Good morning, ladies and gentlemen, and welcome to the Lawson Products Third Quarter 2020 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 questions and answers.

Please note 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. This call is being audio simulcast on the Internet via 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 November 30, 2020. I will now turn the call over to Lawson Products’ CEO, Mike DeCata..

state, local and educational, called SLED, customers and federal customers. SLED represents approximately 65%, and federal represents approximately 35% of the government sales. During the quarter, SLED segment grew 32% sequential growth versus the second quarter, and 10% when compared to the third quarter of 2019.

Federal civilian grew by 15% as compared to the second quarter, and 3.5% versus the third quarter of 2019. By contrast, our military sub-segment declined 43% from the second quarter of 2020 and 63% versus last year’s third quarter.

This change in military sub-segment is primarily attributed to a change in the purchasing platform, which the Defense logistics agency uses. Year-to-date, we have been awarded 111 SLED agreements with another 41 pending.

For the military segment, we are also in the process of refocusing our sales efforts through multiple channels to market and the new purchasing platform. Our operations teams in the distribution centers are doing an extraordinary job under very difficult circumstances produced by the coronavirus.

In August, we brought our Suwanee, Georgia distribution center partly back online as a result of company-wide increased line value. Our three-part growth strategy remains unchanged, although the timing of each component has been impacted by the economic impact of COVID-19.

After eliminating some less productive sales rep positions, in the second quarter, we ended this quarter with 1,120 sales reps including approximately 200 Partsmaster reps. We began to add sales reps in underserved territories, increasing our efforts in the third quarter. Partsmaster sales reps have continued to drive sales.

We anticipate that nearly all of these reps will continue under the combined company. Sales rep productivity remains a key focus area through the pandemic. Excluding the Partsmaster sales reps, we realized a 22% improvement in sales reps productivity, sales per rep per day versus the second quarter.

From an M&A perspective, we continue to fill the pipeline with potential future acquisitions. Finally, the recent acquisition of Partsmaster will not slow our commitment to this leg of our growth strategy. We have both the financial flexibility and management bench strength to support our M&A ambitions.

Let me conclude my remarks by saying that we are seeing good progress on a sequential basis. The team is working hard to accelerate our recovery. While this pandemic and the economic impact that it has caused has certainly put a strain on our customers and the overall economy. The drivers of our business and value proposition have not changed.

There is still an acute shortage of maintenance mechanics and customers depend on us more than ever to maintain their overall productivity. Now, I would like to turn it over to Ron for more details..

Thank you, Mike and good morning everyone. I will first provide some key takeaways and business trends during the quarter. I will also comment on our recent acquisition of Partsmaster and its impact on our business. A few highlights for the quarter.

First, sales improved by 25% over the second quarter and also improved sequentially month-to-month throughout the third quarter. On a consolidated basis, average daily sales were $1.294 million in July, $1.315 million in August and $1.629 million in September.

September reflects $5.4 million in sales from the Partsmaster acquisition for average daily sales of $0.257 million. So excluding Partsmaster, average daily sales for September were $1.372 million. Second, our adjusted EBITDA improved $3.1 million over the second quarter to 10.4% of sales versus 8.7% in Q2.

This represents adjusted EBITDA of $9.3 million for the quarter or an improvement of 49% sequentially. The cost actions that we discussed on both the first and second quarter earnings calls and implemented in mid-April continued for the majority of the quarter.

We have struck a balance between managing our cost structure while continuing to invest in the business, in particular, areas that drive sales growth.

Third, the acquisition of Partsmaster, Mike has already commented on the progress to-date, but let me say that we continue to be very excited about our ability to bring our companies together, to strengthen our offerings for our customers, enhanced our opportunities for both Lawson and Partsmaster sales reps, and also to be accretive to our overall financial results.

And fourth, we have proactively managed our working capital and liquidity position to ensure we maintain and exit the pandemic with a strong balance sheet. We ended the quarter with $17.2 million of cash and cash equivalents, representing an increase of $7.2 million in the quarter and an increase in $11.7 million on a year-to-date basis.

We were deemed an essential business early in the second quarter, which allowed us to continue to serve our customers. We have adapted our corporate functions to the current environment and have been working remotely since the end of March.

And we’ve been able to adjust our cost structure, while our distribution centers continue to fulfill customer orders. As we reflect on the third quarter, we have continued to see month-to-month improvement in almost all aspects of our business.

Sales continue to improve, as does our customer service metrics, the number of ship to locations, and our sales rep productivity. This has allowed us to reverse some of our previous cost actions, such as reinstating certain furloughed employees and bringing our Suwanee distribution center back online.

Excluding the Partsmaster acquisition, our September average daily sales ran at approximately 93% of the 8 weeks prior to the pandemic. We have made great progress in this environment and continue our focus on driving sales, cost controls and cash flows, all while ensuring the safety of our teams.

For the quarter, excluding the acquisition, average daily sales declined by 10.5% compared to a year ago. From a monthly sequential perspective, July was up 3.8% from June. August was up 1.6% over July, and September was up 4.3% over August.

We continue to stay focused on incrementally driving sales through our existing customers as well as adding new customers. As Mike previously mentioned, we remain focused on supporting our customers and generating revenue in this environment while ensuring the safety of our teams.

We are also now able to perform on-site visits to the majority of our customers. We are continuing to offer additional support through phone outreach, internal customer service representatives, e-mail communication and our website, but to a lesser degree than Q2 as our customers have reopened for business.

Consolidated gross margins for the quarter came in at 52.3%.

On a stand-alone basis before the service cost reclassification, MRO margin was 58.8% for the quarter versus 60.9% a year ago, with the decline primarily being driven by the de-leveraging effects of fixed distribution center costs over a smaller sales base, higher net freight expense and a shift in sales mix toward lower margin PPE product categories.

For the quarter, total operating expenses were $45.2 million compared to $44.1 million a year ago. The increase was primarily driven by higher stock-based compensation, severance, acquisition costs in partially – and Partsmaster, partially offset by lower sales expenses and specific actions taken to adjust our cost structure.

During the quarter, we recorded stock-based compensation expense of $4.7 million, primarily associated with an increased stock price during the quarter, and this compares to expense a $2.4 million in the third quarter of 2019.

Excluding stock-based compensation, severance expense, acquisition costs and Partsmaster, adjusted operating expenses decreased 13% or $5.4 million over a year ago quarter. Our reported operating income was $2 million for the third quarter, inclusive of aggregate stock-based compensation and other nonrecurring expenses of $5.7 million.

On an adjusted basis, non-GAAP operating income was $7.7 million compared to adjusted operating income of $4.8 million in the second quarter of 2020 and $8.9 million in the year ago quarter.

Adjusted EBITDA as a percent of sales was 10.4% for the quarter compared to 8.7% in the second quarter of 2020, and 10.9% a year ago as we adjusted our costs on lower sales. Partsmaster contributed nearly $600,000 of EBITDA to the quarter.

On an adjusted basis, excluding stock-based compensation and other nonrecurring items, diluted earnings per share were $0.62 for the quarter versus $0.37 in Q2 and $0.68 in the third quarter of 2019. Capital expenditures for the quarter were approximately $591,000, as we eliminated nonessential CapEx to manage our cash flows.

As we manage our liquidity for the remainder of 2020, we expect our total capital expenditures for 2020 to be in the range of approximately $2 billion to $3 billion versus the previously guided range of $3 million to $4 million. This includes planned upgrades to our Suwanee infrastructure to allow for increased volume in the future.

As an organization, we continue to make investments in the business, in particular, areas that have a direct impact on sales. We have brought back certain individuals that were previously furloughed to drive sales in specific segments and regions.

While there is still uncertainty in the marketplace, we continue to make investments in the business and balance our cost structure against current sales trends. We continue to judiciously manage our balance sheet, as evidenced by our net cash position of $17.2 million at the end of the quarter.

While we took on debt of $33 million related to the acquisition from the sellers, we ended the quarter with $66 million of availability under our $100 million credit – committed credit facility. The $66 million is net of the $33 million letter of credit issued to secure the acquisition.

During the quarter, our cash position improved by $7.2 million, which is net of the $2.3 million payment to the sellers on the closing date of the Partsmaster acquisition.

As Mike and I have both previously stated, we are managing through this challenging time with the expectation that we will come out of this environment in a strong of a position as we entered it. Before, I turn it over for questions let me echo Mike’s comments about the strength and commitment of our team members over the past 6 plus months.

In a very difficult environment, our leader team has continued to step up as we’ve requested more from them, along with taking on additional work related to the Partsmaster acquisition and integration. Everyone has stepped up and remains committed to the long-term success of the organization.

Thank you to the entire Lawson, Kent, Bolt Supply and Partsmaster teams. I will now turn it over to the operator for questions..

Thank you. [Operator Instructions] Our first question comes from the line of Carl Schemm with KeyBanc Capital Markets. Please proceed with your question..

Hey, good morning, everyone. Congratulations on the quarter..

Good morning, Carl..

Good morning, Carl..

Just a couple of questions, mostly around Partsmaster here, I think you mentioned in your prepared remarks, profitability is similar to sort of the legacy business.

Is that true for both kind of the gross margin and operating margin side or is there any sort of mix dynamics there that we should think about going forward?.

Yes. Carl, this is – Carl, I am going to say that yes, the gross margins are very similar. Ron will get into that a little bit of detail here in a second, but we are really excited about the private label product. This is a large number of new products for the Lawson team.

And of course, the Partsmaster team gets the benefit of all of the existing legacy products. So we see significant upside potential, certainly in the addition of 200 sales reps. But as well, in the addition of some very unique, high-quality and differentiated products that will be available as soon as possible to all of the Lawson sales reps.

And of course, the Partsmaster sales reps get access to all the Lawson product. But because of the service, the integration of superior product, private label product as well as service-intensive vendor-managed inventory, the two gross profit profiles are very similar.

Ron, did you want to jump in?.

Yes, Mike, I will jump in just really quickly. So Carl, on the gross margin side, Mike commented on this, similar to our margin rates, actually just a little bit higher, really related to product mix.

And then secondly, Mike and I have talked about a milestone of achieving 10% EBITDA as a percent of sales, and you’re able to see that we did accomplish that here in the third quarter. And I would say that Partsmaster has been on a path to get to 10% over the last couple of years. Not quite there yet.

However, I would comment that the September was pretty strong. So we feel, as Mike said, we feel really good about the acquisition. The integration is on plan, and we think there’s tremendous upside as we bring our organizations together..

Great, thanks. Secondly, on – maybe on top line then, understanding, of course, the product set is fairly similar from – with Partsmaster.

But is there any sort of seasonality dynamics that we should know about just taking from a modeling aspect that maybe is different? Do they have any sort of different trends in a seasonal basis from quarter-to-quarter?.

Yes. Carl, this is Mike. No, they really don’t. It’s a very similar profile to Lawson broad spectrum of products across a broad spectrum of customers, about 16,000 active customers, and again, a broad product portfolio, not really seasonal beyond the normal variation.

You see fasteners and surface treatment for snowfalls in the winter, and summer products in the summer, but not really any variability that way..

Great, thanks. And then just one more, I think you mentioned Partsmaster contributed, I think you said 200 sales reps. So just – if my math is correct here, it seems like then the core loss in sales rep count actually would have gone down, if I’m looking at sales reps based on the period end.

Is that correct? Or am I missing something? And then kind of what are you thinking about for adding sales reps for 4Q and going forward?.

Yes. That’s right, Carl. And so, coming off of – well, through Q2, we have reengineered some of the territories. We removed some of the underperforming reps, a little sharper focus on performance management. We’ve always had it, but an even sharper one, April, May and June. And so, that continued a little bit.

However, here in the last month, we are reinitiating our efforts to fill untapped territories and underserved territories. So we see ourselves on the organic side, putting aside the Partsmaster sales reps.

We do see ourselves adding sales reps, both on the core Lawson – in the core Lawson territories as well as adding to the sales rep count for Partsmaster.

Now at some point in the future, they will just be completely integrated, all sales reps having all access to all products, and that will take some time, but we will be adding sales reps, both on the Lawson side and on the Partsmaster side for the foreseeable future and we have already started that effort on the Lawson side in the last month.

But you’re right. There has been a step back based on COVID and based on what we initially did along those lines..

Got it. That’s all for me. Thanks guys. .

Thanks, Carl..

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

Hey good morning Mike and Ron I wanted to continue to talk about Partsmaster a little bit. Maybe any color you can provide on how their sales have trended the last couple of quarters here in light of the pandemic..

Sure. So Kevin, this is Ron. I will jump into that. You mentioned through Carl’s question just a minute or so ago that they had a pretty strong September. And we have continued to see that really over the last few months. And I would say even here in October they are on a nice trend as well.

So we have seen really good productivity from the sales reps from their – approximately 200 sales reps, which we anticipate that, for the most part, everybody will come over into on a combined basis with Lawson. And so, they have been on a nice trend upward here in the last few months.

I would say, certainly, they saw the impact of the pandemic earlier this year, probably not quite, as much as, the Lawson side did. They have – their end customer base is a little bit different than ours from a substantial government business.

But overall, they did see a downward trend there for a couple of months, and then they’ve reversed that nicely over the last few months.

So again, we feel really good about where the sales reps are at, and where they are performing and getting them the opportunity ideally to be able to sell some of the Lawson product, and for the Lawson reps to be able to sell some of the Partsmaster product going forward, as we work through the integration..

The other thing, Kevin, as Ron just alluded to the very strong government – well I should say military business or Partsmaster beautifully augments and is synergistic with the very, very strong state, local and educational markets for loss. We have been strong in both.

But this year in particular, state, local and education, which has been an area of focus for core Lawson for quite some time is producing really nice results. And as well, Partsmaster’s military business is producing really great results.

Back to SLED, as I think I mentioned in the prepared comments, we have been awarded about 111 agreements relative to SLED, with another 41 in the hopper with a very, very high hit ratio of success.

So the combination of the very strong Partsmaster military along with the very strong state, local, and I will say federal non-military this year for Lawson will be a really nice growth synergy when both companies are fully integrated.

So we are really excited about all kinds of upside potential product, share wallet as well as market segments that this will deliver..

Mike, maybe – or Kevin, just maybe one additional comment, in that Partsmaster was able to jump pretty quickly on PPE type of products really in April and May and June timeframe. So that was similar to us. We did the same thing, which we have seen – continue to see a nice increase in that category.

They saw a pretty good jump in that category as well during those few months, and help offset some of the other declines that were happening in the business..

Okay, great. So is Partsmaster’s military business kind of held up okay, I mean, you mentioned kind of the transition and the purchasing platform that had some impact on the organic military business.

I am just wondering how theirs has fared?.

Very well, Kevin. Those are fared very well. They were a little ahead in getting under the new military platform. We are very optimistic about ourselves getting onto that same platform, before Lawson getting out of that same platform, but they have done very well over the last – this year as it relates to the military uptick..

Okay great. Ron, you mentioned Partsmaster seeing a good trend into October.

What about the organic Lawson business? What have you seen the start in October, in terms of trends versus September?.

Sure. So on the Lawson side, we did see, as I mentioned in my prepared remarks, we saw a nice sequential increase, really for every month during the third quarter, which was really on top of that same – on top of that sequential growth in Q2 as well.

Here in October, it’s been what I would describe as maybe a little uneven or we have kind of flattened out a little bit here in October. Nothing that is overly concerning to us. And we are up against some pretty strong numbers from a year ago as well.

So our focus is continue to drive volume within our existing customer base and really work on attracting and reactivating some previous customers as well, so, a little sideways movement here in October, but nothing that is alarming to us on the surface..

Okay, good..

We are excited about much of the stuff we have in the hopper in the way of strategic accounts and across multiple segments, we’re really excited about stuff that we’re working – agreements – strategic account agreements and customer agreements, penetration of existing accounts, kind of excited about, looks like on the horizon..

Okay, Lastly, I wanted to ask about the – again, the core loss and MRO segment, the gross margin there. Just a bit below the typical 60% level, you mentioned de-leveraging effect from lower sales, also the mix of PPE products.

Should we think about that mix of PPE being a significant factor in the gross margin there and would you expect that to continue, I guess, into the fourth quarter?.

Yes. I would – yes, in terms of the overall mix, the PPE piece of it is probably about 50 basis points of the movement from a year ago, and a little bit even from Q2 into Q3. So we feel really good about ending the quarter at nearly 59%, which I think is pretty well within our guidance of the high 50s, kind of almost 60ish range.

And we’ve seen some variation between 60.5%, down to 59% and so forth over many, many quarters. In fact, if you go back, I think it’s for the last 7 or 8 years, it’s been a pretty narrow band.

So yes – so we still feel good about those high-50s – 59ish going forward, in particular, as sales continue to move upward, and we get the leveraging effect on our distribution center costs. So Kevin, I think that our guidance historically would apply going forward as well. It might be a little bit impacted by product mix.

Not dramatically, and certainly, for us, a focus on sales dollars as well as gross margin dollars as well, is certainly where our focus is at and trying to get additional dollars through from new customers, existing customers and then also the additional products that we’ve been able to add as part of our PPE profile..

Kevin, if I could just add that, the other thing about PPE. And for us, PPE is really consumable PPE. There are some PPE products and SKUs that are kind of more durable in nature. When you think about gloves or masks or eye protection, ear protection, that’s more consumable in nature, which has always been our primary emphasis.

And – but the PPE has been a real door opener for us with new customers, many government customers, schools, in particular, as open doors that will enable us as – with that as the door opener to then broaden the relationship and build share of wallet with all of our more traditional products.

And so, we see – while PPE is not the center of our effort at all. It still is a tremendous door opener, and we are very excited about what opening the door with PPE will lead to in our more core and foundational products. So we see PPE is a really good thing, even though it has this effect that you are talking about..

Okay, great. That’s helpful. Well, thanks and congratulations on the nice results in this environment..

Thank you, Kevin..

Thanks, Kevin..

[Operator Instructions] This concludes our question and answer session. I would like to turn the conference back over to Mr. Mike DeCata for any closing remarks..

Thank you operator. And first, thank you all for your patience with our technical issue with our provider. We certainly appreciate that patience. And thank you for joining us today. We covered a wide range of topics this morning. And I would like to leave with you with a few overarching themes.

First, we are experiencing good sequential growth in sales and EBITDA and have made significant sequential progress since the downturn in April. Partsmaster integration is going very well and on plan. We believe this is a great strategic fit for us, and we are excited with the progress that we have made today, and we are very excited about the future.

We have always taken a balanced approach to our cost control is part of our DNA, and growing our business, we have demonstrated our ability to be assertive and act quickly when the situation requires that kind of action. We continue to have a strong balance sheet and even in this environment, generating solid – very solid cash and cash flow.

Lastly, safety of our teammates and suppliers is paramount. We have protocols in place, and we’re managing the business with that in mind. Thank you to all of our teammates, including the new Partsmaster team. Thank you to our customers and our suppliers. We are grateful for your dedication and loyalty to Lawson Products.

Our underlying value proposition is strong. We have a great future ahead of us. We look forward to speaking with you on the next conference call. Have a wonderful day..

Thank you. The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect..