Disclaimer: This interview is for informational purposes only and should not be relied upon as a basis for investment decisions. In Practise is an independent publisher and all opinions expressed by guests are solely their own opinions and do not reflect the opinion of In Practise.

{audio:0:06:59} Perhaps you can start with your background and how it relates to TestEquity, and we can go from there.

{audio:0:07:05} I’ve been in industrial B2B distribution for about 22 years. The majority with Grainger; I was there for 12 years. My last role was to lead sales coverage and design for the business. I left Grainger in 2015, and I’ve been in medium-sized private equity distribution businesses for seven years. In that time, I’ve worked with a few companies, one of which is TestEquity. I was with TestEquity for just less than two years and led sales and marketing for them. My time there came in the middle of a brutal ERP integration, and we had just got the wheels back on that train when Covid hit. Having been through all that, I ended up jumping ship and walking away, but I know the business extremely well. Grainger actually bought and sold about half the business – the electronic production side – when I worked with them. 

{audio:0:08:23} That sounds helpful. If you worked for Grainger, you are probably also familiar with Lawson and Gexpro Services, is that correct?

{audio:0:08:28} Yes, more so with Lawson. 

{audio:0:08:40} Okay; we will discuss Lawson later. What are these strengths and weaknesses of TestEquity?

{audio:0:09:02} I need to talk about this as two sides of the business; on the test and measurement side, they had a lot of strength. They’re differentiated in the market because of the size of the sales force, their tie to the suppliers in that business, and to key integrators or diversified suppliers that sell into the prime contractor markets. They have other unique offers; their rental and used product brokering, which is strong. Also, the environmental chamber business they have designed and built up gives them a unique strength in that market. Their strategy is good through their marketing and ecommerce. Also, their targeting of end markets and corporate accounts is a further strength. 

{audio:0:10:17} What about on the production supplies side? 

{audio:0:10:23} For me, this side is a different story. I like what they’ve done recently. I think the leadership team and their go-to market strategy are changing. They are focused on a generalist and specialist approach, where all sellers can sell all products, and they have specialization. That helps that market, but the production supply side is a little more affected by the ‘Amazon Effect’ and online buying. While their products are specialized, tweezers are tweezers at the end of the day, so they’re not as specialized. 

{audio:0:11:05} Are there any weaknesses on the test and measurement side? 

{audio:0:11:15} One of the challenges is that the suppliers control the margin. There's no opportunity to turn a 20% margin to 30% or 40% margin, it’s heavily controlled. That’s one of the risks for me. 

{audio:0:11:34} Were they tied to Keysight when you were there? 

{audio:0:11:40} Yes, definitely. I think 60% or more of their business is Keysight. While Tektronix and Rodhe & Schwarz have some footprint, they're not as strong in the market. I bet the ratios align well to the market. Keysight are dominant in the market. 

{audio:0:12:10} There has been some thought Keysight might start doing more of their own distribution. Do you see that as a risk to TestEquity? 

{audio:0:12:29} I think there's some risk. However, I've been in a space for a long time, and I see lots of manufacturers test it and then fail at it. For example, Parker Hannifin is the biggest manufacturer in the business, and they try to take orders directly often, and we end up serving direct customers. Their targets are large customers to take direct, but they often don’t have the inventory, because it’s spread out in the channel. They end up stumbling and then rely on their distribution channel to solve that problem for them. So, I don't see Keysight fully getting away from the channel. There’s only about 30% to 40% of the Keysight offer is sold in the channel, so Keysight does have half of their business direct anyway. 

{audio:0:13:44} Help me understand the relationship between Keysight and TestEquity; how do they work together? What value for Keysight is TestEquity? 

{audio:0:13:57} Considering the entire distribution channel for Keysight, there are three or maybe more distributors in their US channel; TRS-Rentelco, Electro Rent and TestEquity, and they're going to market with those predominantly. There are many other distributors that carry Keysight products, like Allied, and others that predominately sell it at list, online. 

{audio:0:14:31} What differentiates the three companies I talked about from the Keysight channel is that they have expertise, rental, and used equipment, and can configure and calibrate Keysight product on site. They can bring stuff in and calibrate it for customers. They can provide full, life cycle solutions for customers, whereas none of the other sellers of Keysight have that capability set. There are three to six larger distributors that provide full life cycle solutions to their customers, on behalf of Keysight, and keep them differentiated in the market. 

{audio:0:15:21} It’s the expertise and those skilled sales engineers that is the value, because it helps Keysight manage their customers. Is that a fair assessment?

{audio:0:15:36} There are many customers out there that want even more. There are customers who would love a company to know every piece of test and measurement equipment they have in all their facilities, and if they’re calibrated or not, what their life cycle is and how they manage all that. That's a direction in which TestEquity can go, and that's where this market is. The majority of the markets in aerospace, prime government contract manufacturers, such as Lockheed, Raytheon, and BAE, are the anchor for the market. Some of those types of customers will have 80,000 pieces of test and measurement equipment in their inventory. They don't know what to do with it and manage it, so they're dependent on the channel partners. Keysight’s never going to do that type of stuff; they’re a manufacturer. That provides long-term growth capability for a company like TestEquity, because those big customers aren’t going anywhere, and their demand is so heavy for those solutions.

{audio:0:16:55} You mentioned the three big players, TestEquity being one. How do you view their competitive position versus the other two players?

{audio:0:17:08} It works around the amount of rental business, TestEquity has the least rental at about 30%, TRS-Rentelco is about 50/50, and Electro Rent is more like 70/30 rental. TestEquity is the best pure distribution, new product business with the best inventory, compared to those other players.

{audio:0:17:43} What's the value proposition for customers to rent versus buy?

{audio:0:17:51} Usually, it’s around things like duration of need, which can be project based, or seasonal. For example, you can only do 5G antenna placement when it’s warm, so a contractor that’s doing a lot of that work may choose to rent the signal generators and signal analyzers you use for that from April to October, and then turn them back in for six months and get the benefit of that. It could be on a new build project, for example, if Google is building a big lab, the company that’s working on will only need equipment for a year or two, so they can rent it. It’s better financially for them than to buy it. 

{audio:0:18:54} In non-rental distribution, you said TestEquity are the strongest players, why don’t they do more rental?

{audio:0:19:08} Primarily, because of the investment. To have a huge rental place, you have to have a massive amount of used inventory. So, you have to charge up millions of dollars of used inventory, which is feasible, but then you have many assets on the books. I think they could go after more, but it’s an investment decision. 

{audio:0:19:33} Would customers switch frequently between these three players, or play them off against each other to get better pricing? 

{audio:0:19:48} Yes, I would compare it to any other big businesses that are going after each other. From a sales standpoint, you’re trying to differentiate on whatever your value points are. If you’re better at calibrating and vendor managed inventory, and solutions that are good for a customer, you’re going to anchor in those and try to shift the business. 

{audio:0:20:13} How often do those shifts happen? How often would a big 5G contractor change their test and measurement equipment supplier?

{audio:0:20:27} There are probably four to six, mid-six-figure deals that shift a year. 

{audio:0:20:44} Out of how many? Is that a lot in this context?

{audio:0:21:01} If any of these companies are doing their job well, they should take 2% or 3% market share, share of wallet, from competitors in a year. 

{audio:0:21:19} How much of the market do those top three control? Do they control a long tail of small competitors? 

{audio:0:21:25} Most of them started as calibration houses, which have a lab and can test and configure equipment. Then they'll get into some new equipment and have some rental inventory. There are quite a few mom-and-pop shops, spread throughout the US. They are almost too small to be acquisition targets, so they're not something to go after. 

{audio:0:21:56} The share goes to those three bigger players each year because they have better capabilities?

{audio:0:22:02} Yes. They’re going to gain share in two ways: one is better capabilities, taking it from the other big ones, and that mom-and-pop market will consolidate.

{audio:0:22:14} One of the strategies for TestEquity now is to start acquiring more of those mom-and-pops and be the consolidator? 

{audio:0:22:20} Yes, I don’t know this for sure, but they are trying to find a few regional calibration businesses. It would probably be a greater metropolitan area type of business, Greater Phoenix, for example, with perhaps two labs and 10 vans. They are better acquisition targets than the ‘one guy and his wife’ shop with a stool.

{audio:0:23:07} One of the concerns we touched on is TestEquity’s reliance on Keysight. Recently, they have announced many agreements with other suppliers. Is there anyone in the industry who would be valuable to add on?

{audio:0:23:39} There’s a company that makes more custom products, called National Laboratories. Let's say you have a production line, and you build hydraulic manifolds, and at the end of that line you want to test that manifolds for pressure, and you’re building a system to do that. They’re a big player in the industry. If you could get more of their distribution, it would be careful. Tektronix and Rohde & Schwarz are the next two announced this year. 

{audio:0:24:30} Would you say they are smaller than Keysight? 

{audio:0:24:33} Yes, I think they're smaller. I think Tektronix has lost market share over a couple of decades. Rohde & Schwarz hasn’t figured out how to play well in the US. They love the European direct model. 

{audio:0:24:53} Europe is more of a direct model, and the US is more of a distribution model, is that right? 

{audio:0:24:57} Yes, it’s much more direct. 

{audio:0:25:01} Why does that work in Europe, but not in the US?

{audio:0:25:04} I don't know. Possibly it’s that it's much easier for the manufacturers; the market’s controlled, smaller, they can maintain inventory and get it to where they want it. But I’m just speculating. 

{audio:0:25:28} It sounds like adding suppliers is obviously good, but there's no one big thing that would move the needle in terms of diversifying them away from Keysight?

{audio:0:25:44} Yes. There is Fluke, and they sell that too, but it’s lower value, handheld equipment, and everybody sells it, so it’s not differentiated at all. 

{audio:0:26:03} The good thing is they add significant value to Keysight and the customers. What is the likelihood of them being significantly disintermediated? How likely is it that in five years we've got more European style, direct distribution in the US? 

{audio:0:25:24} Zero likelihood, in my mind. 

{audio:0:26:27} Is that because of the services and calibration? 

{audio:0:26:33} Yes, the channel is too important. The number of bricks and mortar, sellers, and laboratories, and so on, that Keysight would have to add to suck up the channel, would be a lot.

{audio:0:26:57} You were there during the ERP implementation; can you talk about the disruption that caused and why that was the problem?

{audio:0:27:07} Yes. It was a mystery to me. I came in two and a half months into it. From an ERP implementation standpoint, there are things that stick out: There were four ERPs, because the production supply side was three separate businesses, and they weren't going to one of the ERP platforms, so there was no benefit of it already known in the business. It was a completely new ERP. I think the ERP company over promised capabilities for things like rental, supply, invoicing, and vendor managed inventory. Those were issues. The last one is that TestEquity had a cool homemade system that did everything they wanted quickly, and technical people who knew how to use it well. That all went away, and that made it difficult for them. 

{audio:0:28:23} What actual, tangible impact did that have? Did it impact your ability to sell products?

{audio:0:28:39} There were impacts on both the sales side and the invoice and payment side. It’s a double whammy when you’re struggling to get a quote to a customer, with the information they need on it. That was the impact on the sales side. There was critical information that used to go on quotes, such as technical information about products, etc. built into the system, and specifications too. There was a lot of Keysight stuff that was very modular from a firmware standpoint. Much of that is done at the distributor, where it's a base unit, and the firmware is updated to where the customer needs. It's important to make sure that’s right, so if there is a breakdown in communication and it’s not right, that's a big failure to the customer. 

{audio:0:29:47} Would the customer then go to another supplier?

{audio:0:29:53} Yes. Electro Rent benefited the most from it, during that time. 

{audio:0:30:04} Were they still stuck with those problems while you were there, or did they come out of it?

{audio:0:30:13} They came out of it on the test and measurement side, because the TestEquity side of that business had so much value in terms of technical knowledge, people knew so much and worked well with it. So, that bounced back pretty fast. The approach in the market worked well. Whereas on the production supply side, if you’re having problems and that business moves, there's no impetus to move back. If you're buying tweezers from one company and don't like them, you move and buy them from somebody else. That's a harder business to build back. I’ve been away for a few years, so I don't know what's happened. But there are more differentiators on the test and measurement side with returning customers, than on the other side.

{audio:0:31:16} I believe they’ve approached coverage with more of a layered approach of marketing, phone channel deployment, and all field sellers bringing all the products to market. Then, with test and measurement as a layer of specialization. It’s how I would have done it if I had stayed there. I'm pro that model, and I think it’ll have more success with that. That's where those products start to tie together, when you can get sticky because of a value like test and measurement, and sticky around a value like vendor managed inventory of production supplies, especially for electronics, aerospace manufacturing, and those sort of businesses. That's a good, combined solution. 

{audio:0:32:13} That’s the overall plan for them. Considering the industry, how do you consider the organic growth potential for the industry? 

{audio:0:32:47} I think the investment in aerospace in the US is so strong that it will continue to grow. They also get the benefit of onshoring. Aerospace is here to stay, but when you think about most electronic manufacturing IoT, while design R&Ds are usually in the US, manufacturing is overseas. So, onshoring is a benefit to them. There's definitely an uptick in the medical device industry, and that tends to get manufactured onshore too. That's a good market for this business. Part of that is that in the electronic production space, every bench will have a piece of test equipment. Things like MRI solutions and incubators, and all that stuff in medical, are all network tied. As it's being built, you have to be connected to a network and test that capability the whole time. That’s a good market for them too. They've also done well in higher education. Higher ed, aerospace, onshoring and medical are all good opportunities for them. 

{audio:0:34:14} They are set up in a good set of industries? 	

{audio:0:34:26} Yes. I think automotive will bounce back here, and the chip manufacturing. I think they're in a good four-to-five-year position. 

{audio:0:34:32} If we looked at five years, do you think TestEquity would have gained or lost market share? 

{audio:0:34:44} From what I generally know of the leadership and their market strategy, I think they’re well positioned to gain market share. I don’t think they’ll gain a large percentage from those primary competitors, but a small percentage gain. The benefit of the rest of the market consolidating will help them. Some of that will be non-organic. 

{audio:0:35:11} Who's their best competitor? Who is most likely to take market share from them?

{audio:0:35:15} Electro Rent. On the other side, it’s Hisco. 

{audio:0:35:35} You mentioned the management team, did you work with Russ Frazee? 

{audio:0:35:42} Russ and I are good friends. 

{audio:0:35:45} What’s your impression of him as a manager?

{audio:0:35:51} I am a huge fan. When he was promoted to CEO, I was excited. It's exactly what that business needs. Russ and I came from FCX, the previous company, together. He led ops and I led sales. I couldn't be more thrilled, not just from a business operation standpoint, but from a cultural standpoint. He's the type of leader that will rally that business.

{audio:0:36:22} Can you expand on that and tell me how you would describe the culture of TestEquity? 

{audio:0:36:35} I was there during a very bumpy period. With ERP, Covid, and the previous CEO, those were challenging times. The previous CEO, Steve, brought great people with him; Dan, the head of marketing, Nick, the CFO, Russ, and they promoted a sales leader; Dan. Those core four are a solid group, and you get the blend of good market leadership and knowledge, and a good internal promotion. I love that mix. I stay tuned in to them on LinkedIn, and I know people who work there, and from everything I hear culturally, things are going well. 

{audio:0:37:37} If we looked at it in five years and TestEquity had struggled, what’s the most likely reason for it? 

{audio:0:37:51} There are some sniper risks. I think the Keysight Direct is a sniper risk, but a low one. Another thing that could happen is Keysight could add larger distributors in the market. For example, if Hisco added a lab and more technical sales, and Keysight decided to help them develop more business in the market. If they went from three big ones to four, that could be a risk for them. I'm completely speculating, but those are the types of things that can hurt them. The other would be an awkward, huge downturn in the aerospace and dispense industry. 

{audio:0:39:19} Would it ever make sense for TestEquity to acquire Hisco?

{audio:0:39:23} I think it would look more like a merger, but that would be a good merger in the market. I think they could get a lot of protection out of that.

{audio:0:39:50} Do Transcat compete in this space?

{audio:0:39:54} They do. I remember them carrying a broader, more diverse, unique, set of test and measurement products, things that would go in a panel system and live, and test like a server farm. They were not as focused on the big stuff and carried more unique and diverse test brands. 

{audio:0:40:38} They seem to have more medical and have a huge service component to their business that is higher margin and more stable than pure distribution. TestEquity doesn’t seem to have as much of that.

{audio:0:40:52} It’s around that space where they install stuff, and that's going to be permanently situated. 

{audio:0:41:05} I would have thought that would be a bigger portion of TestEquity’s business.

{audio:0:41:12} No. I think they would have to acquire into it. 

{audio:0:41:15} Why would they have to acquire into it?

{audio:0:41:22} Mostly because it’s hard to greenfield the service side. It’s hard to find techs in the field and have them do the work. 

{audio:0:41:32} Is it someone else doing the service work on TestEquity installs?

{audio:0:41:43} Like I said, I think it's because it's different equipment. Most of that Keysight stuff is less permanently installed and used on a fly. They have a lot of mobile equipment, a lot of stuff that you would carry strapped onto you. Much of it is stationary in labs, too. A lot of the service on it is pick up and go. If you went to Raytheon or Lockheed Martin, you would see a calibration house that picks up equipment, tests it, repairs if they need to, calibrates it, and brings it back. They’re there every day. There's a calibration company in Fort Worth at the Lockheed plant, which is there every day. They pick up equipment, take it to the lab, test and fix it, then send it back. I think that's a different service than Transcat do.

{audio:0:42:58} When they acquire companies, they talk about providing relationships with manufacturers that other distributors don't have, such as, if they bring in someone who covers a certain region or industry, they can also bring in the supplier relationships. Does that make sense to you, as a benefit to acquiring something? 

{audio:0:43:22} Yes, that would be part of their acquisition strategy. It would either be acquiring in the service, like the regional size calibration company I talked about, installation service, or acquiring through some adjacent lines. There are other lines that are unique and specific, that would be a good addition, but they’re not big. These are $10 or $20 million manufacturers that have found niche piece. You could get into some of those spaces through acquisition, but you’d need product or service even more. I would focus on service, and that’s where I would go for my acquisition strategy. 

{audio:0:44:21} We haven’t yet discussed the chambers business. Could you help me understand how that works, and what their competitive position is? 

{audio:0:44:33} They thought about spinning it off or selling it off and on. I don't know where they manufacture today, but they were manufacturing it in the Valley in Los Angeles.

{audio:0:44:44} They say now they’ve outsourced it.

{audio:0:44:47} Yes. That’s right. They outsourced it to a contract manufacturer, which is a way better situation for them. That said, the intellectual property is good, and it's one of the only US manufacturer brands. I went to many trade shows where I’d look at the other ones, and it wasn’t near the quality of our product. It was all in the specifications, how cold or hot it can get, how quickly it can transition between hot and cold, and how closely it can hold a temperature or humidity level. Those are important. I was impressed by how much stuff gets environmentally tested in chambers. I’ll give you a bizarre example; one of the high-end auto companies tested their leather in an environmental chamber. It was so much stuff. There are many manufacturing environments where either a federal regulation or other elements require environmental testing. For example, every hydraulic component on every airplane must be environmentally tested. 

{audio:0:46:19} It's got a good market from that standpoint. There's plenty of government regulation requiring it, and more and more companies are testing all sorts of different stuff environmentally, to see how it stands up. 

{audio:0:46:32} They actually have good IP, but it was the kind of business they shouldn’t have been manufacturing themselves, so it makes sense for them to outsource it to a contract manufacturer?

{audio:0:46:44} Yes, that's what they should do. I remember them talking about how those contract manufacturers do such a good job of taking any update and specification and applying it quickly. They would actually provide overtime cost benefits too. They would reduce the cost of manufacturing overtime, as part of the guarantee that a contract manufacturer made. They could get some profitability benefit on it too. 

{audio:0:47:25} When you compare that to the other two business lines; the supplies and the test and measurement equipment, which of those three has the highest margin line, on an EBITDA basis? 

{audio:0:47:53} It was a good profit. It was probably 40% on new and 55% on rental. They made good money on rental on the chambers, because they rent it at one 12th of the cost. If someone rented it for a year, it was paid for. Your cost ends up being inventory, carrying and repair. I'm used to the other space, the supplies space, and that tends to sit in the 30s. I would say the chambers were probably the most probable piece. 

Distribution Solutions Group: TestEquity, Gexpro, & Lawson

Former SVP at TestEquity

inpractise.com/articles/lawson-products-testequity-gexpro-and-lawson

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Former SVP at TestEquity

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Were they still stuck with those problems while you were there, or did they come out of it?

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