Distribution Solutions Group, Inc. quarterly report, Q1 FY2013

Business context and reporting period

Important issuer discrepancy: The request identifies Distribution Solutions Group, Inc., but the supplied Form 10-Q is for Lawson Products, Inc. This summary reflects the filing text provided, not a filing verified as belonging to Distribution Solutions Group.

Lawson Products reported unaudited results for the three months ended March 31, 2013. Its MRO segment distributes maintenance, repair and operations products; its OEM segment manufactures, sells and distributes component parts.

Financial results

Cash and equivalents were $1.3 million at March 31, 2013. The revolving credit balance was $19.8 million, with $15.8 million of additional availability; the weighted average borrowing rate was 3.0%. Total assets were $178.3 million and stockholders’ equity was $67.6 million at quarter-end. No dividend was declared for Q1 2013, versus $0.12 per share in Q1 2012.

Changes versus prior-year quarter

• Sales declined 5.2% (5.1% excluding Canadian exchange-rate effects). MRO sales fell 5.8%; OEM sales rose 4.0%.
• MRO sales were affected by an 11% lower average number of sales representatives, $1.5 million lower government sales, and one fewer selling day. MRO average daily sales fell 4.3%.
• Gross margin improved to 56.9% from 54.4%, helped by better-than-expected liquidation values for discontinued products and improved freight recoveries; management cautioned that margins could remain under pressure.
• SG&A was nearly flat in dollars but increased to 60.9% of sales from 57.9%. Selling expenses included a $1.2 million national sales meeting and $1.0 million of additional payroll-related taxes following the transition of U.S. independent agents to employees.
• Stock-based compensation rose to $1.6 million from $0.2 million. Lower G&A costs from prior cost-control initiatives partly offset these increases.
• The company recorded $57,000 of income tax expense, compared with a $1.1 million tax benefit in Q1 2012; a valuation allowance prevented a federal tax benefit in 2013.

Liquidity, outlook, and risks

Operating cash use primarily reflected working-capital investment: receivables increased $4.8 million and inventory increased $3.2 million. Inventory also included a temporary investment associated with moving operations from Addison to the McCook distribution center. The company borrowed $3.7 million under its credit facility during the quarter.

Lawson stated that cash from operations and available credit were expected to fund operating requirements, strategic initiatives, and capital improvements through 2013. This is management’s assessment, not formal earnings guidance. The company met its March 2013 minimum EBITDA covenant: facility-defined EBITDA was $0.7 million against a breakeven requirement. Subsequent quarterly minimums rise to $2.0 million for June 2013, $3.5 million for September, and $3.0 million for December. Management warned covenant failure could increase financing costs, restrict borrowing, or reduce availability.

Material contingencies include an IRS worker-classification dispute concerning Drummond American sales representatives: the IRS proposed $9.5 million including penalties; the company disputed the assessment and had accrued $1.2 million as its estimated resolution cost. An Alabama site investigation had identified hazardous substances in soil and groundwater, but the company could not reasonably estimate remediation costs and recorded no reserve. The company reported that possible exposure related to unpaid subcontractors at the McCook project had fallen to zero and considered payment by the company remote.

Other disclosed risks include workforce retention, execution of strategic initiatives, cash generation and credit-covenant compliance, economic conditions, inventory obsolescence, customer demand, commodity and energy costs, transportation disruptions, environmental compliance, and tax matters. Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.

Important facts for investors to verify

• Verify the issuer: the supplied filing names Lawson Products, Inc., not Distribution Solutions Group, Inc.
• Review MRO sales and sales-representative coverage trends, including the effects of the employee transition and government sales.
• Monitor the higher EBITDA covenant thresholds, borrowing availability, and cash consumption as working-capital needs evolve.
• Track the IRS assessment and the adequacy of the $1.2 million accrual, as well as updates on the Alabama environmental investigation.
• Assess whether improved gross margin is sustainable given management’s stated competitive and customer-mix pressures.