Lawson Products (LAWS) Q3 2019 Earnings Call Transcript

Lawson Products (LAWS)
Q3 2019 Earnings Call
Oct 24, 2019, 9:00 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good morning, ladies and gentlemen, and welcome to the Lawson Products third-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 business as well as covering relevant financial and operational information. There will then be time for question 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 the 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 29, 2019. I will now turn the call over to Lawson Products' CEO Mike DeCata.

Mike DeCata -- President and Chief Executive Officer

Good morning, and thank you for joining the call. This morning, I'll comment on the third-quarter results and our continued progress. Ron Knutson, our CFO, will provide a more detailed review of our financial results followed by your questions. We continue to be very pleased with our results and our trajectory during the third quarter, as we again achieved over 10% adjusted EBITDA margin during the quarter.

Our results this quarter were driven by strong MRO sales, EBITDA and operating leverage, complemented by strong sales performance at Bolt Supply. Consolidated sales grew by 7.1% for the quarter, and average daily sales increased by 5.4%, including a 3.7% increase in the Lawson MRO segment and the 15% increase at Bolt Supply. These results, combined with effective management of our cost structure, drove adjusted EBITDA as a percent of sales to 10.9%. Previous investments, such as our commitment to Lean Six Sigma, encouraging teammates to explore their intellectual curiosity through the use of analytical tools, and better alignment between departments with an eye toward customer service, are producing the desired results.

This is the second quarter in a row that we've exceeded our 10% milestone. Congratulations to the entire Lawson and Bolt teams for the continued improvement in our performance. Trends in our gross margin remain positive, reinforcing that our customers are finding value in our service and premium product. Our gross profit percent has held steady, in a narrow range for many years.

That was the case again in the third quarter, with MRO margin finishing at 60.9%. In an environment of labor shortages, especially as it relates to maintenance mechanics, shop supervisors, welders and truck drivers, customers rely on their Lawson product sales reps to manage their inventory, solve problems and share best practices every week. Our service model enables customers to achieve the maximum productivity from these critical resources and in turn maximize their machine time utilization. Our value proposition continues to resonate as the lowest total cost alternative for our customers.

And the service that we provide makes Lawson products more valuable to our customers over time. With our sales growth and continued focus on cost management, we exceeded our previously stated guidance of 25% to 30% operating leverage, having achieved 54% this quarter within our MRO business. This compares favorably to the 34% leverage we achieved in the second quarter. Ron will discuss the financial details.

But I'd like to highlight a couple of areas that we are especially pleased with for the quarter. Our government business remains strong. Sales are up 27% compared to the third quarter of 2018, on top of 38% increase realized in the second quarter. We recently expanded our government strategic account reach by adding a field-based strategic account manager and focusing sales resources on several additional army bases.

This will strengthen our relationship with key government customers. We also added three new state contracts to our portfolio. Over the past few years, Lawson has become increasingly process oriented, with an analytical approach that has become part of our DNA. An example of this is that we now track and report our quote-to-award cycle time and our award-to-delivery cycle time to the Department of Defense customers.

This has differentiated us in the market. Additionally, we continue to take positive steps within our strategic account business as we execute on our conversion process for strategic accounts that I'd discussed in the past. As you'll recall, this is a focused effort to win new site locations within existing customers. During the third quarter, we added 59 new locations within existing accounts, bringing the year-to-date total to 220 new locations.

We have also added three new strategic account customers this quarter in the natural resources, construction and integrated supplies industries. Ten strategic accounts continue to grow, and we are well positioned to capture additional growth through industry consolidation. Our disciplined and thoughtful approach to acquisitions continues to deliver, most recently in the case of Bolt Supply. Bolt Supply had a terrific third quarter, with sales growth of nearly 17% in Canadian dollars, on top of 18% growth achieved in the second quarter.

We continue to be pleased with the Bolt acquisition. And I'd like to express thanks and appreciation to the Bolt team and our corporate team who supports them. We also continued to make progress in implementing our operational excellence initiatives. I've commented in the past that we have a concerted effort under way to improve retention of customers.

Our progress this quarter continues, as we improved our revenue retention rates. This date continues to demonstrate that the loss and value proposition is sticky. Operationally, we achieved improvement in distributions in our productivity and inventory effectiveness. Our order completeness rates, fine service levels and customer backorder metrics continue to improve.

We also integrated the Screw Products kitting and distribution process into our McCook distribution center. This will provide Screw Products access to a much larger product portfolio than it had prior to our acquisition. Screw Products has also now been integrated into SAP. Our three-part growth strategy continues to deliver.

First, growing our sales team. Including Bolt Supply, we finished the third quarter with 1,019 sales reps and plan to incrementally hire for the foreseeable future. Sales rep retention has also continued to improve. Second, increasing productivity.

This quarter, Lawson core sales reps achieved 1.3% improvement in sales rep productivity versus the third quarter of 2018. Our MRO average daily sales also grew by 3.7% versus third quarter of 2018. Third, growth through acquisitions. We recently announced several actions which will enable us to target larger acquisitions.

On October 14, we announced a new $100 million-plus multibank credit facility. And on September 7, we announced the addition of Brian Hoekstra to our team to lead our M&A efforts. Our previous six acquisitions over the past four years are performing well. And we believe that we have a rigorous and disciplined process that will further drive our success, supported by these recently announced new resources.

We are well positioned to further drive the business through our compelling value proposition, commitment to continuous improvement and the 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 2019 as we come up against challenging comps in the fourth quarter. Let me comment on the overall business environment. Economic metrics have indicated a slowing of the industrial economy.

While we saw some moderation on a sequential basis from the second quarter to the third quarter, we continue to drive growth through our internal initiatives. While we are prudently running our business against this backdrop, we remain very confident that Lawson Products is well positioned, and our value proposition is more important to our customers' success than ever before. Now I'll turn the call over to Ron for more insight into the third-quarter financial results.

Ron Knutson -- Chief Financial Officer

Thank you, Mike. And good morning, everyone. Before I discuss the third-quarter results, I'd like to comment on our new $100 million credit agreement that was recently announced, an achievement that we're very excited about for several reasons. The new agreement will provide us the additional access to capital to further support our acquisition opportunities as well as our organic growth initiatives.

We're also pleased to expand our bank group to include JPMorgan Chase and Bank of America. These two financial institutions, along with our long-term partnership and support from CIBC, positions us well to accelerate our growth. The new facility, which is cash flow based, provides additional borrowing capacity, flexibility on financing acquisitions; and lowers our overall borrowing costs. I'll now comment on the quarter.

As Mike mentioned, the third quarter of 2019 reflects a continuation of our strong results with solid execution, favorable operating leverage and continued improvement in adjusted EBITDA. Let me share some of the highlights. First, for the second quarter in a row, we exceeded our stated 10% EBITDA milestone as a percent of sales. Adjusted EBITDA was $10.3 million for the quarter or 10.9% of sales.

This represents a $3 million or 40.9% increase over year-ago quarter. Second, sales were $94.8 million for the quarter, up 7.1%. On an average daily basis, sales were up 5.4% versus the third quarter of 2018. Third, consolidated gross margin was 53.4% and was in line with our expectations.

The organic Lawson MRO business segment gross margin percentage was 60.9%, consistent with the year-ago quarter prior to allocating service-related costs. Fourth, we reported diluted earnings per share of $0.51 for the quarter compared to a loss of $0.09 in the third quarter of 2018. And fifth, we generated cash flows from operations of $10.3 million and ended in a net cash less borrowings positive position of $6.4 million. I'll now discuss some of the drivers for the quarter and provide some additional commentary.

We generated sales of $94.8 million in the quarter on 64 selling days. This was one additional selling day than Q3 2018 and the same number of days as Q2 2019. As compared to a year ago, our third-quarter sales benefited from the following. First, Bolt Supply generated sales of $11.3 million in U.S.

dollars for the quarter, an increase of 15%, driven primarily by favorable broad-based demand across its product categories, newly stocked items, and the development of new customer relationships. In fact, Bolt Supply set an all-time record in sales during September. Second, as Mike mentioned, MRO average daily sales grew by 3.7%. MRO sales rep per-day productivity continued to improve, with an increase of 1.3% over the year-ago quarter.

And third, Screw Products incrementally added approximately $600,000 in sales for the quarter, as it was acquired in Q4 2018. We ended the quarter with 1,019 sales reps, including 26 territory managers in the Bolt Supply business. Our focus remains on profitably growing our sales force, improving sales rep productivity and retaining our talent. On a Lawson MRO organic average daily sales basis, U.S.

sales were up 5.7%; while our Canadian ADS, including Bolt Supply, were up 5.4% in local currency. From a sequential average daily sales basis, the Lawson segment July sales were $1.275 million; August, $1.303 million; and September, $1.308 million. From a Lawson segment standpoint, strategic accounts sales were up 7.6% for the quarter. Government continued to be strong, growing approximately 27%, with a 3.2% growth in the Kent Automotive business; and a 1.5% growth in our Lawson core business.

Reported gross margins for the quarter was 53.4%. Despite the inflationary environment, the organic Lawson MRO gross margin was 60.9%, flat with the year-ago quarter. Similar to prior quarters this year, consolidated gross margin was impacted by $4.6 million of service-related expenses that were classified into cost of goods sold, in addition to lower Bolt Supply and Screw Products gross margin profile than the core Lawson segment. Through effective pricing and operational efficiency initiatives in our product fulfillment processes, we continue to drive MRO margins in excess of 60%.

We continue to efficiently manage total operating expenses as a percent of sales and further leverage our existing infrastructure as evidenced by this quarter's results. Selling, general and administrative expenses were $44.1 million for the third quarter, compared to $50.4 million a year-ago quarter. The decrease was primarily driven by lower stock-based compensation of $5.3 million. However, excluding stock-based compensation, total operating expenses were down 2.3% on a 7.1% sales increase, as we prudently managed our operating costs.

Lawson MRO adjusted EBITDA operating leverage was nearly 54% for the quarter, reflecting the combination of sales growth and lower operating expenses. Our reported operating income was $6.4 million for the third quarter compared to a loss of $2.3 million a year ago, driven by increased sales, margin management and lower adjusted operating expenses. On an adjusted basis, non-GAAP EBITDA was $10.3 million compared to adjusted EBITDA of $7.3 million in the year-ago quarter, a 41% increase. Net income for the quarter was $4.8 million or $0.51 per diluted share.

On an adjusted basis, excluding stock-based compensation, severance and other nonrecurring items, diluted earnings per share was $0.69 for the quarter versus $0.59 a year-ago quarter. This now puts our adjusted diluted earnings per share for the first nine months of the year at $1.79, a 61.3% improvement over 2018. We continue to improve our available cash position. Cash flows from operating activities of $10.3 million in the quarter drove available cash less debt to a positive position of $6.4 million.

Capital expenditures for the quarter were approximately $450,000. We expect our capex in 2019 to be in the range of $2 million to $3 million for the full year. Let me now provide some thoughts for the remainder of 2019. Current economic indicators in our sector now show a slowing industrial economy.

While we have seen some moderation in recent months, we continue to drive growth through our internal initiatives. We continue to monitor inflation in tariff trends and are committed to taking the necessary actions to ensure that we stay ahead of increasing product costs. We've now exceeded our 10% EBITDA to sales milestone for two consecutive quarters. While our expectation is to achieve 25% to 30% MRO operating leverage, keep in mind that Q4 2019 has three fewer selling days than Q2 and Q3, which will naturally impact our Q4 results.

Moving into 2020, we will continue with our sales and operating initiatives to drive incremental earnings as a percent of sales. I'll now turn it over to the operator for questions.

Questions & Answers:

Operator

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

Kevin Steinke -- Barrington Research -- Analyst

Good morning, Mike and Ron. Congratulations on the really nice results here. You continue to talk about the 25% to 30% incremental operating leverage target. Obviously, you've exceeded that thus far in the first nine months of 2019 here.

I know there were some incremental nonrecurring costs in 2017 that helped you exceed that goal in 2018. But just trying to get a sense of why you've been able to outperform that 25% to 30% target thus far this year. I mean, have you been able to manage costs more tightly than you expected? Or is Lean Six Sigma reducing costs? Anything you could highlight there that's driving that really strong operating leverage?

Ron Knutson -- Chief Financial Officer

Sure, Kevin. This is Ron Knutson, so I'll take that question. I think it's a combination of a lot of the activities that we're doing and a lot of the investments that we've made over the past many years. We do feel comfortable in that 25% to 30% range, albeit we have been able to exceed that here for the first nine months of the year.

And for us, it's all about managing margin, continuing to focus on sales growth and, as I think both Mike and I said in our prepared comments, really prudently managing our overall operating costs. So as we look into 2020, that's our continued stated guidance. But again, we continue to manage the business to drive incremental earnings as a percent of sales. So again, we feel good about where we've been so far for 2019 and looking into 2020 with that same level of guidance.

Kevin Steinke -- Barrington Research -- Analyst

And now that you've exceeded that 10% adjusted EBITDA margin goal for two consecutive quarters here, when do you start thinking about maybe is the right time to think about a higher margin goal, if you think that it's the case that you can get beyond 10%? I know it's maybe too early to state anything. But just what are your thoughts long term on margin goals and maybe where it could go from here?

Mike DeCata -- President and Chief Executive Officer

Kevin, this is Mike DeCata. Thank you for the question. So I can say that we've been saying all along that the 10% was a milestone, certainly not a destination. And we certainly will continue to drive that higher to the best of our ability.

As Ron mentioned in his prepared comments, first and fourth quarter are structurally different for us than second and third. So the next step is trying to drive that number all four quarters. But we will continue to drive through share gain and growing topline, managing costs. We're extremely pleased with how our team across the company has embraced Lean Six Sigma and the analytical orientation.

And every day there are opportunities to find a penny here and a penny there in process improvement, both that enables us to grow topline. And we've commented on a few of those relative to governments and so on and so forth. That's process reengineering targeting customers, but also process reengineering targeting cost management internally and enabling higher-quality work life for our employees. When you put all that together, I'll say again, it's not a destination; it's a path through.

And our goal is to run the company more profitably, more efficiently, more effectively every day. Continuous incremental improvement is what we've been at for a very long time. And we'll continue on this path. Again, not ready to set new numbers.

But I can say with a certainty the number is more.

Kevin Steinke -- Barrington Research -- Analyst

Fair enough. OK. That sounds good. Yes.

So in relation to -- you mentioned Screw Products. I know that that's a pretty small piece of your business right now. But you mentioned you got it integrated into the McCook facility and on SAP. So with that, what do you think you could do with that business now? Or what are you looking to do to maybe drive more growth there?

Mike DeCata -- President and Chief Executive Officer

Yes, Kevin, this is Mike again. It's a great question. And it is a small acquisition, but it was sort of a means to an end -- value-added things like kitting, assembly, modest assembly of components. And so it becomes a platform and a learning exercise for us to springboard that business itself into market growth.

And a great many of our customers are looking for value-added, and again, assembling fasteners together or coatings, or more value-added services than the physical labor that we deliver in the form of VMI, service-intensive VMI. So it becomes a springboard to other growth. We are working with customers and partners, channel partners, to open additional business for Screw Products. And now that they're integrated -- and our McCook distribution center has always done kitting in building preassemblies of bids in cabinets.

So that's something that we have the processes and labor and applied Lean Six Sigma for quite a number of years at McCook. So now that the Screw Products business is integrated into McCook, it opens the door with a lot more products and even more cost-effective service to do that kitting. So we're sort of at the beginning. The way we do that and everything else is systematic, deliberate, methodical in our strategies and our growth.

And that's where we are right now. We've got great optimism relative to the future of Screw Products, and Screw Products as a platform for organic growth of Screw Products and likely acquisition growth similar to Screw Products.

Kevin Steinke -- Barrington Research -- Analyst

Yes. That's interesting. And following up on that, you mentioned potential acquisitions. And you've made some moves there with the credit facility and in hiring Brian.

Maybe what does the pipeline look like right now, the size of deals you're looking at perhaps, and just maybe a general range in the types of businesses you'd like to acquire?

Mike DeCata -- President and Chief Executive Officer

Again, this is Mike. So what we're looking at is a continuation of what we have looked at, except larger. We have now done six acquisitions. We feel like we've integrated them very successfully, the largest of those being Bolt Supply, which we've highlighted because of their recent performance.

But their performance all along has been very, very solid and just doing far better. So now we feel the confidence. And originally, when we started down this path, three, four, five years ago, we talked about our desire to sort of get our sea legs with smaller acquisitions, test our paradigms and integration skills. We've now done that, and we now have confidence to do substantially larger acquisitions.

With the multibank deal that we have and the resources that we have between financial resources, our own integration internal resources and Brian, we feel very confident that we can go after substantially larger acquisitions in our space and in very near adjacencies. Not big differences from where we are, but in the kind of business that we're in, which is to say value-added, service-intensive vendor-managed inventory; characteristics being small parts, consumable; pretty close to sticking to the knitting. But there is a large pipeline and a large number of companies in our space. It's a huge, some would argue, $20 billion highly fragmented market.

And we will never run out of customers. And I think we will never run out of acquisition targets. But we are very disciplined. We are very disciplined in pushing back from ones that aren't quite right.

Because we feel very good about our organic growth and our leverage and where we're going, just in operating the company every day. So that gives us, let me say, the luxury but the discipline to do the right acquisitions that are accretive and make strategic sense to us without the urgency to do ones that are terribly provocative. So that's kind of our orientation. But we feel great about the pipeline.

And now we feel great about the resources available to bring to bear on that pipeline.

Kevin Steinke -- Barrington Research -- Analyst

OK. Great. I guess lastly, just in relation to, obviously a bit of a slowing in the industrial economy, you said maybe a little moderation on a sequential basis, but still growing year over year. I know it's still just a few weeks in the quarter here.

But maybe what you've seen thus far? And maybe just broader comments on how your businesses reacted in the past to slowing economic indicators? I know you have a 65-year-plus operating history. And maybe if we just continue muddling along, do you think you continue to grow here? Or how long, how deep of a contraction would you think you'd need to see to really, I guess, slow things more meaningfully? I know there's a lot in there, but just wanted to get your overall thoughts on the environment.

Ron Knutson -- Chief Financial Officer

Sure, Kevin. This is Ron Knutson. So I'll take the first part of that. And relative to, call it, the first few weeks of October, what I would say is we've seen really, I would say, consistent performance with where we saw the third quarter operating.

I would say Bolt Supply continues to have a nice month. Again, we're three weeks into it. And relative to the overall economic cycle and so forth, I think Mike made some comments on this in his prepared comments. And it's something that, as we look at for 2019 as well as moving into 2020, we are seeing a little bit of a softening.

But what I would say is that our internal initiatives -- examples of that would be our focus on the government business, adding resources there; our conversion process within the strategic account area, continued investment into our sales force -- we feel as though those internal initiatives can help dampen what we're seeing a little bit on the overall economic side. So again, we feel good about our internal initiatives. We think that those will help fuel our growth going forward, again keeping in mind Q4 being a shorter quarter for us. But beyond that, we feel good about the actions we're taking internally to drive growth.

Mike DeCata -- President and Chief Executive Officer

Yes, Kevin, I would echo that as well. This is Mike. We feel great about the actions we're taking, the part of the world that we control, our processes, our strong teammates and their orientation toward continuous improvement every day in every department at every function, every activity of the company. One thing that does excite me more and more is it is my view that our value proposition becomes more valuable and more critical to customers every day.

Just last week, we had the president of a large customer in who was talking about how desperate they are for labor, especially in the form of mechanics, welders, shop supervisors, parts managers. Yesterday, I had a conversation with our senior vice president of Sales, who echoed the same thing relative to a customer visit that he was at on Tuesday of this week. So over the long term, customers do think of us, our sales rep, as kind of like their employee -- I'm speaking figuratively here -- for about 45 minutes a week. And because we're there every week, never letting them down, never letting them run out of product, never overstuffing the bin -- so it's the balance between not letting them run out.

And again, with our average piece price being $0.94, the last thing one of our customers wants is their large injection molding machine or their excavator or their big piece of equipment down for a few-dollar part. So the combination of all of these macro and demographic factors, I believe, makes the Lawson value proposition more valuable and more critical every day for a very long time to come. And that's echoed by conversations with many customers across the spectrum.

Ron Knutson -- Chief Financial Officer

Kevin, I would just add that we continue to make investments into the organization to drive sales; certainly continue to add sales reps. And we are also adding individuals, retention specialists, inside sales reps and so forth. So even if the economy slows a little bit, we will continue to make investments into the organization to help drive topline sales.

Kevin Steinke -- Barrington Research -- Analyst

OK. That's great color. Thanks for taking all the questions

Operator

Thank you. [Operator instructions] This concludes our question-and-answer session. I'd like to turn the conference back over to Mr. Mike DeCata for any closing remarks.

Mike DeCata -- President and Chief Executive Officer

Thank you, Michelle. Thank you for joining the call today. Lawson Products had another great quarter. Sales, EBITDA, gross margin and leverage all continue the positive trends that began in late 2016.

We're confident that the actions that the Lawson team has taken over the past few years, along with our commitment to operational excellence, positions the company to prosper in the coming years. Share gain and customer retention highlight the increasing value that customers place on our ability to improve their profitability. I would like to extend special appreciation and thanks to our teammates. I'm 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 in 2020. Have a great day.

Operator

[Operator signoff]

Duration: 39 minutes

Call participants:

Mike DeCata -- President and Chief Executive Officer

Ron Knutson -- Chief Financial Officer

Kevin Steinke -- Barrington Research -- Analyst

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