Michael DeCata - President, Chief Executive Officer Ron Knutson - Executive Vice President, Chief Financial Officer.

Kevin Steinke - Barrington Research Ryan Cieslak - Keybanc.

Good morning ladies and gentlemen, and welcome to the Lawson Products Third Quarter 2017 Earnings call. This call will be hosted by both Michael DeCata, Lawson Products’ President and Chief Executive Officer, and Ron Knutson, Lawson Products’ Chief Financial Officer. They will open the call with an overview of the third quarter results.

There will then be time for questions and answers. This call is being audio simulcast on the internet via the Lawson Products Investors Relations page on the company’s website, lawsonproducts.com. A replay of the webcast will be available on the website through December 31, 2017.

During this call, the company will be providing an update on the business as well as covering relevant financial and operational information.

I would like to point out that statements 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. Please consider the information presented in that light.

The company may at some point elect to update the forward-looking statements made today but specifically disclaims any obligation to do so. I will now turn the call over to Lawson Products’ Chief Executive Officer, Michael DeCata. Please go ahead, sir..

Good morning and thank you for joining the call. This morning, I’ll comment on the quarter and our overall progress. Ron Knutson, our CFO, will provide a more detailed review of the financial results for the quarter, and then we’ll take questions.

Overall, I would summarize the quarter by saying that we have demonstrated very good progress across many aspects of the company, highlighted by the largest acquisition that Lawson has ever made. We achieved 9.5% sales growth on an ADS basis for the quarter which contributed to a 68% increase in adjusted operating income.

In the past, we’ve communicated that as we grow the top line and hold costs flat, we will see impact on our operating leverage as more earnings will drop to the bottom line. This quarter demonstrates that fact.

This makes the fifth consecutive quarter of increasing average daily sales versus the prior quarter, having delivered an 8.2% increase in Q2 and a 7% increase in Q1. Organically, we grew 8.5% for the quarter. On a year-to-date basis, we have grown average daily sales by 8.2% overall, including acquisitions.

On an adjusted basis, we improved operating income by $1.5 million and achieved a 26.2% flow through on one less selling day. Now let’s discuss some of the specifics for the quarter. We continued to achieve broad-based growth across the company.

Every one of our regions achieved growth, and our Canadian business was up 28% for the quarter in local currency on an ADS basis. Strategic accounts ADS grew 58% versus last year and 46% year-to-date. Overall, we’ve seen continued strength across the broad market; however, we are seeing disproportionate growth from our oil and gas sector.

This is attributable to both increased production but also share gain. Overall, I believe that our superior service is enabling large and small customers to fully utilize their equipment and increase their productivity. As an aside, I recently spent time with one of our large customers who is in the middle of a large and logistically complex project.

The master mechanic explained to me that down time can cost his company $2,700 per minute. This was a great reminder that instant access to repair parts is critical. While we often discuss strategic accounts, it is important to note that we are equally focused on our local and regional accounts.

Excluding strategic accounts as well as government and Kent accounts, our core business grew at 7.7% this quarter on an ADS basis. We currently serve approximately 70,000 customers and ship to approximately 30,000 unique locations per month.

Our unique ship-to locations continue to increase as well as our average order size, which has grown from $367 to $381 over the past year. While the industrial market is growing nicely, based on general market research and various analyst reports, we believe that our growth is outpacing the overall market.

Turning to margin, we achieved 60.8% gross profit this quarter, which is an increase over both Q1 and Q2 of this year. Several factors contribute to our ability to maintain gross margin in an environment that is putting downward pressure on margins. First, we are continuing our efforts to work with suppliers to better manage costs and inventories.

Second, where we have experienced cost increases from a few suppliers, we have been able to pass them through. Third, we continue to source product directly from the originating manufacturer. Our goal is to grow gross profit dollars while understanding that customer mix will put pressure on gross margin percent.

Turning our attention to the markets, our growth strategy is on track. First, our sales rep count held approximately flat at 988 sales reps while we work on on-boarding and training.

Second, programs that I mentioned above along with enhancements to our sales rep order entry tools, the strategic accounts conversion process, and our efforts to increase share of wallet with existing customers are all having a positive impact on sales rep productivity. I always like to highlight examples of process innovation on these calls.

Today, I’d like to discuss our use of an internal social network that we call Lawson Central and Microsoft Teams. We have created several digital communities in which over 700 of our sales reps participate, along with many subject matter experts. For example, we have a digital community that focuses exclusively on serving the automotive market.

Sales reps ask questions and share best practices and success stories related to Kent products, applications, tools, and sales opportunities. We have a similar community that focused on Lawson products, applications, tools and best practices, and recently we added a digital community for our French-speaking sales reps in Canada.

Using their mobile phones, our sales reps are able to quickly exchange answers and suggestions with teammates across North America. It is becoming an incredibly powerful knowledge sharing and selling tool.

For example, recently one of our sales reps posted photos of rust stains in a hotel bathtub and explained how to use a chemical called E-Ruster quickly and effectively to remove stains. He even included before and after photos.

As more and more people become active in the network, we hope to shorten the cycle time between questions and answers to a few minutes, as well as build a sustainable knowledge base for our sales reps, an incredibly powerful tool. I’d like to turn to the third leg of our growth strategy, acquisitions.

Prior to our most recent acquisition, we completed four small acquisitions over the last 24 months. We’ve gained invaluable experience through this process. For example, the acquisition of Mattic Industries last year refined our understanding of the job shop OEM market segment.

This is a segment that uses our products and values our service in consultative problem solving, but it’s not repair. Product quantities are smaller than large scale OEM manufacturers, but VMI is critical to these customers. The Feeney acquisition that we completed some time ago is deepening our understanding of the truck and trailer market.

In short, we’re gaining significant benefits from our previous acquisitions which all now have been integrated into our core operations. They are also accretive to our bottom line. (Indiscernible) we announced the acquisition of The Bolt Supply House.

Bolt Supply, which will be immediately accretive, has sales of CAD$43 million and averages low double digit EBITDA. There are many reasons for us to be excited about Bolt Supply. Bolt has an outstanding leadership team and an employee base committed to outstanding customer service.

Bolt has 13 branches in western Canada along with 27 outside sales account managers and a 43,000 square foot distribution center in Calgary. We are also committed to growing the Bolt business and also leveraging their existing western Canada distribution center to benefit our Lawson and Kent customers through shorter delivery cycles.

Lawson and Bolt have several important similarities. Approximately 54% of Bolt sales are fasteners and approximately 70% are shipped directly to the customer site; however, Bolt also services the trades through their branch-based network. While we’ve now made five acquisitions over the past 24 months, we continue to fill our acquisition pipeline.

We have the personnel and financial resources to continue to act on acquisitions, which are one part of our three-part growth strategy. Overall, we’re optimistic about the actions that we’ve taken and our plans for future growth; however, having said that, the fourth quarter and next year will face tougher comparisons.

We work hard every day to gain share through superior service and execution. Our customer relationships tend to be very sticky. Our goal is to win share and add new accounts every day, and we’re making great progress. Now I’ll turn it over to Ron for more detailed insight into our third quarter financial results..

first, actions that we’ve taken to drive growth are getting results.

This includes converting new locations for our existing strategic relationships, improving the on-boarding process of new reps, driving additional accountability to the field management, providing reps with forums to support product and technical questions, continuing to invest in technology, and rewarding reps who achieve significant growth.

Second, our 2016 acquisitions boosted Q3 sales by approximately $700,000. For the quarter, these acquisitions drove 1% of our total growth. Third, sales to our oil and gas segment were up $2.4 million versus the year ago quarter, and finally, a general improvement in the overall MRO marketplace.

As Mike mentioned, the 9.5% sales increase was widespread throughout the business with our regional and large national sectors of our business increasing and all product categories realizing gains. On an ADS basis, U.S.

sales were up 7% while our Canada sales were up over 28% in local currency, fueled by both organic growth and our previous acquisitions. From a divisional standpoint, strategic accounts average daily sales were up 58% over a year ago and now represent approximately 16% of our total volume.

We also realized solid ADS growth of 7.7% in our Lawson core business, fueled by an 11% improvement in sales rep productivity. Our Kent Automotive and our government sectors were essentially flat for the quarter.

From a sequential average daily sales basis, both July and August finished with sales at $1.198 million while September finished at $1.206 million. As Mike mentioned, we ended the quarter with 988 sales reps.

As we’ve said in the past, while adding sales reps negatively impacts our earnings in the short term due to the upfront investments, it will ultimately help drive our total revenues and allow us to further leverage our existing infrastructure. We are continuing to focus on our sales team during 2017, both in terms of rep hiring and rep productivity.

We will balance those efforts with other priorities to drive the highest return to the organization. For the quarter, gross margin was 60.8%, in line with 60.6% from the year ago quarter and up from 60.2% in the second quarter.

Even though our sales mix continued to shift towards strategic customers who typically have a lower gross margin percentage, it was more than offset through additional vendor rebates and lower distribution center operating costs. There continues to be a lot of focus in the market around pricing and margin pressures.

Consistent with the second quarter, when we look at our pricing to the same customers for the same product from a year ago, our pricing has not declined in either the second or third quarter. Our customers understand the value of the service and premium products that we provide and understand that there is a premium for our offering.

Furthermore, they recognize the difference between cost and price. Ours is the lowest cost solution as it ultimately saves them time and money.

As discussed in the past, our plan to increase strategic customer relationships and to pursue more greenfield sales territories will put downward pressure on our gross margin percentage; however, our goal is to increase aggregate margin dollars as we’ve done in the last few quarters.

Selling, general and administrative expenses were $44.9 million for the third quarter compared to $40.2 million a year ago and $42.7 million in the second quarter.

The increase versus a year ago was primarily driven by a $3 million increase in stock-based compensation, restoring incentive accruals given improved performance, and acquisition costs associated with our recent acquisition. We will continue to tightly manage our ongoing operating costs. Operating income was $1.1 million for the quarter.

Adjusted non-GAAP operating income, taking into account stock-based compensation and severance, was $3.6 million for the quarter compared to $2.1 million a year ago and $2.9 million in the second quarter. Net income for the quarter was $1.3 million or $0.14 per diluted share compared to $1.8 million or $0.20 per diluted share in the year ago quarter.

From a balance sheet perspective, we ended the quarter with $19 million of cash on hand, no outstanding borrowings, and $36 million of availability under our credit facility. After the effect of our recently announced acquisition on October 3, our cash position was reduced to approximately $3 million with $16 million of outstanding borrowings.

Capex for the quarter was $728,000. We expect our capex for the full year of 2017 to be in the range of $1.5 million to $2 million, primarily in maintenance capital for our distribution network and continued technology enhancements to improve our customer facing processes. We do not anticipate significant capex related to our recent acquisition.

Now let me comment on a few items for the remainder of 2017. First, we are optimistic about the remainder of 2017 given our sales over the past few quarters, other economic indicators in our space, and actions we are taking to drive growth. However, we are up against tougher sales comps in Q4 as we lap a 2016 acquisition made in mid-Q4 of 2016.

Second, we will continue with our current strategy to expand our sales force while also focusing on existing rep productivity and acquisitions. Q4 will benefit from our recent October 3 acquisition of The Bolt Supply House. Third, we will continue to leverage our existing infrastructure to drive adjusted EBITDA.

We firmly believe that we are well positioned to leverage our existing operating costs. I will now turn it over to the operator for questions..

[Operator instructions] Our first question is from Kevin Steinke of Barrington Research. Please go ahead..

Good morning, Mike and Ron. So congrats on the nice results. Obviously you talked a lot about the internal growth initiatives and the acquisitions, how that’s contributing to growth. You also mentioned the improving MRO marketplace.

Just wondering if you can talk about that a little bit more outside of oil and gas, which has been a big contributor to growth, what the MRO marketplace feels like or what sort of improvement you’re seeing, and if you think that’s sustainable..

Yes Kevin, good morning, thank you. I think there are a number of drivers here.

As you see time utilization increasing for over-the-road trucking miles, for example, as you see the rental equipment industry increasing, certainly oil and gas as you see rig counts, and beyond rig count as you see unfinished rigs, oil wells that have been drilled but fields that have not been fracked, all of that in aggregate drives machine utilization.

So for us, what drives our business is when customers run their machines more for any reason, whether they go from the second shift and add a third shift, or there’s more over-the-road trucking miles or time utilization of their equipment increases, that just drives wear and tear on machines, so we’re seeing that across the broad spectrum.

Now, we’re also working hard through the strategic accounts conversion process, through technology, we saw an 11% increase in our sales rep productivity, so there are a broad range of processes, technologies that we’re putting in place to try and distance ourselves from the market, so we are seeing the market lift, but our challenge here is to grow beyond the market.

As well, I mentioned Lawson Central and MS Teams. I cannot over-emphasize just how powerful a tool it is when every rep has access to the knowledge of every other rep on a short cycle Q&A kind of a process. That is an incredibly powerful tool, and the more people who are in and more people who participate, the more effective the network becomes.

So all of those are drivers, both the market and our ability to win share and capture more customers and share of wallet..

Okay, great. Yes, that 11% increase in sales rep productivity, that looked like an especially strong number there.

I don’t know if you can dig into that a little bit more? I guess you’ve talked about the tools and the networking and what have you, so do you think those are the key contributors there to the increased productivity? Obviously you’re also getting a lift from the market, but I guess any more color about that increase in productivity would be helpful..

Yes, that is again. Again, there is some component , and in our environment it’s hard to dissect how much is market and how much are the activities that we’re engaged in. We’re going to deal with the market as it comes to us. Our challenge is what are the actions we can take. We talked about conversion of strategic accounts.

As an example, this is something we’ve been working on for a while, we worked on it last year.

This year, we targeted seven strategic accounts where we’re working on the conversion, and just to remind you, the conversion process is one where we already have an existing relationship with a large multi-site strategic account and yet we aren’t capturing all of the locations, so here we have a welcome audience, the corporate folks that are strategic account customers welcome us and try and help, and yet we have to go out and earn that business one day at a time.

So that is providing a lift for our sales reps and for our company, winning more share, and then while we’re at an account picking up more share of wallet and servicing more of the 12 product categories at every account, all of these things in aggregate contribute.

It’s pretty hard to dissect the specific numbers associated with each one of these activities..

Right, fair enough. That’s helpful. The strength in the gross margin, 60.8% despite the customer mix shift, Ron, you cited lower distribution center cost as one of the drivers there.

Are we seeing the benefit of the Fairfield closure flowing through there?.

Yes Kevin, so we’re seeing a couple of things.

First is we did see consistent with the second quarter a little bit of downward pressure just from a customer mix standpoint, but we were able to more than offset that with really overall distribution center productivity improvements, including the benefit of Fairfield, and then also some of the additional programs that Mike talked about relative to our relationships with our suppliers and vendors with some higher rebates coming through in the quarter.

So we were pleased with the overall percentage; however, our focus, and I think you saw this in the third quarter--I mean, we’re really growing aggregate gross margin dollars, so there will probably continue to be some pressure on the percentage, in particular the customer mix shift moving that around a little bit, but our goal is to increase the margin dollars, which we saw this quarter and actually second quarter as well..

Okay, sure.

You mentioned the focus on increasing gross margin dollars, although you still feel comfortable around that 60% level going forward?.

Yes, we do. Now, one item to take into account is that’s pre-The Bolt acquisition, so we did talk about this a little bit on The Bolt conference call, that they do create gross margins slightly less than ours, so that will put--you know, that will bring down the percentage just from including Bolt Supply in our Q1 and go-forward numbers.

But again, it will certainly add to our gross margin dollars..

Okay, right, yes. Thanks for that reminder.

Speaking of Bolt Supply House, now that it’s been a few weeks since the acquisition has been completed, can you just give us an update on what you’re seeing in terms of the integration, what the steps are there? As you’ve talked about, you gained confidence in doing integrations from some of the other acquisitions you’ve done, so just kind of wondering where you are in that process and what the next steps are there..

Yes, right. It’s been a nice and smooth transition, a team that is really committed and seamlessly jumped in, so we’re feeling great about it from that perspective.

You know, the first order of business is we have wanted a western Canada distribution center for quite some time, and while that was not the only reason that we put the two companies together, certainly it is one of the benefits that we see, and so the first order of business is putting some of the A and B items that are Lawson and Kent items into that distribution center, and so that’s the first order of business.

There will be expansion opportunities to add more branches, probably in British Columbia to begin, and of course as a reminder, it is our intention to run Bolt as a standalone for the foreseeable future, so that enables us a little more time.

Our primary opportunity with Bolt is growth, and we are extremely excited about Bolt’s growth and also Lawson growth because of the now western Canada distribution center. The combination, though, our primary driver was all about upside rather than cost-related synergies..

Okay, got it. Perfect. Thank you for taking the questions..

Thank you..

Thanks Kevin..

As a reminder, ladies and gentlemen, it is star, one if you would like to ask a question. The next question is from Steve Barger of Keybanc. Please go ahead..

Good morning, guys. This is Ryan on for Steve..

Oh, hey Ryan..

Hey. Sorry if I missed this, but kind of curious to know if you could give us a little bit of color on the trends you’re seeing so far in October..

Sure, so I’ll comment on that, Ryan - this is Ron. For the first, call it four weeks, I guess, from a Q4 standpoint, we’re not seeing any dramatic shift one way or the other from where we ended the third quarter.

What I would say is that, and I think both Mike and I commented on this, we are up against tougher comps as we move into the fourth quarter, so our sales started ticking up really at the end of Q3 of 2016 and continued to expand throughout the fourth quarter, so we are--and in combination with that, we are lapping an acquisition that we made in mid-fourth quarter of 2016, so that will add to the tougher comps as well.

But I would say that we feel good about where we are right now from a sales perspective. We feel good about the trends that we’ve seen over the past few quarters and don’t see anything in the foreseeable future as we enter into the fourth quarter and even into 2018 that would take us off course..

Okay, thanks. I believe in your prepared remarks you said you started to get some price increases.

Are you hearing anything from your suppliers that would suggest more meaningful price increases in the future?.

No, in fact--maybe I misstated that. No, we are not seeing anything out of the ordinary either on the cost side or the pricing side that--you know, anything changed for the last several years.

It’s really over the last several years been pretty steady state, both on the supplier side and our ability to pass through where we do see the normal price increases, which are few and far between, and same thing on the pricing side. No unusual pricing pressures over the last several years. .

Okay, then you had nice incremental margins, around 26% this quarter.

How should we think about incremental with Bolt Supply going forward?.

So what we’ve stated in the past is that we typically can achieve 25 to 30% leverage on our organic business going forward, and we’ve realized that over the last--I would say the last few quarters. As Mike mentioned, The Bolt Supply will be run more as a standalone organization.

There certainly are opportunities for us to take advantage of their western Canada distribution and so forth, but going forward we expect that their EBITDA will be able to grow.

I think Mike commented in his prepared remarks that they’ve been in the low double digit range from an overall EBITDA perspective, so Bolt Supply will be accretive to us immediately, so it’ll allow us to trend more on the higher end of that 25 to 30%..

All right, thanks guys. Congrats on the quarter..

Thanks Ryan..

Thank you..

Just another reminder, it’s star, one now if you would like to ask a question. Gentlemen, it appears we have no further questions in the queue at this time.

Would you like to make some closing comments?.

Yes please, thank you. Thank you for joining the call, and thank you for following Lawson Products. The third quarter continued our growth trend and reinforces our improving earnings trends. We remain optimistic that the actions that we’ve taken as well as process improvements through Lean Six Sigma are enabling us to win share in the market.

As the U.S. and Canadian industrial economies continue to expand, customers need our services even more and depend on Lawson Products to maximize their productivity. We feel very good about our progress. There is considerable work ahead of us to continue to accelerate our sales and earnings growth.

I have the utmost confidence in our value proposition and our teammates. Lastly, I’d like to take this opportunity to publicly welcome the outstanding team at The Bolt Supply House. Our team and our company overall continues to grow stronger. We’re positioned and committed to a prosperous future.

Thank you again for joining us this morning, and have a wonderful day. .

Thank you. Ladies and gentlemen, this does conclude today’s teleconference. You may disconnect your lines at this time and thank you for your participation..