson operations beginning on the Merger Date and not including any Lawson operations prior to the Merger Date.

Supplemental Information

For management to discuss Lawson's operating results on a comparable basis, Lawson's GAAP results of operations were adjusted to include its results prior to the April 1, 2022 Merger Date in order to reflect the total operating activities attributable to Lawson for each period presented. These non-GAAP Adjusted Results presented in the table below are referred to within this results of operations discussion as "Adjusted".

(1)For comparability purposes, Lawson's GAAP results of operations were adjusted to include the historical results of Lawson prior to the Merger Date. Refer to the section Factors Affecting Comparability to Prior Periods and the non-GAAP measures section Supplemental Information - Lawson Non-GAAP Adjusted Operating Income and Non-GAAP Adjusted EBITDA for more information related to the calculation of adjusted amounts.

(2)Refer to the Non-GAAP Adjusted EBITDA section in Overview for a reconciliation of Adjusted EBITDA to operating income.

Revenue and Gross Profit

Adjusted revenue increased 15.6% to $429.7 million for 2022 compared to adjusted revenue of $371.7 million for the same period a year ago. The increase in adjusted revenue compared to the prior year was primarily driven by the realization of price increases enacted throughout 2021 and 2022 to offset rising supplier costs, increased quantity volumes and strengthening sales to our strategic customers and automotive end market.

Adjusted gross profit increased $25.8 million to $226.3 million for the year ended December 31, 2022 compared to $200.5 million in the prior year primarily as a result of increased sales and the related price increases put in place. Lawson adjusted gross profit as a percent of adjusted revenue was 52.7% for 2022 compared to 53.9% in the prior year. The adjusted

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gross margin percentage for 2022 was impacted by increased supplier costs from inflation, supply chain disruptions and a sales shift toward lower margin customers. Adjusted gross profit was also impacted by an inventory charge of $1.7 million to reduce inventory related to discontinued products where the anticipated net realizable value was lower than the cost reflected in our records and the amortization of the fair value step-up of $1.9 million related to the Mergers. Price increases enacted throughout 2021 and 2022 have generally offset the negative impacts of these higher costs.

Selling, General and Administrative Expenses

Selling, general and administrative expenses consist of compensation and support for Lawson sales representatives as well as expenses to operate Lawson's distribution network and overhead expenses. Adjusted selling, general and administrative expenses increased to $208.7 million for the year ended December 31, 2022 compared to the adjusted amount of $192.3 million in the same period a year ago. Higher expense on a year-to-date basis versus a year ago were primarily driven by compensation expense to support increased sales, higher severance and higher amortization expense related to the reverse merger accounting, partially offset by lower costs related to the Mergers and stock-based compensation.

Adjusted EBITDA

During the year ended December 31, 2022, Lawson generated Adjusted EBITDA of $38.6 million, an increase of 27.1% or $8.2 million from the same period a year ago driven by increased revenue and margins.

TestEquity Segment

(1)Refer to the Non-GAAP Adjusted EBITDA section in Overview for a reconciliation of Adjusted EBITDA to operating income.

Revenue and Gross Profit

Revenue increased to $392.4 million for the year ended December 31, 2022 from $264.2 million during the same period in 2021. This increase was primarily driven by the TEquipment and National Test Equipment acquisitions during the second quarter of 2022 and the acquisition of MCS in 2021, which generated aggregate revenue of $96.6 million for the post-acquisition periods, as well as organic growth of 12.1% in the existing base business.

Gross profit increased $32.2 million to $89.4 million in 2022 compared to $57.2 million in the same period of 2021 primarily due to acquisitions and increased sales in the base business. As a percent of revenue, gross profit improved to 22.8% in 2022 as compared to 21.6% in 2021 driven by an expansion of margins within the existing base business and a shift in sales mix toward higher margin electronic production supplies.

Selling, General and Administrative Expenses

Selling, general and administrative expenses increased $21.1 million to $78.0 million in 2022 from $56.9 million in 2021. Approximately $14.8 million of the increased costs were due to the acquisitions made in 2021 and 2022. The remainder of the increase was driven primarily by an increase in merger and acquisition related costs of $2.8 million and additional compensation and distribution costs to support the organic revenue growth in the base business.

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Adjusted EBITDA

During the year ended December 31, 2022, TestEquity generated Adjusted EBITDA of $34.7 million, an increase of $18.6 million from the same period a year ago with approximately $8.5 million of the Adjusted EBITDA increase driven by the acquisitions closed during 2021 and 2022 and increases in revenue and margins on the base business.

Gexpro Services Segment

(1)Refer to the Non-GAAP Adjusted EBITDA section in Overview for a reconciliation of Adjusted EBITDA to operating income.

Revenue and Gross Profit

Revenue for the year ended December 31, 2022 was $385.3 million. This compares to revenue of $256.1 million for the same period a year ago, or a 50.4% increase. A selling day generally represents a business day in which Gexpro Services ships products to its customers. Average daily sales increased 51.1% over the same period a year ago, primarily as a result of revenue generated from the 2021 and 2022 acquisitions of $107.0 million for the post-acquisition periods and organic growth in the base business of 8.9% through an expansion of products and services to existing customers as well as the addition of new customers.

Gross profit was $112.9 million or 29.3% of revenue for the year ended December 31, 2022 compared to gross profit of $73.1 million or 28.5% for the same period a year ago. The gross profit increase was driven by the 2021 and 2022 acquisitions, an improvement in the global supply chain over 2021 activities and price increases put in place.

Selling, General and Administrative Expenses

Selling, general and administrative expenses consists of sales and marketing expenses primarily relating to compensation, costs associated with supporting Gexpro Services’ service facilities, overhead expenses within finance, legal, human resources and information technology, and other costs required to operate the business and service customers.

Selling, general, and administrative expenses for the year ended December 31, 2022 was $91.6 million compared to $62.0 million for the same period a year ago. The increase of $29.6 million over a year ago was primarily driven by the inclusion of the 2021 and 2022 acquisitions of approximately $24.5 million. The remainder of the increase was driven primarily by an increase in merger related costs of $2.8 million and additional compensation and product fulfillment costs to support the organic growth of the existing base business.

Adjusted EBITDA

During the year ended December 31, 2022, Gexpro Services generated Adjusted EBITDA of $43.2 million, an increase of $19.9 million from the same period a year ago with approximately $16.7 million driven by the acquisitions closed during 2021 and 2022 and increases in revenue and margins on the organic base business.

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Consolidated Non-operating Income and Expense

Interest Expense

Interest expense increased $7.6 million in the year ended December 31, 2022 primarily due to higher borrowings offset by a lower interest rate with the debt refinancing related to the Mergers.

Loss on Extinguishment of Debt

The $3.4 million loss on extinguishment of debt for the year ended December 31, 2022 was due to the write-off of previously capitalized financing costs as a result of the debt refinancing related to the Mergers.

Change in Fair Value of Earnout Liability

The $0.5 million expense in the year ended December 31, 2022 related to the change in fair value of the earnout liabilities associated with the earnout provisions of the Merger Agreements and the Frontier earnout. Refer to Note 8 – Earnout Derivative Liability and Note 3 – Business Acquisitions, respectively, within Item 8. Financial Statement for information about the earnout liability.

Other Income (Expense), Net

Other expense, net increased $1.2 million in the year ended December 31, 2022 compared to the prior year primarily due to the inclusion of Lawson operations subsequent to the April 1, 2022 Merger Date.

Income Tax Expense (Benefit)

Income tax expense was $5.5 million, a 42.8% effective tax rate for the year ended December 31, 2022 compared to income tax expense of $0.3 million and a (6.6)% effective tax rate for the prior year. The change in the year over year effective tax rate was primarily due to changes in the valuation allowance and merger costs incurred during 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 within Item 8. Financial Statements. Relative to the U.S. statutory rate, the effective tax rate for the year ended December 31, 2022 was impacted by state taxes, foreign operations and liabilities and transaction expenses related to the Mergers.

LIQUIDITY AND CAPITAL RESOURCES

Cash and cash equivalents were $24.6 million on December 31, 2022 compared to $14.7 million on December 31, 2021.

The Company believes its current balances of cash and cash equivalents, availability under its Amended and Restated Credit Agreement and cash flows from operations will be sufficient to meet its liquidity needs for the next twelve months. As of December 31, 2022, liquidity for the Company was $101.6 million comprised of $24.6 million of cash and cash equivalents and $77.0 million of borrowing availability remaining, net of outstanding letters of credit, under the Amended and Restated Credit Agreement.

Our primary short-term and long-term liquidity and capital resource needs are to finance operating expenses, working capital, capital expenditures, potential business acquisitions, strategic initiatives and general corporate purposes. Our current debt obligations under the Amended and Restated Credit Agreement mature in April 2027. Principal payments on the

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Amended and Restated Credit Agreement for the next twelve months are $15.0 million. Refer to Note 9 – Debt within Item 8. Financial Statements for additional information related to our debt obligations. Access to debt capital markets has historically provided the Company with sources of liquidity, beyond normal operating cash flows. We do not anticipate having difficulty in obtaining financing from those markets in the future, however, we cannot provide assurance that events beyond our control will not have a material adverse impact on our liquidity.

Sources and Uses of Cash

The following table presents a summary of our cash flows:

Cash Provided by (Used in) Operating Activities

Net cash used in operations for the year ended December 31, 2022 was $11.0 million, excluding non-cash items, primarily due to increased accounts receivables and inventories driven by higher sales and increased supplier costs driven by inflation and global supply chain disruptions.

Net cash provided by operations for the year ended December 31, 2021 was $10.3 million, excluding non-cash items, primarily due to decreased accounts receivable and increased accrued expenses partially offset by increased inventories.

Cash Provided by (Used in) Investing Activities

Net cash used in investing activities for the year ended December 31, 2022 was $126.7 million, primarily as a result of the other acquisitions completed during the year by TestEquity and Gexpro Services as described in Note 3 – Business Acquisitions within Item 8. Financial Statements.

Net cash used in investing activities for the year ended December 31, 2021was $41.4 million, primarily due to business acquisitions and purchases of rental equipment.

Cash Provided by (Used in) Financing Activities

Net cash provided by financing activities was $148.5 million for the year ended December 31, 2022, primarily due to proceeds under the April 1, 2022 Amended and Restated Credit Agreement partially offset by repayment of previous indebtedness. 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. Deferred financing costs of $12.0 million were incurred during the year in connection with the April 1, 2022 Amended and Restated Credit Agreement and January 3, 2022 Gexpro Services Credit Agreement.

Net cash provided by financing activities for the year ended December 31, 2021 was $34.7 million, primarily due to increased borrowings on the Company's revolving lines of credit partially offset by payments on the Company's term loans and a capital contribution to finance the MCS acquisition.

Financing and Capital Requirements

Credit Facility

On April 1, 2022, in connection with the closing of the Mergers, DSG entered into an Amended and Restated Credit Agreement, which includes a $200 million senior secured revolving credit facility, a $250 million senior secured initial term loan facility and a $50 million senior secured delayed draw term loan facility. Refer to Note 9 – Debt within Item 8. Financial Statements for a description of the agreement.

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On December 31, 2022, we had $417.1 million in outstanding borrowings and $77.0 million of borrowing availability remaining, net of outstanding letters of credit, under the revolving credit facility.

As of December 31, 2022, we were in compliance with all financial covenants under our Amended and Restated Credit Agreement.

While we were in compliance with our financial covenants as of December 31, 2022, failure to meet the covenant requirements of the Amended and Restated Credit Agreement in future quarters could lead to higher financing costs and increased restrictions, reduce or eliminate our ability to borrow funds, or accelerate the payment of our indebtedness and could have a material adverse effect on our business, financial condition and results of operations.

Purchase Commitments

As of December 31, 2022, we had contractual commitments to purchase approximately $168 million of product from our suppliers and contractors which is expected to be paid in the next twelve months.

Stock Repurchase Program

The Company's Board of Directors previously authorized a stock repurchase program that permits the Company to repurchase its common stock. The timing and the amount of any repurchases will be determined by management under parameters established by the Board of Directors and depend on various factors including an evaluation of our stock price, corporate and regulatory requirements, capital availability and other market conditions.

On November 2, 2022, the Board of Directors increased the existing repurchase program from $7.5 million to $12.5 million, and as a result, the Company had $7.6 million of remaining availability for stock repurchases under the program as of December 31, 2022. See Note 11 – Stock Repurchase Program within Item 8. Financial Statements for further information.

CRITICAL ACCOUNTING ESTIMATES

We have disclosed our significant accounting policies in Note 2 – Summary of Significant Accounting Policies within Item 8. Financial Statements. The following provides information on the accounts requiring more significant estimates.

Inventory Reserves - Inventories principally consist of finished goods stated at the lower of cost or net realizable value using the first-in-first-out method for the Lawson segment and primarily the weighted average method for the TestEquity and Gexpro Services segments. Most of our products are not exposed to the risk of obsolescence due to technology changes. However, some of our products do have a limited shelf life, and from time to time we add and remove items from our catalogs, brochures or website for marketing and other purposes.

To reduce the cost basis of inventory to a lower of cost or net realizable value, a reserve is recorded for slow-moving and obsolete inventory based on historical experience and monitoring of current inventory activity. Estimates are used to determine the necessity of recording these reserves based on periodic detailed analysis using both qualitative and quantitative factors. As part of this analysis, the Company considers several factors including the inventories length of time on hand, historical sales, product shelf life, product life cycle, product category and product obsolescence. In general, depending on the product category, we reserve inventory with low turnover at higher rates than inventory with higher turnover.

At December 31, 2022, our inventory reserve was $10.7 million, equal to approximately 3.9% of our gross inventory. A hypothetical change of one hundred basis points to our reserve as a percent of total inventory would have affected our cost of goods sold by $2.8 million.

Income Taxes - Deferred tax assets or liabilities reflect temporary differences between amounts of assets and liabilities for financial and tax reporting. Such amounts are adjusted, as appropriate, to reflect changes in enacted tax rates expected to be in effect when the temporary differences reverse. Significant judgment is required in determining income tax provisions as well as deferred tax asset and liability balances, including the estimation of valuation allowances and the evaluation of uncertain tax positions.

Goodwill Impairment - Goodwill represents the cost of business acquisitions in excess of the fair value of identifiable net tangible and intangible assets acquired. The Company reviews goodwill for potential impairment annually on October 1st, or

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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.

Business Combinations - We allocate the purchase price paid for assets acquired and liabilities assumed in connection with our acquisitions based on their estimated fair values at the time of acquisition. This allocation involves a number of assumptions, estimates, and judgments in determining the fair value, as of the acquisition date, of the following:

•intangible assets, including the valuation methodology (the relief of royalty method for trade names and multi-period excess earnings method for customer relationships), estimations of future cash flows, discount rates, royalty rates, recurring revenue attributed to customer relationships, and our assumed market segment share, as well as the estimated useful life of intangible assets;

•deferred tax assets and liabilities, uncertain tax positions, and tax-related valuation allowances;

•inventory;

•property, plant and equipment;

•pre-existing liabilities or legal claims; and

•goodwill as measured as the excess of consideration transferred over the net of the acquisition date fair values of the assets acquired and the liabilities assumed.

Our assumptions and estimates are based upon comparable market data and information obtained from our management and the management of the acquired companies. We allocate goodwill to the reporting units of the business that are expected to benefit from the business combination.

Valuation of Earnout Derivative Liability - 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 is 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.

Other Information Regarding DSG’s Independent Registered Public Accounting Firms

While Lawson Products, Inc. was the legal acquirer of TestEquity and Gexpro Services in the April 1, 2022 Mergers, TestEquity and Gexpro Services were treated as the combined accounting acquirer of Lawson Products, Inc. (now DSG following the name change of the registrant on May 5, 2022) for financial reporting purposes. As TestEquity and Gexpro Services were under common control for the historical periods presented prior to the Mergers in this Form 10-K, they are presented on a consolidated basis following consummation of the Mergers for all periods presented herein. 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. Accordingly, the consolidated financial statements as of December 31, 2022 and December 31, 2021 and for the year ended December 31, 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.

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BDO USA, LLP (BDO) was the principal auditor of Lawson Products, Inc., prior to consummation of the Mergers, and audited the 2021 financial statements of Lawson Products, Inc., which were included in Lawson Products, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2021. Grant Thornton, LLP (GT) was the auditor of TestEquity prior to consummation of the Mergers. The historical consolidated financial statements of Test Equity and Gexpro Services (and including, the legacy Lawson Products, Inc. business since April 1, 2022) had not been audited prior to their inclusion in this Form 10-K. In connection with and following consummation of the Mergers, the Company engaged BDO to audit the 2022 consolidated financial statements (and BDO’s engagement was ratified by the stockholders of DSG at the 2022 Annual Meeting of Stockholders, held on November 15, 2022), and engaged GT to audit the 2021 consolidated financial statements of DSG. Under the applicable SEC rules and interpretations, a registrant may only have one principal auditor at any one time, and the auditor engaged to conduct the audit of the most recently to be completed fiscal year end period is considered to be the principal auditor. As DSG had not been previously audited and BDO is both the principal auditor of DSG following the Mergers (as auditor of the most recently completed fiscal year included in this Form 10-K) and prior to the Mergers (as auditor of the registrant), the Company concluded that DSG did not experience a change in its principal auditor in 2022. GT’s engagement as auditor of the 2021 financial statements was completed upon filing this Form 10-K.