Good morning, ladies and gentlemen and welcome to the Lawson Products Fourth Quarter 2019 Earnings Call. This call will be hosted by Michael DeCata, Lawson Products’ President and Chief Executive Officer and Ron Knutson, Lawson Products’ Chief Financial Officer.

During this call, they will be providing an update on the business as well as covering relevant financial and operational information. There will then be time for question and answers.

Please note that the 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. This call is being audio simulcast on the Internet by the Lawson Products’ Investor Relations page on the company’s website, lawsonproducts.com.

A replay of the webcast will be available on the website through March 31, 2020. I will now turn the call over to Lawson Products’ CEO, Mike DeCata..

Good morning and thank you for joining the call. This morning, I will comment on the fourth quarter results and our continued progress. Ron Knutson, our CFO will provide more detailed review of the financial results, followed by your questions. Lawson Products had a solid fourth quarter and a strong fiscal 2019.

Our results this quarter were driven by ongoing consistency of several factors, including MRO sales, EBITDA growth and significant operating leverage complemented by strong sales performance at Bolt Supply. Consolidated sales grew by 2.7%, including an increase of 1.7% in the Lawson MRO segment and a 13.3% increase at Bolt Supply.

These results, combined with effective management of our cost structure, supported a 240 basis point increase year-over-year in adjusted EBITDA margin, with $7.3 million in adjusted EBITDA or an 8.3% margin for the fourth quarter compared to $5.1 million or 5.9% margin in the fourth quarter of 2018.

For the year, sales increased by 6% with adjusted EBITDA of $34.5 million, representing a 37% increase over 2018 levels and our adjusted consolidated EBITDA leverage was over 44%, primarily due to our ability to leverage our existing infrastructure.

In sum, both the fourth quarter and the full year results reflected successful execution of our growth strategy. A recurring theme to our performance in the quarter, as well as the year is the commitment of our teammates to identify productivity improvement opportunities resulting in broad-based process improvements.

This commitment has also enabled us to effectively manage our cost structure while investing in the future. Overall we’re pleased with our continued progress, and we’re very confident in our ability to continue to build on the successes that we’ve achieved over the past three-plus years. Now let’s discuss some of the details.

Our gross profit trends remain favorable. Lawson core achieved 60.9% gross profit for the fourth quarter, essentially flat adjusting for the new revenue recognition standard. For us, there is a consistent theme here, the ongoing appeal of our value proposition. This continues to differentiate Lawson Products.

For example, our customers continue to experience labor shortages, especially as it relates to maintenance mechanics. These are mechanics, shop supervisors, welders and parts managers.

This strengthens the importance of the Lawson value proposition which blends superior performance products, including 60% private label products, which have been designed to meet the needs of maintenance mechanics and superior service, including visiting our 70,000 customers on average every 10 days.

Our approach also strengthens the barriers to entry as Lawson Products value proposition becomes more integral part of our customers’ success. We have very strong customer retention.

We’ve been rewarded with approximately 92% sales retention and we’ve discussed in the past, we continue to invest in initiatives to increase customer retention while growing share of wallet and adding new customers. Our government business continues to achieve significant growth.

Sales increased 10% for the fourth quarter versus the fourth quarter of 2018 and 24% for the full year. We continue to win proposals at the state level that will help us fuel our government business growth going forward. The military end market grew 137% for the year.

However, we did see a slowdown during the fourth quarter which was attributed to a delay and reauthorizing the Defense Appropriation by Congress. The good news is that in late December, Congress reauthorized this budget. Our strategic accounts business continues to execute and the conversion process which I’ve highlighted in past earnings calls.

During the fourth quarter, we added 46 new locations within existing accounts, bringing the year-to-date total to 266 new locations.

Another positive indicator of the strength of our value proposition and solid execution, several of our large strategic accounts continue to bring us into new locations and when they grow through acquisition, we win a disproportionate share of the opportunity. Our goal continues to be 100% share within existing accounts.

We have also added five new strategic account customers this quarter in the healthcare, environmental services, construction and integrated supplies industries. Overall, strategic accounts were impacted by the slowdown of two oil and gas customers. Growth for the year was 4.5%.

However, excluding the two customers that I just referred to, our yearly growth would have been over 18% versus 2018. It is important to mention that we still retain those customers. However, as their machine time utilization slows their maintenance processes have also slowed.

The strategic account business remains solid with fourth quarter growing over 4% versus a year-ago quarter. Bolt Supply had another great quarter with sales growth of 13% in Canadian dollars on top of 17% growth achieved during the third quarter and 18% in the second quarter. Results this quarter were broad-based.

In addition, several construction companies in Calgary were particularly strong. We expect continued positive trends from Bolt Supply in 2020. Operationally, we also continue to pursue process improvement in every area of the company.

For example, we are nearly complete with an AP automation project that employs optical character recognition and other invoice matching technologies to improve the department’s productivity. This is just one example of how we’re embracing new technologies throughout the company.

Stepping back from the puts and takes of the quarter and the year, our message is that our three-part growth strategy continues to deliver. First, growing our sales team, including Bolt Supply, we finished the year with a 1,030 sales reps and plan to incrementally hire for the foreseeable future. Sales rep retention has also continued to improve.

Second, increase in productivity. This quarter, Lawson core sales reps achieved 0.3% improvement in sales rep productivity versus the fourth quarter of 2018. Similar to others, soft sales in late December deflated this growth rate. Our MRO average daily sales grew by 1.7% versus the fourth quarter of 2018 and were up 5.6% for the full year.

Third, growth through acquisition, we feel very good about the acquisition pipeline and will remain disciplined in our executing on the plan. Growth through acquisition continues to be an important part of our strategy.

As a reminder, to support these efforts, we recently added Brian Hoekstra, our VP of M&A in September, as well as completed a new banking relationship with JPMorgan, CIBC and Bank of America in October. In sum, we are optimistic about our M&A efforts in 2020.

As I mentioned a moment ago, even with middle single-digit sales growth and continued focus on cost management, we were able to exceed our previously stated EBITDA leverage of 25% to 30%.

We are well-positioned to further drive the business through our compelling value proposition, commitment to continuous improvement and disciplined approach to capital allocation including executing accretive acquisitions. We feel confident in our previously communicated range of 25% to 30% MRO operating leverage for 2020.

As the quarter and the year demonstrated, day-to-day tactical execution has never been stronger. Let me comment on the overall business environment. As forecasted, the overall environment did slow in the fourth quarter of 2019. In particular, the last couple of weeks of December were soft. We believe this was in large part due to when the holidays fell.

It is also important to note that we continue to hold G&A costs nearly flat while amortizing our excess distribution capacity. EBITDA and leverage continues to improve. Process reengineering, the use of productivity-enhancing technology, and close relationships with suppliers will also enable us to continue to successfully leverage our infrastructure.

One other topic on everyone’s mind is supply and customer impacts from the coronavirus. We have been in regular contact with suppliers and today, we have not experienced any shortages. Suppliers have also assured us that they have ample supply of our product on hand.

We import approximately 12% of our products from China and very little of our maintenance engineered private-label products. Having said that, we are monitoring the situation closely and should the need arise, we will purchase extra safety stock. Today, we have also not experienced any customer impacts associated with the situation.

Last week, we hosted our sales leadership team in town for three days of training and planning. Our team is very optimistic about the state of the company and progress that we’re making in the marketplace. Now, I will turn the call over to Ron for more insight into the fourth quarter and the full year financial results..

strategic accounts, governments, Kent Automotive, Core Lawson and Bolt Supply, which had a great sales year. Through managing our gross margins and our operating expenses, 2019 adjusted EBITDA increased 37% to $34.5 million from $25.2 million a year ago. This also represents a 210 basis point improvement as a return on sales.

Now, some thoughts as we move into 2020 current economic indicators in our sector show growth, but at a slower rate. We continue to drive growth through our internal initiatives such as focusing on core product categories, expanding our reach into existing strategic customers and growing our state and local government presence.

We continue to monitor inflation and tariff trends and we’ll take the necessary actions to ensure that we stay ahead of increasing product costs. We exceeded our 10% EBITDA to sales milestone for two quarters in 2019 and ended the full year of 2019 at 9.3%, an increase of 210 basis points year over year.

While our expectation is to achieve 25% to 30% operating leverage, our business does have some seasonality to it, in particular Q1 and Q4. During 2020, we will continue with our sales and operating initiatives to fully leverage our business. I will now turn it over to the operator for questions..

Thank you. [Operator instructions] Our first question comes from the line of Kevin Steinke with Barrington Research. Please proceed with your question..

Good morning, Mike and Ron..

Good morning, Kevin..

Good morning, Kevin..

So the operating leverage in the model continues to be outstanding.

We can continue to talk about broad-based process improvements, you continue to streamline costs, just as you look out over the next few years here, what’s the opportunity that you have to continue that process through – I know you have Lean Six Sigma initiatives across the company, but do you think there is still a decent amount of runway to continue improving processes and streamlining costs or at least holding them flat going forward?.

Yes, Kevin, thank you. This is Mike. We don’t see an end in sight, whether we turn our attention to G&A cost, process improvements, stripping out non-value-added activities, the use of technology, but also turning our attention to sales rep productivity, again, through the use of Lean Six Sigma and dissecting sales processes, hiring processes.

By the way, tomorrow, I am kicking off another Lean Six Sigma class for teammates here at corporate. So the short answer is, we don’t see an end in sight. There will always be process improvement, there will be new technologies even years from now. So, it is a continued process and you have to work at it every day.

But we are very, very optimistic about our ability to continue to manage costs and deliver more and more productivity for the foreseeable future..

Okay, great.

And Ron, just to make sure you are reiterating that 25% to 30% operating leverage target for 2020?.

That’s correct. Yes, we still feel comfortable with that, Kevin even though we were able to outperform it for 2019 I think all-in operating leverage for this year was a little bit north of 40%. But we feel that the 25% to 30% is the flow through from a guidance standpoint..

Okay, great. And then you continue to make progress on adding new locations with strategic accounts, as well as adding new strategic accounts, but I think, Mike, you said your goal is to get 100% penetration of your strategic accounts in terms of capturing locations with them.

Have you ever tried to take a deeper dive and looked across your strategic account base and said okay, what percentage we are at now and kind of give us a sense of the runway that still exists to continue penetrating your strategic accounts?.

Yes, absolutely, Kevin. Thank you. So a couple of thoughts though, the 100% yes refers to 100% of the locations within strategic accounts and they range all over the map and the way strategic accounts have worked for us through our history, in most cases, it’s a hunting license.

So, we develop a relationship with a number of locations then it moves to the corporate headquarters of that company, they help a little bit, but we have to work one location at a time to displace a competitor.

And as we bring on new strategic accounts wherever you start there is more to be had, but when I talk about 100% it’s broader than the strategic count, what I really mean in that statement is within our 12 broad product categories, we want 100% share of all customers, whether it’s local accounts, just one location, one small location, or a very large strategic account.

When our sales rep is in-servicing that location, we want to service all that we can and the reason we want to do that is that because of our operational excellence, superior performance and the fact that our sales reps are visiting with the customer on average every 10 days, which is usually every week or every other week averaging 10 days.

We are there reliably never let the customer run out of product they are consuming and also because we are there so frequently, we never overstock the customer, so when I say 100% share I mean really, we’ve heard all 70,000 customers, we want 100% share within the bounds of our consumable products.

There is a huge potential, and let me say, I have never ever been more excited about the state of the company and our underlying value proposition and very recently, we even had a large number of potential strategic accounts reach out to us and invite us to begin broader dialogue with them.

These are not customers today, but they’ve reached out to us and invited us into talk about broader relationships.

So on every dimension, whether it’s cost management, Lean Six Sigma, our sales rep productivity costs, supply chain, suppliers and every dimension of the company, I have never been more confident in the future of this company that I am at this moment..

Okay, good, good. That’s good to hear. So looking forward to 2020, I would assume the plan is to continue adding sales reps at kind of a modest pace, and maybe talk a little bit more about the sales rep retention, you mentioned they continue to improve.

That seems like it’s been kind of a multi-quarter trend there and how much more room do you see to improve there?.

Yes, it is. It’s small continuous incremental improvement in retention. We will continue to hire incrementally, and of course, the hiring number gets a little less pressure as you’re able to retain and when you are retaining, they track along the curve of growing their book of business and growing the profitability of the sales rep.

But it is a continuous improvement of retention. By the way, Lean Six Sigma here has helped us.

Several years ago, we started talking about the Lean Six Sigma project to in a very systematic way on board reps, trained reps and then help them, this most of the weight of this work falls on our district sales managers, but help and coach and monitor them, so that they can start tracking initially successfully.

Now, other initiatives we have in place that we think will pay dividends for us this year is a focus, there are foundational products that are extremely important to our customers, they are very sticky to our customers and so, a real focus just starting recently on these core foundational products from which to build.

They are the bedrock of the relationship with customers. And if you have those core products, the long-term retention of the customer and the profitability of the sales rep and customer relationship is far higher. All of these things serve to improve sales rep retention, customer retention and profitability of that specific customer..

Okay, got it. Maybe let’s switch to the operating environment as you see it now. You mentioned a slowdown among two of your oil and gas customers, strategic customers, and the impact that had in the fourth quarter.

Have they shared with you their plans for 2020 or how do you see those two particular customers impacting your overall growth outlook as you move throughout this year?.

Yes. Of course, we can’t share all the details relative to specific customers but they are in the oil and gas industry. However, it’s important to recognize that the oil and gas industry represents less than 5%. I think it’s more than 4% of our total business.

So we call them out in general because they are relatively large customers, but they are relatively small as a percent. The whole industry is relatively small as a percent of our total mix.

It’s likely that those specific customers – by the way, it’s important to recognize we retain those customers as their demand goes down and it’s really about how hard they’re running their machines. As you idle machines, the maintenance cost goes down because you don’t run them they don’t break.

Those two customers are probably going to move sideways this year. They might tip up but likely move sideways. However, there are so many other opportunities we have for new strategic accounts that we are very, very excited..

Kevin, the other point I would add on top of that is as we look at call it the first eight weeks of 2020, we have seen a sequential increase both over December. In my prepared remarks, I commented on ADS for October, November and December.

So we have seen a nice increase in our average daily sales going from December into January and February, and are also trending in the first couple of months of the year, higher than where our full Q4 ADS ended up. Bolt has gotten off to a strong start as well.

So even though we continue to see a little bit of softness in these couple of customers, we have continued to see nice sequential increase over Q4 of 2019 as we start out this year..

Okay. Well, that’s helpful, because it was actually going to be my next question about what you’ve seen thus far through the first couple of months of the year.

But it sounds like even though you mentioned indicators for the industry show growth but maybe at a slower rate that it has not materially impacted you at least as of now, it sounds like?.

It just goes to the specific customers not in the industry, those two customers..

I think January the ISM was 50.9 and that was the first month in five months that it had ticked up about 50. We saw some of that increase – we saw some of that lift here in January as well..

Okay, great. Well, that’s all I had for now. Thanks for taking all the questions..

Sure. Thanks, Kevin..

[Operator instructions] Our next question comes from the line of Carl Schemm with KeyBanc. Please proceed with your question..

Hey, good morning..

Good morning, Carl..

Good morning, Carl..

I am just curious first, you mentioned the acquisition pipeline, if you could kind of expand on that, what you are targeting, what areas you are looking at specifically and what kind of leverage you are looking to get to?.

Let me comment, this is Mike, Carl let me comment on the first part of that and then Ron can pick up the second part. We continue to pursue a broad range of opportunities from, let me call it $10 million of revenue up too much, much, much larger well over $100 million of revenue.

And now that we have even more financial capacity, we feel good about that. We have been developing relationships for a number of years. Certainly, our vice president of M&A is having a very positive impact and his thorough approach we are very, very pleased with.

So we feel good about the pipeline across that spectrum by the way and we are very optimistic that during 2020 we will succeed along that dimension.

The other thing is that as we have gone through the acquisition process that’s behind us, that has enabled us to build the integration process and our integration team and all the functional leaders that participate after we succeed. Even by the way even in the analysis prior to doing an acquisition.

So we feel great about our ability after acquisition to integrate successfully. We feel like here all the hard work over the past couple of years will pay dividends here in 2020.

Ron, did you want to comment on leverage?.

Yes. Carl, I would just add on top of that. As Mike and I both mentioned in our comments that putting the new credit facility in place in the fourth quarter with J.P. Morgan Chase and CIBC and Bank of America really gives us the wherewithal to make those acquisitions that we are looking at.

That combined with the free cash flow that we throw off on our base or our core MRO business puts us in a really, really good position going forward to be able to make those acquisitions. So we feel really good about not only the pipeline but also our financial wherewithal to be able to finance those acquisitions..

Great. Thanks.

And then just a couple of housekeeping questions, what are you expecting for the number of business sales days by quarter this year?.

Sure. So for 2020, we pick up one additional day. The way that the calendar fell going from 2018 to 2019, we picked up one day and going from 2019 to 2020 we pick up an additional day. So by quarter for 2020, Q1 has 64 days, Q2, 64 days, Q3 64 days and then Q4 is 61 days, again.

Then if you look further out into the calendar out to 2021, we actually lose 2 business days so – but we picked up that extra day here in the first quarter..

Okay.

And lastly what’s your expectations for your tax rate for fiscal 2019 – 2020, sorry?.

Sure. So for fiscal 2019, we are in for the year. We were at 25.4%. That’s about where our expectation is moving into 2020 as well. What I would say is that we will be a tax-paying entity in 2020. The NOLs that we were carrying forward most of those will expire throughout 2020.

So we will be using some of our cash to pay taxes where historically we have not had to cut checks. So, I do want to highlight that but the effective tax rate should still be in the 25% to 26% 27% range..

Great. That’s all I had. Thanks..

Sure. Thanks, Carl..

Thanks, Carl..

Thank you. We have no further questions at this time. Mr. DeCata, I would now like to turn the floor back over to you for closing comments..

Thank you very much. Thank you for joining the call today. Lawson Products had another great quarter and a great year. Sales, EBITDA, gross profit and leverage all continue the positive trend that began in late 2016. Share gain and customer retention highlight the increasing value that customers place on our ability to improve their productivity.

More customers and potential customers are recognizing our value proposition. This is especially true of potential strategic account customers. We are confident that the productivity-related actions will continue and produce earnings growth while improving the quality of the work day for our teammates. I would like to extend thanks to our teammates.

I am grateful for their dedication to customer service and the knowledge that their work is enabling 70,000 customers to prosper. Thank you again for joining the call today. We look forward to speaking with you again shortly when we release our first quarter results. Thanks again. Have a wonderful day..

Ladies and gentleman this does conclude today’s teleconference. You may disconnect your lines at this time. Thank you for your participation and have a wonderful day..