Business context and reporting period
Filing identity discrepancy: The request identifies Distribution Solutions Group, Inc., but the supplied Form 10-Q is for Lawson Products, Inc. (Nasdaq: LAWS), for the quarter ended September 30, 2019. The summary below reflects the supplied filing, not Distribution Solutions Group.
Lawson distributes maintenance, repair and operations products through its Lawson sales-representative/VMI business and Bolt Supply branch network. Bolt Supply operated 14 branches in Western Canada. Results include Screw Products, acquired in October 2018.
Financial results and liquidity
Unless otherwise indicated, amounts are in U.S. dollars. Revenue and operating results are for the three and nine months ended September 30; balance-sheet amounts are as of September 30, 2019.
| Metric | Q3 2019 | Q3 2018 | First 9 months 2019 | First 9 months 2018 |
|---|---|---|---|---|
| Total revenue | $94.8 million | $88.5 million | $282.2 million | $263.4 million |
| Gross profit | $50.6 million | $48.1 million | $150.5 million | $143.5 million |
| Gross margin | 53.4% | 54.3% | 53.3% | 54.5% |
| Operating income (loss) | $6.4 million | $(2.3) million | $13.6 million | $5.1 million |
| Net income (loss) | $4.8 million | $(0.8) million | $10.2 million | $3.6 million |
| Diluted earnings per share | $0.51 | $(0.09) | $1.09 | $0.39 |
| Operating cash flow | Not separately presented | Not separately presented | $8.0 million | $10.3 million |
- Q3 operating margin was 6.8%, versus a 2.6% operating loss margin in Q3 2018; nine-month operating margin was 4.8%, versus 1.9%.
- For the first nine months, cash from operations was $8.0 million; capital expenditures were $1.4 million. Cash and cash equivalents were $8.6 million, plus $0.8 million of restricted cash.
- Revolving-credit borrowings were $2.2 million on the balance sheet, including $1.3 million under Lawson’s facility and C$1.2 million under Bolt Supply’s facility, as separately described in the notes. The filing states the company was in compliance with applicable covenants.
- Total assets were $207.7 million and total liabilities were $94.8 million. The company reported $14.1 million in lease liabilities after adopting ASC 842.
Material changes and management commentary
- Q3 revenue grew 7.1% year over year; nine-month revenue grew 7.2%. Management attributed growth to higher sales-representative productivity, strategic and government business, Bolt Supply growth, and Screw Products sales. Q3 had one additional selling day; excluding currency effects, Q3 sales rose 7.4% and nine-month sales rose 7.9%.
- Consolidated gross margin declined 0.9 percentage point in Q3 and 1.2 points year to date. Management cited service-related costs and the lower gross-margin profiles of Bolt Supply and Screw Products; core Lawson MRO gross margin before allocated service costs was broadly stable.
- Operating expenses declined year over year, notably Q3 general and administrative expense, primarily because stock-based compensation expense was $5.3 million lower. Nine-month G&A was nearly flat, with lower stock compensation partly offset by higher severance expense.
- Operating cash flow fell to $8.0 million from $10.3 million year to date, with working-capital outflows, including higher receivables and payments of accrued items, contributing to the decline. The company used $10.2 million in financing activities, primarily for revolving-debt repayment and share repurchases.
- Management reported the U.S. manufacturing PMI averaged 49.4 in Q3 2019 versus 59.6 a year earlier, indicating a shift from expansion to slight contraction. The sales force averaged 989 representatives, and Lawson representative productivity rose 1.3% in Q3.
Outlook, risks, contingencies and unusual items
- No specific earnings or revenue guidance is provided. Management expected the sales force to remain relatively stable through the rest of 2019, with emphasis on training and productivity. It stated operating cash flow and available funds under the new credit agreement should cover operating needs, strategic initiatives and capital improvements for the next 12 months.
- On October 11, 2019, after quarter-end, the company entered a five-year credit agreement with $100 million of revolving commitments, potentially expandable to $150 million subject to conditions. The agreement matures October 11, 2024 and includes defined leverage and fixed-charge covenants. Prior facilities were paid off.
- Principal risks cited include economic and manufacturing conditions, cash generation and credit-covenant compliance, customer demand and product mix, inventory obsolescence, input costs and tariffs, oil-and-gas demand, cybersecurity and systems disruptions, employee retention, acquisition integration, foreign exchange, competition, regulation, tax matters, and the influence of a significant shareholder.
- The company continued remediation at its Decatur, Alabama site, which has historical soil and groundwater contamination. The remediation plan was approved by the state in 2018; injections were completed in Q1 2019. After $1.3 million of payments during the first nine months, management estimated the remaining accrued liability at approximately $0.1 million and believed it sufficient for remaining plan costs.
- The company adopted ASC 842 on January 1, 2019, recognizing lease assets and liabilities; the transition increased opening retained earnings by $1.9 million. Stock-based compensation expense was $7.6 million for the first nine months, and the severance reserve was $1.0 million at September 30.
- A $7.5 million stock-repurchase program was authorized in Q2. In Q3, 32,362 shares were repurchased under the program at an average $38.13 per share; additional shares were repurchased to satisfy tax withholding obligations.
Important facts for investors to verify
- Confirm the intended issuer: the provided filing is Lawson Products, Inc., not Distribution Solutions Group, Inc.
- Assess whether sales growth can continue amid weaker manufacturing indicators, and distinguish organic growth from acquisition, selling-day and currency effects.
- Monitor gross-margin pressure from service costs and lower-margin business mix, alongside the company’s ability to sustain expense reductions.
- Review cash conversion and working-capital trends, including receivables, inventory and accrued-liability payments.
- Track compliance with the new credit agreement’s covenants and the availability and cost of borrowing.
- Follow the Decatur remediation process and whether the estimated remaining liability proves adequate.