Earnings Call Transcript - DSGR Q1 2020

Operator, Operator

Good morning, ladies and gentlemen, and welcome to the Lawson Products First 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. Then there will 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 disclaim any obligation to do so. This call is being audio simulcast on the Internet via Lawson Products' Investor Relations page on the company's website, lawsonproducts.com. A replay of the webcast will be available on the website through May 31, 2020. I will now turn the conference over to Lawson Products' CEO, Mike DeCata.

Michael DeCata, CEO

Good morning, and thank you for joining the call. This morning, I will comment first on the actions we're taking in response to the COVID-19 pandemic and then, our first quarter results followed by our plans going forward. Ron Knutson, our CFO, will provide a more detailed review of the first quarter financial results and additional details regarding our actions followed by your questions. First, Lawson was deemed an essential business by the government and as a result, our sales reps continue to call on our customers and our distribution network has remained open during the pandemic. That said, the safety and health of our employees, customers, and suppliers are our highest priority. We are fully implementing the guidelines set out by the CDC and Health Canada. I am extremely proud of the dedication and efforts of our teammates across every functional area of the company, including the sales team, our distribution centers, corporate, and bolt supply. Every function and group across the company has demonstrated their ability to be nimble and innovate. We are grateful for their support and dedication. Let me now provide some examples of the actions that we've taken. Within corporate, the team is largely working remotely and we have supplied the necessary supporting equipment as needed. Our distribution centers have taken steps to maintain social distancing as well as adding extra cleaning, disinfecting, and using PPE masks and gloves throughout. Our sales reps are diligently working to support our customers and continue to provide the high-quality service that Lawson is known for. We continue to visit our customers' locations on a reduced schedule or selective basis and we are also leveraging our customer service function, phones, and website. Despite the environment, we continue to win new customers. Several CEOs of large and small customers have reached out to meet directly with our executives to personally express their appreciation for our continued service and support. One example of this is the president of a landscaping company who called to express his appreciation for our support. He made the decision to bring us on as his hydraulic supplier in early April and we have continued to service his company during the pandemic. As far as the first quarter results, our sales were increasing both year-over-year and sequentially through the middle of March. The key metrics we track were all increasing nicely. However, we began to experience weakness due to the economic impact of the COVID-19 pandemic in the second half of March and this has continued into April. In response to the impact of the COVID-19 pandemic, we immediately took actions to ensure the safety and health of our employees, customers, and suppliers as well as support our business. Let me highlight a few of the initiatives that we've already implemented. Lawson sales representatives remain in close contact with customers through phone, fax, internet-based communication, and in many locations our in-person call cycle continues albeit wearing PPE and practicing social distancing. Additionally, our service department has taken on a larger role to support our customers and sales reps. Bolt branches remain open and we're offering curbside pickup for customer orders to maintain social distancing. We are also in contact with our current suppliers, as well as reaching out to additional suppliers to ensure that orders for inventory are fulfilled in a timely manner. Similar to other MRO distributors, access to PPE is more challenging than in the past, but our supply chain for other product categories has not been interrupted. Over the past weeks, we've taken numerous additional actions to manage the business during this period. All exempt employees and the Board of Directors have taken salary reductions. We have also suspended several performance-based awards. In addition, we have furloughed 100 corporate and DC teammates. Other actions include no new hires, reducing discretionary travel as well as reducing capital expenditures and getting better payment terms from suppliers. Ron will discuss our actions in greater detail in a moment. These actions will significantly reduce our operating costs. While we're working with our teammates, customers, and suppliers, we will enable us to snap back as soon as the environment gets back to normal. In reviewing our customer segmentation, most of our customers are in suburban and rural areas versus urban centers. I believe these customers are likely to resume operations ahead of our urban customers. From an operational perspective, we also suspended operations in our Suwanee, Georgia distribution center, and orders are now being built from our McCook distribution center. We have seen very little customer disruption from this action. During this challenging time, our sales team has worked hard to continue servicing customers and is developing innovative approaches to meeting our customers' needs. For example, our marketing team has developed marketing tools that enable our sales reps to customize offerings which meet their specific customer needs. Programs that we rolled out several months ago continue to gain traction, such as the hydraulics program that I mentioned a moment ago. We have continued to add new accounts and develop new relationships that we expect will produce positive results as we exit the situation. Considering the overall environment, Lawson Products has performed very well in the first quarter and up until the last two weeks was in line with our performance expectations. Consolidated sales contracted by 0.3% year-over-year and 1.9% on an EBS basis driven primarily by the decline in the second half of March. We reported total sales of $91 million versus $91.3 million for the first quarter of 2019. Despite the flattish sales trends, our adjusted EBITDA margin increased over 200 basis points to 10.4% of sales versus 8.2% a year ago, resulting in an adjusted EBITDA increase of nearly 27%. These results reflect continued leveraging of our fixed costs and cost reduction actions starting in March. Despite the last two weeks of March, we did see some sales success during the quarter. Strategic accounts achieved 1.7% growth and 14.3% growth excluding two oil and gas customers who were negatively impacted by the decline in oil prices. Strategic account customer growth included two equipment rental companies, three integrated supply distribution partners, one truck and trailer customer, and several other companies. Our Kent Automotive strategic accounts grew 5% for the quarter with our national relationships continuing to increase. Our government accounts contracted by 1.8% for the quarter; this softness was broad-based. Bolt Supply grew by 8.4% year-over-year for the quarter. While our three-part growth strategy remains unchanged, we are making adjustments based on the current environment. We finished the quarter with 993 sales reps and over the intermediate and long-term, we will continue to add sales reps incrementally. However, we have deferred start dates for new reps until at least July 1st. Our focus on sales rep productivity also continues though improving productivity during this period is a challenge. Sales rep productivity contracted by 3.1% on a sales per rep per day basis for the quarter. However, actions that we mentioned during previous earnings calls, such as our training and focus on core private label products will continue in this environment. These products include fasteners, chemicals, abrasives, cutting tools, and electrical connectors. All our sales managers have also completed training and distance coaching which will pay long-term dividends as we exit this environment. We continue to progress on the acquisition front. Well, it's likely that the current environment will slow some aspects of our M&A process, our conversations remain productive. We're committed to exit this environment as strong as we entered it. I'm confident the actions we've taken will ensure these results. Now, I'll turn the call over to Ron for more insight into the first quarter results as well as our recent actions.

Ron Knutson, CFO

Thank you, Mike, and good morning everyone. I will first provide some key takeaways from the quarter and our actions being taken. Then I'll discuss trends in the first quarter of 2020 and April followed by various actions that we've taken to date in light of the economic impact of the COVID-19 environment. Finally, I'll discuss in detail our first quarter results on both the reported and adjusted basis. Let me now provide some key takeaways. For the majority of the first quarter, our sales showed continued improvement and the economic impact of the COVID-19 did not manifest itself in our results until the second half of March with the softness continuing into April. Second, effective cost management has been a cornerstone of our operating approach for the past several years. In March, we began an aggressive program to gain further efficiencies and have implemented broad-based and necessary cost actions which I'll comment on further in a moment. Finally, proactively managing our working capital and liquidity while supporting our customers is a core part of our operating philosophy. We ended the quarter with $4.1 million of cash and cash equivalents with an additional $88 million of availability under our committed credit facility. We are very well capitalized and continue to actively pursue opportunities to further enhance our financial position. As Mike discussed, we really break the first quarter down into two separate periods. First, January 1 through say mid-March and then the second period being from mid-March through the end of the quarter. For the quarter, sales contracted by 0.3% compared to a year ago driven by the softness in the last two weeks of March. Consolidated sales were slightly positive for the quarter excluding the foreign exchange impact. Our reported average daily sales were $1.447 million for January, $1.468 million for February, and $1.356 million for March. As you can see, we were generating a month-to-month sequential increase for the first two months until the second half of March. Let me provide some further details. On the MRO side of the business, March started a little soft with our average daily sales from March 1 to March 13 at approximately $1.34 million. This compares to MRO sales during the week ending of March 20 of $1.19 million and the week ending of March 27 of $1.06 million. So we ended the last week of March, running at about 78% of sales as compared to the first two weeks of March. Both supplies drew similar results but their decrease occurred more in the fourth quarter of March than in the third week of March. And in fact, they hit their planned ADS for March during the third week. During the last two weeks of March, our sales decline was broad-based across most of our district territory and customer types. More specifically, as we look at sales for the quarter by end customer, we realized increases in sales to our Kent Automotive and strategic customers while seeing declines in our government business and our core Lawson segment. Despite the slowdown in sales during the last week of March for Bolt, they ended the first quarter with an increase of 8.4% on a year-over-year basis in local currency. From a products category perspective, our sales decline was pretty consistent across our core categories except for increases realized in our specials orders and our safety category. Let me now comment on the trends that we've seen for April and then I'll conclude my comments with the results with commentary on our reported and adjusted results for the quarter and the action items that we've implemented. First, similar to other distributors, sales for the month of April have trended lower than the latter half of March. In the MRO business, our April average daily sales are currently trending at approximately 61% of sales versus the first two weeks of March, resulting in a decline versus April 2019 of approximately 35%. For Bolt Supply, we're seeing better results with April ADS trending at approximately 73% of the first two weeks of March, but we are down approximately 33% as compared to a year ago. As Mike mentioned, we remain proactively focused on supporting our customers and generating revenue in this challenging environment. We continue to perform on-site visits to many of our customers' locations while providing additional support through phone outreach, internal customer service representatives, email communication, and our website. There have been some great success stories from our reps being able to support our customers as well as reaching out to new customers in this environment that Mike has already shared with you. Gross margin for the quarter came in largely at expected levels with our consolidated gross margin at 53.7% versus 53.6% in the same quarter a year ago. On a standalone basis before the service costs reclassification, MRO margin was 60.8% for the quarter unchanged with a year ago. For the quarter, total operating expenses were $30.3 million, compared to $43.4 million a year ago. During the quarter, we recorded a benefit for stock-based compensation of $10.7 million with the benefit primarily associated with the stock price which declined during the quarter. This compares to an expense of $408,000 in the first quarter of 2019. Excluding stock-based compensation and minimal severance expense, total operating expenses decreased by $2 million or 4.6% on slightly lower sales as we closely managed our fixed operating expenses as well as reduced performance-based awards, travel, and award trips late in the quarter. Our reported operating income was $18.6 million for the first quarter inclusive of the stock-based compensation benefit at $10.7 million compared to income of $5.5 million a year ago. On an adjusted basis, non-GAAP operating income was $7.9 million compared to adjusted operating income of $6 million in the year-ago quarter, a 33% increase. This results in adjusted EBITDA as a percent of sales of 10.4% for the quarter compared to 8.2% a year ago. On an adjusted basis excluding stock-based compensation and severance, diluted EPS was $0.52 for the quarter versus $0.48 in the year-ago quarter. Capital expenditures for the quarter were approximately $551,000. As we manage our liquidity for the remainder of 2020, we expect our capital expenditures in 2020 to be approximately $2 million primarily for maintenance capital versus the previously guided range of $3 million to $4 million. I will now comment in greater detail on some of the specific actions that we've taken from a cost and liquidity perspective. While some benefits were realized in the first quarter from these actions, the majority of the savings will be realized in April and the go-forward months. With sales at the current run rate, we've effectively taken out an average monthly cost of $4 million to $4.5 million throughout the organization. In terms of costs, our actions include but are not limited to the following: consolidating our Suwanee Georgia distribution center operations into our McCook facility capacity; reducing salaries for all salaried individuals ranging from 10% to 30% depending on their role in the organization, as well as reducing board compensation; in addition, we've eliminated many of our performance-based awards; furloughing approximately 100 employees throughout the organization and deferring new hire start dates; eliminating approximately 40 sales rep positions with slower end markets; and eliminating all non-critical travel including sales award trips and district sales meetings. We are also proactively managing our balance sheet and liquidity. We have reached out to our vendor and supplier community for extended payment terms, eliminated non-critical capital, and we continue to monitor our customer credit to manage customer past-due balances. We ended the quarter with $4.1 million in cash and cash equivalents and an additional $87.5 million of availability under our $100 million committed credit facility led by JPMorgan Chase. As of today, we essentially had the same level of availability under our facility from four weeks ago. While we've taken actions to date, we are prepared to take further action if the environment worsens. As we manage through these interim periods, we look to come out of this environment as strong as we entered into 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 six weeks. Actions that we have taken have put additional pressure on our teammates and every one of them is stepping up to the challenges in this difficult environment. We are committed to the organization, and it's humbling to lead the confidence that they put in the leadership team to make the necessary but difficult decisions to ensure that Lawson comes out of this stronger than when we entered it. As one of our regional sales directors said, 'Let the tough get tougher!' Thank you to the entire Lawson and Bolt teams for their commitment over the last six weeks. I'll now turn it over to the operator for questions.

Operator, Operator

Thank you. We will now begin the question-and-answer session. Our first question today comes from Kevin Steinke of Barrington Research. Please proceed.

Kevin Steinke, Analyst

Hey, good morning, Mike and Ron.

Michael DeCata, CEO

Good morning, Kevin.

Ron Knutson, CFO

Good morning, Kevin.

Kevin Steinke, Analyst

Thanks for all the detail on the sales trends. You've seen second half of March going into April. That was very helpful. I'm just wondering as you move through April if you have this level of detail kind of on a week-by-week basis, have you seen any stabilization as the month progresses?

Ron Knutson, CFO

Yes, I can jump in on that, Kevin. We've seen stabilization throughout the weeks in April and as you can imagine, we're looking at the trend. Not only weekly, but on a daily basis. In our business, it can be a little spiky from time to time on a daily basis, but overall, from a weekly perspective, it's been pretty consistent for most of the week of April. Mike, did you want to comment as well? I know just kind of jumped out of you.

Michael DeCata, CEO

We are seeing consistency for the last couple of weeks.

Kevin Steinke, Analyst

Okay. Yes, thank you, it's helpful. And then on the cost reductions, obviously pretty aggressive actions $4 million to $4.5 million a month. I believe you said $12 million plus on a quarterly basis. How should we think about those costs being distributed across your various categories, cost of goods sold, selling expenses, G&A expenses?

Ron Knutson, CFO

Yes, Kevin, this is Ron again. Most of those costs within both the selling and the G&A lines as we report them separately on our financial statements and certainly a portion of those expense reductions are variable relative to our sales coming down, but there is a significant portion of those expenses that are fixed as well. The actions that both Mike and I commented on really are across the organization. So the salary reductions and the furloughing and so forth, that's across the entire organization. It's not solely within just the sales organization, or just corporate, or just the DCs. So from a flow-through perspective as to where you will see those, you'll see the reduction in expenses in both of those lines. The gross margin really doesn't include that much from an operating expense standpoint; it's more on the direct expense lines.

Kevin Steinke, Analyst

Okay, got it. And then, you mentioned you consolidated the Georgia distribution center into McCook. Did you see that as a permanent action going forward?

Michael DeCata, CEO

No, we don't. It's volume-based. We smoothly made the transition without disrupting customers, and as volume increases, we plan to gradually bring back our furloughed employees. As demand grows, the need will also rise.

Kevin Steinke, Analyst

Okay, got it. It's good that you have a pretty diverse customer base. You mentioned that more weighted to suburban locations for your customers which might come back sooner. But do you have any sense as you look at your customer base? I know you were deemed an essential business, maybe like roughly how many of your customers or what percentage might be also deemed essential?

Michael DeCata, CEO

Kevin, we don't track it in that manner. There are indeed many trucking companies, food production companies, and various manufacturers among our customers. However, prior to the recent circumstances, we never considered the concept of critical interest across these companies. It's not included in our typical customer database regarding what that customer ratio might be. Still, a significant portion of our customers are trucking companies, food producers, and manufacturers of various products. Since most of our products are B2B, I'd estimate that the majority is not related to consumer B2B products. One exception is Kent Automotive, which deals with auto body repairs. If these repairs are discretionary, we anticipate they could decline a bit as people may postpone minor repairs until conditions improve. That's the one area that's somewhat closer to consumers; it's still B2B but tends to be more discretionary. Generally, though, most of our customers are likely more aligned with essential services.

Kevin Steinke, Analyst

Okay, now that makes sense. Yeah, that's helpful. And then encouraging that you mentioned you continue to win new customers. Do you think that can continue kind of during the worst of this downturn? How has the process changed for winning new customers? Do you think it could slow down materially? I wouldn't doubt that it would slow a bit, but just maybe a little about winning new customers in that process in this environment.

Michael DeCata, CEO

Everything is a bit harder to predict clearly these days. This is a challenging environment, and many of our competitors have faced difficulties. When I mentioned new customers, I was referring to discussions with our field sales managers. They've indicated that companies they have been trying to engage for some time are suddenly reaching out to us, reporting that their current suppliers can't meet their needs or that they are being underserved, especially in more remote areas. This is an advantage for us due to our larger number of sales reps. For us, geographic remoteness is less of a concern compared to competitors with fewer sales reps. The real opportunity for us lies in continuing to serve our existing customers and capturing more business from them. Additionally, prospects we’ve been targeting are now more receptive, particularly those being underserved. We've gained several new locations from both large and small competitors across the board. It's difficult to predict the future, but we plan to retain the customers we've gained and continue on our previous growth path. Our core business remains solid with a strong trajectory. This temporary stagnation will pass, and we'll return to our growth path. I believe we will emerge stronger, more resilient, and more innovative, with improved customer loyalty, as reflected in our 92% revenue retention rate. This was already impressive, and we aspire to enhance employee loyalty and commitment, as our team has been extraordinary during this challenging time.

Kevin Steinke, Analyst

Okay, great. Yes that's an interesting market dynamic. It sounds like you're really well positioned competitively both within this environment coming out of it. So that's all I have for today. Thanks. Thanks for all the comments.

Operator, Operator

Our next question is coming from Carl Schemm, KeyBanc Capital Markets. Please go ahead.

Carl Schemm, Analyst

Good morning. One question around, I think you mentioned you eliminated 40 sales rep positions just in underperforming areas. Was that at the end of the quarter or did that occur in April? Just trying to sense the timing there.

Ron Knutson, CFO

In April, late April.

Michael DeCata, CEO

And we are able, again this is one of the benefits of critical mass of sales reps, 993 sales reps. We are able to reassign those customers to existing sales reps, to our inside sales people, and customer service people, and we do not anticipate any disruption whatsoever in customer service or the service intensity that we're able to provide those customers.

Carl Schemm, Analyst

Got it, thanks. What about just in terms of, I know you guys have focused a lot on retention, are you evaluating how well you're going to be able to retain sales reps at this point given that you have the higher increases?

Michael DeCata, CEO

Yes.

Ron Knutson, CFO

Yes, this is Ron. I'll dive in. Throughout 2019, we observed a steady improvement in our retention rates, which continued into the first quarter of 2020 and even into April. Although our sales representatives operate on a commission basis, some have a salary plus commission, and all are incentivized. We feel optimistic about our retention. We are making efforts to ensure fair treatment for all our employees, and we’ve noticed significant engagement from our team. Thus far, in the first quarter and into April, even amid these challenging times, our retention has improved slightly.

Carl Schemm, Analyst

Great. And then just kind of lastly on the sales rep side. I know you mentioned the higher increase going through July 1 potentially. Is that just dependent on maybe moving that forward or backward? Is that dependent on if the market conditions improve or how are you kind of evaluating that aspect?

Michael DeCata, CEO

It is somewhat influenced by market conditions, but the primary factor is how district sales managers engage with new hires and initiate the intensive one-on-one training. We have trained all district sales managers in distance coaching, which will yield significant long-term productivity benefits, allowing them to connect with more members of their teams and utilize their time more effectively. We are enthusiastic about the commitment district managers have shown to this distance coaching approach. However, for completely new employees, it is essential to provide in-person, one-on-one time. Thus, the focus is more on the training mechanics rather than the availability of customers or market opportunities. We will resume this training as soon as possible. We have seen consistent increases in the number of sales reps, and we do not anticipate any changes to that trend in the future, although there is currently a pause until we can provide the thorough training that new employees require.

Carl Schemm, Analyst

Got it. That's all I had. Thank you.

Ron Knutson, CFO

Thank you, Carl.

Michael DeCata, CEO

Thanks, Carl.

Operator, Operator

Thank you. This concludes our question-and-answer session. I would like to turn the conference back over to Mike DeCata for closing remarks.

Michael DeCata, CEO

Thank you, Donna. Thank you for joining the call this morning. Over our 68-year history, Lawson Products has faced many challenges, though none quite like this one. I am 100% confident that we will emerge better, stronger, and more resilient than when we entered. This quarter, we demonstrated that with flattish sales, we can still deliver improved EBITDA and generate cash. More customers and potential customers are recognizing our value proposition, especially in these challenging times. This quarter, and more recently, we also demonstrated that we can be nimble and innovate. We're focused on the safety of our teammates and we'll continue to take the necessary actions to remain in a strong financial position. I would like to take this opportunity to again thank our teammates; their innovation has been tested and they continue to demonstrate their commitment to our customers. Thank you again for joining this call. Have a wonderful day.

Operator, Operator

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