Good morning, ladies and gentlemen, and welcome to the Lawson Products' First Quarter 2017 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. They will open the call with an overview of the first quarter results. There will then be time for questions and answers. This call is being audio simulcast on the Internet via the Lawson Products’ Investors Relations page on the company’s Web site, lawsonproducts.com. A replay of the webcast will be available on the Web site through May 31, 2017. During this call, the company will be providing an update on the business as well as covering relevant financial and operational information. I would like to point out 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 disclaims any obligation to do so. I will now turn the call over to Lawson Products’ CEO, Mike DeCata.

Good morning and thank you for joining the call. This morning, I’ll comment on the quarter and our overall progress. Ron Knutson will provide a detailed review of our financial results for the quarter and then we’ll take questions. Let me start by saying that we’re very pleased with the progress that we’ve made during the first quarter of 2017. We made good progress across many aspects of the company. Today, however, I will spend a bit more time discussing progress in the sales arena. Some of our success is market driven and we’ve discussed in the past how we look at the PMI index as a gauge of the industrial manufacturing economy. For the first quarter, the index was 57% as compared to 49.8% a year ago, evidence that there’s growth in the manufacturing economy. However, we’ve taken deliberate actions that are producing positive results beyond market growth. We feel good about the market and more importantly about our ability to grow our customer base and win share. Let’s get into some of the details. First, sales increased by 7% versus the first quarter of 2016 and 3.9% versus the fourth quarter of 2016. All segments experienced growth. Strategic accounts grew by nearly 25% versus the first quarter of '16. Government accounts grew by 6.6%. And our Kent Automotive business grew by 8.5%. The Canadian business grew by 18% in local currency and our core business grew by approximately 3%, all versus the first quarter of 2016. We experienced an increase in ship to locations, line count and unit volume during the quarter. On our last call, I mentioned a process called conversion. We added 355 new locations within existing strategic accounts through this process during 2016 and an additional 47 locations this quarter. During the last call, I…

Thank you, Mike, and good morning, everyone. As Mike indicated, we’ve seen a continuation of solid sales from the fourth quarter of 2016 through the first quarter of 2017. We continue to invest in the business and pursue acquisitions that will provide future growth opportunities to expand and increase our geographic density and leverage our current infrastructure. Specifically, in terms of the first quarter, I’d like to highlight some key metrics. First, sales finished at 74.6 million for the quarter. Average daily sales were up 7% versus a year ago quarter and up 3.9% from the fourth quarter. Excluding the impact of our 2016 acquisitions, average daily sales increased 5% over a year ago with the same number of selling days. Second, our adjusted operating income for the quarter improved by 991,000 to 1.1 million from 156,000 in the first quarter a year ago. Third, gross margin percentage ended at 60.1% for the quarter in line with Q4 of 2016. And fourth, we ended the year with 8 million of available cash and an additional availability of 34 million under our credit facility with 1.8 million of outstanding debt. Let me now share some of the details. As I just mentioned, we finished the quarter with sales of 74.6 million on 64 selling days, the same number of days as Q1 of 2016. On a sequential basis from Q4 2016, we were up 3.9% on four additional selling days. As compared to a year ago, our first quarter sales benefitted from the following. First, deliberate actions we’ve taken internally to drive growth are getting results. This includes, but is not limited to, improving the on-boarding process of new sales reps, actively converting new locations of our strategic relationships, driving more accountability to the field management, providing forums to support technical…

Thank you. We will now begin the question-and-answer session. [Operator Instructions]. Thank you. Our first question is from the line of Kevin Steinke with Barrington Research. Please proceed with your questions.

Good morning, Mike and Ron.

Good morning, Kevin.

Good morning, Kevin.

I wanted to start off by asking about the overall industrial economy and the improvement you’re seeing there. It sounds like you’re stating more definitively that you’re confident that that recovery or that stronger environment can continue? Would you say that’s a fair statement? How does it feel overall and what’s giving you a little bit more confidence that this might be sustainable?

Thank you, Kevin. This is Mike. We are seeing that and we’re seeing it broad based as we’ve mentioned across the sectors, across the product categories. There are some specific data points. The oil and gas industry is coming back. One of our large customers has hired a very large number of mechanics in a couple of their locations over the last year and a half, two years. They’ve reorganized and restructured and now they’re really growing. We’re seeing oil rig counts come back. But beyond that, we continue to win share at some of our large strategic accounts and their picking up fleet utilization – time utilization of their fleets. So we do see it kind of across the board. There are a few data points that we have that are specific causing effect, like hiring mechanics. But beyond the specific data points, it’s kind of broad based.

Okay, that’s good to hear. I wanted to dig a little bit more into the sales per rep per day metric being positive. You’ve talked a lot in the past that you would typically expect to see sales per rep per day go down a little bit just as you continue to hire new reps. So I’m just wondering how that balances out going forward in terms of hiring of new reps, your performance management program and also you talked about the increase in the reps greater than three years tenure. So how do you see that metric playing out as you move forward?

Sure, Kevin. This is Ron. So let me comment first on some of the information, some of the data that we’re seeing. Then I’ll have Mike comment on a couple other aspects of it. When we look at our veteran sales reps, I think that was one of the most significant drivers of the sales per rep per day during the first quarter. And in the last couple of quarters we’ve seen positive results from those more veteran reps as we define with greater than three years of tenure with us. So they service a majority of our customers and to Mike’s comments earlier, the increase in demand that we’ve seen on the customer basis has been really broad based. And certainly that is helping to fuel those existing sales reps.

Yes, relative to the new reps to augment the ones with more than three years, our continued focus on Lean Six Sigma on-boarding them, training them, our social network internal called Lawson Central, all those things we believe are beginning to enable our new reps to become more successful and candidly, a focus on performance management. We do everything we can to enable the reps to succeed and succeed as quickly as possible. But the other side of it is where it isn’t a match or it isn’t going to work out, we accept that reality and displace those reps and look for an alternative. So it’s the combination of putting a lot of effort into enabling the reps to be successful and then accepting the reality sometimes with the reps who are not going to be successful and moving on.

Okay, that’s helpful. Moving on to the gross margin, you talked about some of the factors that played in the gross margin this quarter. And you also talked about excluding some of these transition costs related to Fairfield, you would have actually had about 500,000 more of an increase in adjusted operating income. So how much of that was factored into gross margin in terms of those one-time costs and what would gross margin have been without those costs?

Sure. So let me give you a little bit of a breakdown on that, Kevin. So we were down about 70 basis points versus our gross profit percentage from a year ago and about half of that was directly related to – actually we were down about 80, but about half – not quite half, about 30 basis points of that was driven really by customer mix. Mike mentioned in his prepared comments that our strategic customers increased about 25%. So certainly that had an impact on our overall margins. As well as our acquisitions, the 2016 acquisitions it brought down our gross profit percentage slightly as well. The cost that we incurred relative to Fairfield, the closure, was about 20 basis points on the overall margin, at least the piece that hit the gross profit percentage. Some of the other items were more included within our operating expense lines.

Although I would say that in the past we’ve talked about gross margins in the 60 to 61-ish range and certainly that’s impacted by not only customer mix but also by new sales reps coming on board as well as acquisitions. So we’re still comfortable in that 60 to 61. But as we’ve said in the past, there’s certainly more downward pressure on that percentage. And to the extent that we need to give up a little bit on the percentage in order to increase aggregate gross margin dollars, we’re certainly willing to do that.

And we don’t see a structural change here either on the cost side versus previous quarters and previous years and a lot on the price side.

Sure, that makes sense. It seems like an acceptable tradeoff for sure. So you said 20 basis point impact from Fairfield on the gross margin and then the rest what falls into G&A, was that an impact in terms of basis points?

Yes, all-in, our total Fairfield first quarter costs were about $400,000; so about half fell into the margin and about half into the G&A.

Okay. Thanks. Just circling back to revenue quickly, so you talked about all the success with strategic accounts, Kent, government, et cetera, and you also mentioned the core business growing 3%. Do you see an opportunity for that core business to grow faster as we move forward with the stronger economy and all the various growth initiatives you’ve talked about?

It’s a little hard to tell. The core business, as you know, we have about 70,000 active customers and so it’s broad based. It is probably a better proxy of the U.S. economy and the Canadian economy. So it’s broad based in nature. But as we continue to ramp up our sales reps, the newer sales reps and the greenfield sales reps that’s certainly the goal of putting reps into untapped territories to win more share. In the broad base, they tend to be smaller. We call them regional accounts but they just tend to be smaller accounts. And so we are very much focused there. Our strategy absolutely has not changed. It has not shifted toward large accounts or small accounts. It is the same strategy. It has been all along. We continue to try and win share everywhere we can and we’re very excited about the diversification of our government activities both local, municipal, federal and Department of Defense and of course we’re very, very pleased with our continued effort on this conversion process to win share within existing strategic accounts. So no change in strategy here and just a continuation of what we’re doing.

All right, great. Just a couple more here. On the selling expenses, I guess with the continued hiring of new reps, maybe some higher performance based comp and commissions as sales improve here, should we still expect selling expenses as a percent of sales to be up year-over-year on a percentage basis?

I wouldn’t say that we would expect it to be going up as a percent. Some of the impact that we saw that came through in this quarter, we did incur some additional health insurance costs which were trending higher – which trended higher in the first quarter than what we’ve seen in the past. So that had a negative effect. But generally we’re in that 32% to 33% range and in fact moving forward we should get some leverage off of increasing sales because not 100% of those expenses are variable relative to sales. So the fixed portion of that we’re managing very tightly. The variable piece certainly will flow with sales. So we would not expect the percentage to be increasing as we move throughout the rest of the year.

Okay, that’s very helpful. And then just on the G&A expense line, excluding the stock comp and severance, the sequential increase from Q4 '16 to Q1 '17 in those G&A expenses, is that just more kind of some beginning of year costs that we typically have in terms of pay increases or what have you?

Yes, Kevin, that’s a good way to phase it up. We were down about 600,000 if you compare the first quarter of '17 versus the first quarter of '16. And there are areas such as payroll taxes. We did bump some of our incentive accruals because of the increased sales that we saw in the first quarter. So those are the primary drivers of it. But typically if you look back historically, our first quarter expenses run higher than the remaining three quarters of the year.

Okay, great. Well, thanks for taking the questions.

Thank you, Kevin.

Thanks, Kevin.

Our next question is from the line of Steve Barger with KeyBanc Capital Markets. Please proceed with your questions.

Hi. Good morning, gentlemen.

Good morning, Steve.

Good morning, Steve.

I admit I’m not fully up to speed on the story, so some of my questions maybe a little basic, but I want to go back to the sales rep discussion. You talked about in the press release deliberate actions to improve sales rep productivity and I think your prepared comments you talked about some performance management initiatives in the quarter. Does that mean you cut sales force headcount? And if so, how many of the 30 departures in the quarter were voluntary versus involuntary?

Steve, to that point, yes, we do focus – our primary goal once we bring a sales rep on is through Lean Six Sigma a very structured process to on-board all reps in a consistent manner to when they’re prepared and capable of absorbing the information certainly within the first 90 days, we bring them to a week’s worth of training, product training, corporate training both here at corporate and in our distribution center in McCook, Illinois. So our primary focus is a lot of effort around consistently enabling them to succeed. But conversely, after some period of time, it’s not usually 90 days, it might be a year, it might be two years where we see a sales rep not on the trend they need to be on. Sometimes we just accept the fact that this isn’t a good match between the sales rep and us and at that point, we often part ways. So there is a little bit of that. I don’t have the breakdown myself versus one or the other, but Ron has some data on the terminations.

Yes, we did see slightly higher terminations in the first quarter than what we’ve seen in other quarters and I think to Mike’s point part of that was deliberate around performance and so forth. And the decrease that you see, the 30, is really a net number. So certainly we are consistently and constantly hiring replacements for those individuals that leave us. So if you look at the absolute numbers, about 30% of the reps that left us in the first quarter were some level of lower performance based is I guess the way I would classify it.

Understood.

This is not a change in strategy, just the normal ebb and flow of things that you’re seeing and you’ve seen over the last three, four years.

Sure. I guess what I’m trying to get to is the mix in general of those net departures, were more of them sub three years in tenure?

So what we look at is of the reps that leave us in each quarter, how many of those reps are in their one-year, two-year, three-year base and so forth. And typically what we’ve seen and this has kind of leveled off over the last probably six quarters or so is that about 40% of the reps that leave us in any given quarter they have less than one year of service. And then there’s probably another 25% to 30% within the two to three-year bucket. So it’s certainly a core focus of ours relative to retention. We typically retain about 50% of the reps after a two-year period.

There’s a different sort of diagnosis or corrected action associated with the reps that leave us in under a year that sort of raises the question around, have you attracted the right person, have you on-boarded them right, was it a good match like from the beginning? By contrast when a rep leaves us after two or three years, then it might be more about ongoing performance rather than a mismatch at the outset. And so we sort of dissect that in a different way.

The other comment, Steve, that I would make regarding that is that our retention goes up dramatically or our turnover goes down dramatically after about three to four years. So once we get the sales rep through those first few years, then our turnover is in the single-digit number. So getting them successful in those first two to three to four years is critical for them to stay with us.

Got it, thank you. That’s great detail. In the release it says sales per rep per day increased 2.6% in the quarter. Do you know what that was or can you tell us for reps that have been there longer than three years what that metric is?

Yes, if you look at – so when we look at reps greater than three years, we saw an increase of about 2.5% in the first quarter. And again, we experienced similar numbers in Q4 if you were to look back into earlier quarters in 2016, they were flat to down.

Got it. And outside of this square, just looking at the press release here, it seems like the number of sales reps have been relatively flat over the past year. Can you talk about labor conditions in terms of prospecting, just going to your comment about wanting to sustainably grow to serve new geographies?

As we continue to refine our processes, our outreach social media, candidly, the more successful we become, the more attractive we are to the new candidate. We are out there winning share from our large competitors but as well the small – as you know, it’s an incredibly fragmented market that we operate in. So as we win share both from the large competitor and the small competitor, very often the sales rep says, I’m I better off competing against these guys or more likely am I better off joining them. So all of this taken together – we have a pretty good pipeline of candidates and now the challenge is figuring out finding the needle in the haystack that makes for the most successful candidate. It is probably a little more challenging in a growth economy because people have more options. And yet in a growth economy our existing reps grow also. So the existing reps and we have an internal program to encourage our employees and our reps to nominate others to join the company. So all of this taken in concert probably slightly more difficult in a growing economy but not materially more difficult.

Understood. You talked about – I think you said 365 selling locations last year, 47 this quarter. From a process standpoint, is that your sales reps going out and prospecting or is that a top-down process where you’re targeting specific accounts and specific regions, or just how does that happen?

What I was referring to there is a process. We mentioned on previous call, it’s called conversion. That is a very deliberate and specific process focused on existing strategic accounts. Most of our strategic relationships, the customer’s corporate folks bring us in but they more often than not don’t mandate that the local site buy from us. They encourage the local site but we still have to go win and earn the business locally. And many of these large strategic accounts are themselves highly diverse geographically. So a rental company might have hundreds of locations or a trucking company might have hundreds of locations. So corporate helps us but we have to go out there and win one location at a time and that’s what that process refers to. So it certainly is a combination of a structured process that we lead here in corporate. In fact our marketing and strategic accounts folks lead that process. But the people who execute the process are the sales reps out there one location at a time.

Got it, thanks. Just a couple more. As you and other distributors have seen a rising trend of customer demand over the last couple of quarters, are you seeing anything surprising in terms of product demand trends? Are you well positioned from an inventory standpoint? And I guess what I’m trying to get to is, would you expect to swing to positive free cash flow in 2Q and 3Q?

Let me comment first on the broad product related topic. We aren’t seeing any specific trends relative to product. As you know, 60% of our product is private label and within that private label, we believe that we’re differentiated because our private label products are specifically targeted and designed to serve the maintenance mechanic who’s needs are very different from the production engineer. So we believe we’re well positioned that way. Of course, we are always looking to innovate and bring new products to the marketplace where customers demand those products or where we can innovate with customers. I mentioned some work we’re doing with AutoNation, a tremendous partner of ours and an innovative company. So where we can, we try and innovate with new products and new processes with customers. There’s no fundamental shift going on.

In terms of cash flow, Steve, typically the first quarter for us is generally a little bit of a heavier use of cash and in fact most of what we saw that we had to fund from a working capital standpoint in the first quarter of '17 was really just the increase in the sales. If we look at December sales versus March sales, the AR that we’re carrying is really a direct result of that increase. From an inventory standpoint, we did see inventories go up a little bit from the end of the year partially driven by the increase in the sales and quite honestly the increase in the unit volume that we saw coming through in the first quarter. But typically we turn cash flow positive in Q2 and Q3 and we would expect to do that this year as well.

Got it. And last one for me. If I’m remembering right, your CapEx guide from 4Q is 3 million to 4 million. I think you just said 2 million to 2.5 million. Is that right? And if so, where are you dialing back your spending plans or what changed?

You’re partially correct. So it was 3 million to 4 million and recently we just said 2.5 million to 3 million in my prepared comments. So we typically go into the year a little bit heavy from a forecast standpoint on CapEx. I wouldn’t say that there any specific areas that we’re necessarily dialing back. It’s probably more broad based across the organization. And in fact in the first quarter of '17, I think our total CapEx was about $204,000, so some of that favorability will continue throughout the year. So that’s probably where we picked up most. It was just the fact that in the first quarter we didn’t spend quite as much CapEx as what we had anticipated. But most of our CapEx today is pretty routine type of investments into our distribution network as well as IT enhancements that we continue to make in the organization.

Okay, gentlemen. Thanks so much for all the time. I appreciate it.

Thank you.

Thanks, Steve.

Our next question comes from the line of Brad Hathaway ‎with Far View Capital. Please go ahead with your questions.

Hi, guys. Just a somewhat quick one. I think previously you talked about incremental margins being closer to 25% and on this call it seemed like you mentioned 25% to 30%. Is that a change and if so, what gives you confidence in that higher number?

As you look back over the last couple of quarters specifically excluding the stock-based comp, the severance and some of the Fairfield costs that we saw in the first quarter of this year, we were sitting right at about 29% for the first quarter. And looking back into Q4, the number was – again, it was north of 20%. So I think part of it that gives us comfort is that we continue to manage our overall fixed costs to be flat and we saw that in our G&A costs once again this quarter actually down about 600,000 versus a year ago. So we are managing our cost tightly. We have taken specific actions to take cost out of the organization and that gives us a pretty good feel that we can get 25% to 30% flow through leverage effect on the increasing sales.

This Lean Six Sigma process if you do it long enough and people embrace it, you infuse it into your DNA and then literally every open position that we have at any level in the company, a group of people get together and think about is there the opportunity for an internal promotion through technology, can we reengineer the process, can we take non-value-added workout which certainly lowers costs or prevents the addition of costs. But just as importantly it adds for a higher quality workday for our employees. So when we focus on the financial implications there are also benefits to the employee base to give them a higher quality of work with less work involved. It’s one of the reasons we’re so committed to Lean Six Sigma becoming part of our DNA. Over time you just consistently work down usually in small incremental ways but you work down your costs your hold costs while you grow revenue.

Excellent. Great. Thank you, guys.

Thank you.

Thank you. [Operator Instructions]. The next question is from the line of Walter Morris with Baraboo Growth. Please proceed with your questions.

Good morning, gentlemen. Nice quarter.

Good morning, Walter. Thank you.

Could you expand a little further on your experience and you indicated success to-date with rep acquisitions and talk about the magnitude of the pipeline you’ve been able to build and hope to build going forward? And then to the extent that that helps you accelerate your sales growth, could you comment on your intermediate term goal of 10% EBITDA margins and what it might take in the way of sales to hit that target and how acquisitions may enable you to accelerate that trend?

Thank you, Walter. So the acquisitions as you probably are aware, we started small specifically with the intention of getting our sea legs focused on the most successful integration we could do. And so now that we have four of those smaller ones sort of under our belt, we’ve learned a lot, we’ve broaden our horizons a little bit, we have more confidence in our ability to integrate successfully. And it’s my view that the larger acquisitions will be even lower risk than the smaller ones because we’ve learned so much and the folks we’ve acquired, not just the businesses but the people we’ve acquired have been a huge asset and great teammates to us in helping think through what’s gone well and where we want midcourse corrections. Now relative to filling the pipeline, it’s a little inconsistent. Most of the folks we’ve gone to, we have introduced the idea of joining us and it’s really more of them have been that approach rather than someone who acquires an investment banker and markets their company. So because of the process we have used historically, it’s a little unpredictable. So we need a pretty good pipeline. But it’s my belief that the more successful we are with acquisitions and the more we can use the acquired company’s – the founders of those companies, the sales reps of those companies as a reference, the more their reference encourages other people to join us and that it will be a positive and accretive experience for both parties. So I think like a lot of things the more successful you are, the easier it is to be successful both in attracting acquisitions and then integrating them once they’re in. So that is extremely critical to our longer term strategy. Relative to the 10%, a…

Walter, I would just add to that. I made the comment in my prepared remarks that our sales excluding the 2016 acquisitions were up 5%, so we received a full 2 percentage point lift out of those acquisitions made in 2016. And we’ll be lapping some of those numbers – two of those acquisitions took place one in May of last year and the other one in November. So we will be lapping those numbers here in the second and fourth quarter and our comps get a little bit tougher as we extend throughout the end of the year. But I do think that it shows the impact that it can have on the leveraging effect of the business by getting a couple of additional point increase in sales through the acquisition process.

And again, the acquisitions we’ve done have been relatively smaller on purpose and the acquisitions that we’re likely pursuing are substantially larger.

Thank you, gentlemen. I appreciate it.

Thank you, Walter.

Thanks, Walter.

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

Thank you. Thank you for joining the call and following Lawson Products. 2017 has gotten off to a good start. We believe that Lawson Products is well positioned to grow in the current economy and the hard work that we’ve done is beginning to pay off. In this economy, our customers need even more production from their assets. They recognize that because of our service focused value proposition, their mechanics are more productive and their equipment uptime is improved. Thank you to all of our wonderful and dedicated employees who serve customers every day. And thank you again for your interest in Lawson Products. Have a great day.

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