Business context and reporting period
This is Lawson Products, Inc.’s unaudited Form 10-Q for the quarter and nine months ended September 30, 2020. The filing describes a distributor of maintenance, repair and operations products through its Lawson and Bolt Supply segments. The request identifies Distribution Solutions Group, Inc.; that is not the registrant named in this filing.
Unless otherwise noted, amounts below are in millions of U.S. dollars. Lawson acquired Partsmaster on August 31, 2020; it contributed $5.4 million of revenue and $0.4 million of operating income after acquisition during the quarter.
Financial results and liquidity
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Revenue | $90.3 | $94.8 | $253.5 | $282.2 |
| Gross profit | $47.2 | $50.6 | $134.5 | $150.5 |
| Gross margin | 52.3% | 53.4% | 53.0% | 53.3% |
| Operating income | $2.0 | $6.4 | $21.2 | $13.6 |
| Net income | $1.7 | $4.8 | $14.9 | $10.2 |
| Diluted EPS | $0.19 | $0.51 | $1.60 | $1.09 |
- Q3 operating margin fell to 2.2% from 6.8%; nine-month operating margin improved to 8.4% from 4.8%.
- Management reported Q3 adjusted operating income, a non-GAAP measure, of $7.7 million versus $8.9 million; nine-month adjusted operating income was $20.5 million versus $22.8 million. Adjustments include stock-based compensation, severance and acquisition costs.
- Operating cash flow for the first nine months was $20.0 million versus $8.0 million. Capital expenditures were $1.3 million. Cash, including restricted cash, increased $11.7 million; unrestricted cash at September 30 was $17.2 million.
- No revolver borrowings were outstanding. Availability was $66.0 million, net of letters of credit, including a $33.0 million letter of credit securing the Partsmaster payment. The company reported compliance with its covenants; actual fixed-charge coverage was 4.73x against a 1.15x minimum, and net leverage was 0.71x against a 3.25x maximum.
- The $33.0 million Partsmaster payment is due in May 2021 and is recorded at a discounted $32.5 million current liability. Total assets were $251.3 million and total liabilities $130.0 million at quarter-end.
Material changes and management commentary
- Q3 revenue declined 4.7% year over year, while nine-month revenue declined 10.2%. Lawson segment revenue fell 4.4% in Q3 and 10.5% year to date; Bolt Supply revenue fell 7.5% and 7.6%, respectively.
- Management attributed lower sales to COVID-19 restrictions and weaker customer activity, as well as a downturn in oil and gas. Partsmaster’s contribution partly offset the declines. Sales improved sequentially in Q3 as restrictions eased, but remained below the prior-year quarter.
- Q3 consolidated gross margin contracted 1.1 percentage points. Management cited lower sales and fixed-cost deleverage, product mix, and higher transportation costs. Selling expenses declined, but G&A rose in Q3, including higher stock compensation, Partsmaster costs, severance and acquisition costs.
- For the first nine months, reported operating income increased despite lower revenue, in part reflecting lower operating expenses and a $2.8 million stock-based compensation credit, compared with $7.6 million of stock-based compensation expense in the prior-year period.
- Partsmaster’s purchase price was $35.3 million in cash plus assumed liabilities; the company paid $2.3 million at closing. Purchase accounting values are preliminary, including $16.0 million of goodwill, and may change. Pro forma results are disclosed but are illustrative, not forecasts.
- Management provided no quantified earnings or revenue guidance. It said cash from operations and credit-facility capacity were expected to fund operating needs, strategic initiatives and capital improvements over the next 12 months, while noting uncertainty and potential adverse effects from COVID-19.
Risks, contingencies and unusual items
- COVID-19 could further reduce demand, restrict sales representatives’ customer visits and Bolt branch traffic, disrupt suppliers, freight or facilities, delay customer payments, and impair goodwill or other assets. Management reported furloughs, temporary salary reductions, reduced travel and capital spending, and other cost controls; approximately 70% of previously furloughed employees had returned by Q3.
- The Partsmaster acquisition materially increased goodwill and created a large near-term cash obligation. Funding the May 2021 payment may require cash on hand and, if needed, the credit facility.
- The company identified potential goodwill impairment risk if COVID-19 adversely affects future assumptions. It reported no Q3 goodwill impairment trigger and no intangible-asset recoverability test was required at September 30.
- The filing reports an environmental remediation project in Decatur, Alabama; the recorded liability was fully used in Q3, with only expected immaterial additional fees.
- Management concluded disclosure controls were effective. Partsmaster’s internal controls were excluded from the quarter’s internal-control assessment while integration proceeds.
Important facts for investors to verify
- Confirm the intended issuer: this filing is for Lawson Products, Inc., not Distribution Solutions Group, Inc.
- Track the final Partsmaster purchase-price allocation, integration results and contribution to future revenue and margins.
- Monitor funding and covenant capacity ahead of the $33.0 million May 2021 payment, including the effect of its letter of credit on available borrowing capacity.
- Assess whether sequential sales improvement persists and whether COVID-19, oil-and-gas weakness, supply constraints or customer collection delays worsen.
- Review the composition and sustainability of year-to-date operating-income improvement, including stock-based compensation and other adjustment items.