Good morning, ladies and gentlemen, and welcome to the Lawson Products Third Quarter 2018 Earnings Conference 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 third quarter results. Then there will be time for questions and answers. 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 November 30, 2018. During this call, the company will be providing an update on the business, as well as covering relevant financial and operational information. I'd like to point out that the 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 only. The company anticipates that the 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. And now, I'd like to turn our call over to Lawson Products' CEO, Mike DeCata. Thank you. You may begin.

Good morning, and thank you for joining the call. This morning, I will comment on the quarter and our overall progress. Ron Knudsen, our CFO, will provide more detailed review of our financial results and then we'll take your questions. Our third quarter performance was strong and represents a continuation of our solid first and second quarters. We continue to successfully execute our three-part growth strategy of adding sales reps, increasing sales rep productivity, and pursuing a disciplined approach to acquisitions. Beyond sales growth, earnings and leverage have performed as forecasted during our last call, and this quarter further demonstrates the inherent leverage and earning potential of our business under a wide variety of growth scenarios. We achieved $7.3 million in adjusted EBITDA versus $5.4 million in the third quarter of 2017, and adjusted EBITDA growth continued to outpace revenue growth. So a really good quarter in both sales and earnings. Also the fact that we were able to slightly increase our Lawson segment gross margin percent is further evidence that our customers recognize us as a critical partner in their success. Now, let's discuss some of the details. Total sales grew 17%. Our organic sales grew 4% and the Lawson segment achieved a 6.6% increase in sales rep productivity. Despite facing challenging comps on a year-over-year basis, every market segment group, our strategic accounts increased 3% versus the third quarter of '17 and 12% year-to-date. Considering the 45% growth we achieved during 2017, we are extremely encouraged by the continued growth in this segment. Our Canada automotive segment grew by 4.5% for the quarter. During the 2Q call, I mentioned that we work closely with one of our key customers to bring the cloud-based procure-to-pay suite called Coupa, and digital workflow online. Our Microsoft team's knowledge-sharing platform was especially…

Thank you, Mike, and good morning, everyone. The third quarter reflects the continuation of solid demand trends, favorable operating leverage, and significant adjusted EBITDA improvements year-over-year as we successfully execute our growth strategy. Our third quarter results reflect a full quarter of the Bolt Supply house whereas Q3 2017 does not include any Bolt Supply activity. As I go through our financial performance, I'll comment on both the organic Lawson business as well as the consolidated results that include Bolt Supply. Let me share some of the Q3 financial highlights. First, sales were $88.5 million for the quarter. Consolidated average daily sales were up 17% versus the year-ago quarter. Organic average daily sales excluding Bolt Supply increased 4% over a year ago. Second, our adjusted EBITDA for the quarter was $7.3 million compared to $5.4 million a year ago, an increase of nearly 35%. This improvement was primarily driven by a $1.1 million improvement in our organic MRO business as a result of increased sales and associated operating leverage, as well as a $757,000 EBITDA contribution from Bolt Supply. Third, our consolidated reported gross margin percentage under the new method of allocating certain service-related costs into gross margin as discussed in previous quarters, was 54.3% and in line with our expectations. Excluding Bolt and the service expense reclassification, our organic Lawson segment gross margin percentage was 60.9% compared to 60.8% for the year-ago quarter. Fourth, we reported a diluted EPS loss of $0.09 for the quarter, which was primarily driven by $7.6 million, or $0.64 per diluted share in stock-based compensation, due to the 39% increase in our stock price during the quarter. Excluding stock-based compensation, acquisition costs and severance, our diluted EPS was $0.54 for the quarter. And finally, we reduced our borrowings net of cash by $7.8 million…

[Operator Instructions]. Our first question here is from Steve Barger from KeyBanc Capital Markets.

This is Ryan on for Steve. If I look on a two-year stack basis for average daily sales on the legacy business, they're down about 100 basis points from 2Q. Can you talk about sales during the quarter relative to your expectations, and were there any hurricane impacts or one-time headwinds?

You know, there were some hurricane impacts but not material. We sort of see this as normal variation, a little bit of movement between quarters, some one-off customer situations, not directly connected to us but impacting us nonetheless. And so, the long and short of it is we just see this as normal variation, month-to-month and even quarter-to-quarter.

Okay. And then year-to-date, strong gross margins in the legacy business. And I believe you said they're up year-over-year this quarter. This is pretty solid relative to your peers, so just curious: what is Lawson doing differently to maintain or even improve gross margins? And then to piggyback on that, is strategic accounts and government sales a mixed headwind for Lawson?

Let me take the beginning of that, and then Ron can jump in as well. This is Mike. So there's a number of actions we're taking. We work hard on low-cost country sourcing which now includes Taiwan, India, and other places, Southeast Asia. So there's positive impacts there. As well, we're working hard on distribution center productivity actions, freight savings, and a myriad of other activities. Lean Six Sigma continues to pay dividends for us as it relates to cost of goods sold and operating costs. So there are a broad range of actions. Of course, when necessary, we do take pricing actions and the fact that our customers accept these pricing actions is further reinforcement of their understanding of our value proposition, the service-intensive nature of what we do for them, and the fact that because of the service we provide it enables them to run their equipment more productively and with a higher uptime of their equipment. So while we really don't like raising prices, when we have to, customers are willing to work with us and they have accepted price increases when necessary.

Ryan, regarding the second half of your question on the strategic account headwinds, not too much for this quarter. But on a year-to-date basis, as Mike mentioned, our strategic accounts are up about 12%. So they are putting a little bit of downward pressure on the percentage, but so far we've been able to offset that with the items that Mike spoke about and feel good about being able to keep that margin in that - in that 60-ish range, as we've indicated in the past. We're monitoring all of our vendor activities from a cost perspective, whether or not it's inflationary or tariff-related. And we still feel comfortable that we can manage those overall gross margin percentages.

Okay. And then tariffs are becoming an increasing focus, and sorry if I missed this in your prepared remarks, but do you have an idea of your percent of COGS sourced from China and the potential cost impacts? Also, are you exploring alternative sources?

Yes. So Ryan, this is Ron. We are monitoring the potential impact on the tariffs very closely. What I would say is, is that we have limited exposure on the amount of the product that we're purchasing, and both on a direct as well as on an indirect basis from - from China. So we haven't seen a significant impact so far, and again, we feel like we can still take the necessary actions given that limited exposure to stay within that 60-ish gross margin percentage range.

Okay. One last question for me, and then I'll hop back in the queue. Incremental contribution margins on the legacy business have been pretty strong now year-to-date. You're about to anniversary your Bolt Supply acquisition here some time in 4Q. So just curious, how should we think about consolidated incremental contribution margins in 2019?

So you're right. On the loss and kind of base organic segment side, we've been able to leverage for this quarter, 37% and the guidance that we provided is between 35% and 40% - 35% to 45% for this second half of the year. We still feel that we will end the second half of the year at the high end of that range. There's a little bit less leverage that'll come through when you look at it on a consolidated basis. Typically the Bolt Supply organization operates at about a 10% EBITDA. So on an overall basis it'll bring down the leverage a little bit, but we'll continue to report these numbers separately so that you have visibility to both the Bolt Supply results and - and the Lawson segment results.

Our next question is from Kevin Steinke from Barrington Research.

Hey, I wanted to follow up a little bit on the cost increase and pricing discussion there. As I understand it, typically pricing isn't even really a consideration or part of the discussion when you're dealing with your customers, again, you know, because you're - the parts that you are selling them are so critical. And very low costs on a per piece basis. So you know, given some of the inflationary pressures out there, I mean, have you heard anything at all? Any more pushback or discussion from customers about price, or is it just kind of continuing as-is where even if you do have to implement price, really, it's not even a consideration among customers given the strength of your value proposition?

Kevin, this is Mike. I would say the latter. Again, because we integrate the product, 60% of which is private-label and they recognize, customers recognize the superior performance of that product wrapped around a lot of service. And because we're there on an either every-week basis or every-other-week, averaging 10 days, across the customer base, the value add services that we provide are extraordinary. And those value-add services translate to machine uptime for our customers. So they recognize by having us there so frequently and reliably, also technical problem solving, that we're able to give them more time utilization out of their equipment. And so they still recognize us as the lowest total cost provider. So the short answer is, it's just not a conversation. They recognize the value add, and price is just rarely a conversation at all. Even our large strategic account customers, where we have longer-term agreements, readily work with us to accommodate any cost increases that we have to incur. So even on a more structured basis, customers are really collaborative partners with us and they recognize that relationship. It's a really gratifying situation.

Okay, great. Yeah, thanks for confirming that that continues to be the case. And it doesn't sound like it from your prepared comments, and we talked a little bit about tariffs here in terms of, you know, the cost side. But there's been some chatter in the media lately about maybe the manufacturing environment becoming a bit more challenged due to the tariff situation, and inflation area environment, and stronger dollar. But I mean, our - are you seeing anything from your customers that would indicate maybe they're becoming a little more cautious in terms of their business prospects of you know, are the indicators continuing to be positive across the board as you - I think you noted?

Yes. I think the short answer, Kevin - this is Mike - is we haven't seen any change. If anything, we see a continued strength in some of the things we look at. Time utilization for the construction equipment industry. We look at over-the-road trucking miles. We aren't seeing pullback in - you know, when we start seeing customers go from three-shift operation to a two-shift operation, all of those sort of our indicators of caution or pullback. We aren't seeing any of that. So it's steady state, but steady state at a very good place or a very good rate of growth.

Okay, great. Ron, you mentioned that you expect leverage I guess in the fourth quarter to be at the high end of that 35% to 45% targeted range. Can you just go over the rationale for why you expect it to be at the high end?

Sure. Really, what my comments were that we expect the second half of the year to be at that high end of the range. So with the third quarter coming in at 37%, you can kind of do the math on that. We feel good about where we're at going into the fourth quarter, a couple reasons. One is we've seen, for the month of October, we've seen a good start for the first three weeks of the month. The other piece that I would say is that we did have some expenses in the fourth quarter of 2017 that we know are just not going to be recurring. So we do get a lift on that here on a comparison basis against the - like on a quarter-over-quarter basis. So I think the combination of the sales that we're seeing so far, conversations we're having with our customers, the gross margins that we've talked about that we have a historical track record of being able to maintain, as well as knowing that some of the operating expenses are not recurring, we feel good about the fourth quarter.

Okay. All right, makes sense. I think lastly here, I wanted to ask about the Screw Products acquisition. As you noted, it gives you some knowledge in the kitting and jobs shop space. So can you just maybe just refresh us on the differentiation, or the similarities and differences of that space, relative to your typical VMI model, and now that you've made an acquisition in that space does that knowledge potentially open up other acquisitions in that space in the future?

Yes. So when we think about what we call job shop, there is a space between what we normally do, which is MRO, repairing one machine at a time and once you fix it you're not likely to see that machine broken again for a while. At the other end of the spectrum is somebody who was servicing an assembly line, you know, an automotive manufacturer, or a large tractor manufacturer. Somebody who's running an assembly line. In between those two tend to be a huge universe of smaller manufacturing companies producing limited quantities of things, or in some cases retrofitting items, and in fact what Screw Products brings us is knowledge in that space. That in-between space. As it turns out, one of the acquisitions we made in Western Canada a couple years ago, a percentage of what they did was in this space as well. Theirs was more focused on the trucking industry with rivets and all the infrastructure that goes with rebuilding and rebuilding tractor-trailers. So, there are also services like plating or minimal kitting, or some modest pre-assembly, building a bill of materials for customers. So it's this in-between space and there are in fact a number of what we would call traditional Lawson customers that operate in this. Now, we've never used this language before, but there are situations where stuff is coming back from the field. The fleet of maybe fracking equipment, or that kind, and we're seeing the same stuff over and over and over again. It's not a pristine assembly line, and yet it's not a one-off fix. It's the in-between gray area. The excitement here is that this opens up a very significant opportunity for us in servicing - let me say - smaller manufacturers that don't have the purchasing infrastructure, the sub-assembly infrastructure, to get them the best service that they need. And we think this opens up a real opportunity for us. And candidly, further extends stuff we've been doing on the edges for quite a while. There's tremendous potential here, and we're really excited about this.

Our next question is from Brad Hathaway from Far View Capital Management.

Congrats on another strong quarter; good to see the flow-through on the EBITDA line. I was just wondering if you could give any more color on kind of the acquisition pipeline that you see out there, and how you're seeing that?

You know, basically unchanged as far as process. It's a nice pipeline, a broad spectrum of sizes from small to large. You know, candidly we are a little more focused on the larger ones than this most recent one, but the reason we did this recent one was for strategic reasons. We value this knowledge that this team has. And that will still be predominantly the driver of what we're attracted to. We continue to have conversations with a broad range of companies that we would like to combine with them, acquire them, and the more of this that we do, the more that we're recognized in the marketplace as - I often refer to as a serial acquirer. But most important, our culture, the integrity of our process, the commitments we make to the company being acquired and then holding ourselves accountable to fulfill those commitments; all of these things are building a reputation for us in the marketplace, and it really revolves around our culture and what's going to happen after the acquisition happens. So, while we're feeling great about it, again, we'd love to be doing larger ones. But the common denominator here is a disciplined, systematic and methodical approach to attracting the right combinations and then springboarding from there. By the way, we mentioned recently with Bolt, that we've just opened a branch in Port Kells, a suburb of Vancouver. It's about a 12,000 square-foot branch. We've invested in an upgraded facility in Winnipeg, about 50% larger than the previous facility we had in Winnipeg. And we've invested in territory managers at Bolt. That's our plan with, once the acquisition is done, is how do you sort of springboard it into something much bigger? And that's been sort of the common theme in everything we've done, and everything we will do in the future.

[Operator Instructions]. Our next question is from Steve Barger from KeyBanc Capital markets.

Just a couple more from me. Solid rep count in the quarter. I think they were up 10 sequentially. I know in the past you said modest increase. Should we assume a low-double-digit run rate going forward, or do you think maybe a 5 to 10 run rate would be more realistic?

You know, Ryan, this is Mike. It's a little hard to model that way. We're looking for the best people. There'll be quarters when it - you know, it moves ahead more than that. Be some when it doesn't. You know, the common denominator is really not driving ourselves to the number, but rather, attracting the best candidates, making sure that they get onboarded correctly, opening up markets, retaining customers when sales reps either retire or leave for some reason. So you know, I would say it's going to be a little spikey like it has been for the last kind of five years. But I think you're going to see a continuous incremental increase over multiple quarters and over multiple years to come. We are not going to run out of untapped territories. We're not going to run out of customers anytime for a very, very long time. And operationally the better we do, the more we attract customers. The conversion process with strategic accounts is an example of that. So you know, we will continue to add sales reps.

Okay, and then one last question for me, sorry if I missed it in your prepared remarks. Could you give a little bit of color on October trends, and then just a perspective on your end market performance?

Yes, Ryan, this is Ron. So the October trends that we're seeing so far really are pretty consistent with the overall increase that we saw in the third quarter versus a year ago. So, relative to - I'd leverage comments on the fourth quarter, feel pretty good about where we're at. Now, in the fourth quarter, keep in mind that there are only 61 selling days and we had 63 selling days in the third quarter. So we're - which, you know, so we're up against that as we move into the fourth quarter. And typically, a little bit more seasonal sales - or I should say, a little bit more seasonal exposure as we move into the month of December.

Thank you. This concludes the question-and-answer session. I'd like to turn the floor back over to Mr. DeCata for any closing comments.

Thank you. Thank you, Matt. So, thank you very much for joining the call this morning. We continue to demonstrate consistently solid results, reinforcing the strength of our execution and strong value proposition with our customers. We had a great quarter, and we're excited about it. As a result, our adjusted EBITDA growth is exceeding the pace of our revenue growth. Supporting these trends is the company's continuous focus on productivity improvement. Finally, our opportunity for growth is expanding through potential acquisition activity, increasing share of [indiscernible] with existing customers, the addition of new customers, and the expansion in such areas as government which we mentioned a moment ago. This has resulted in solid leverage and improved EBITDA. Lastly, our culture and our teammates are committed to extraordinary customer service. Thank you again for joining the call this morning and we look forward to speaking to you again for the fourth quarter call in February. Have a great day.

This concludes today's teleconference. You may disconnect your lines at this time. Thank you again for your participation.