Distribution Solutions Group Inc (DSGR) 2011 Q4 法說會逐字稿

Good morning, and welcome to the Lawson Products Incorporated Fourth-Quarter and Full-Year Financial Results Conference Call. All participants will be in a listen-only mode. (Operator Instructions) After today's presentation, there will be an opportunity to ask questions. (Operator Instructions) Please also note that today's event is being recorded.

I would now like to turn the conference call over to Lawson Products' Communications Director, Carolyn Ballard. Please begin.

Thank you, Jamie. Welcome to the Lawson Products 2011 Fourth-Quarter and Full-Year Earnings Conference Call. This call will be hosted by Tom Neri, our Chief Executive Officer, and Ron Knutson, our Chief Financial Officer. Tom and Ron will open the call with an overview of our fourth-quarter and full-year results. There will then be time for questions and answers. This call is being audio simulcast on the Internet via the Lawson Products' investor relations page on the Company's website, www.lawsonproducts.com. A replay of the webcast will be available on the website through March 31, 2012.

During this call, we will be providing an update on the business, as well as covering the relevant financial information and operational data. I would like to point out that statements on this call and in our press release containing forward-looking statements (technical difficulty) our goals, beliefs, expectations, strategies, plans, future operating results, and underlying assumptions are subject to risks and uncertainties that could cause actual results to differ materially from those described.

In addition, our statements during this call are based on our views as of today. We anticipate that future developments will cause our views to change. Please consider the information presented in that light. We may, at some point, elect to update the forward-looking statement (technical difficulty) specifically disclaim any obligation to do so.

I will now turn the call over to our CEO, Tom Neri.

Thank you, Carolyn, and good morning, everyone. Thank you for joining us to discuss our fourth-quarter and full-year results. Importantly, I want to reiterate my message from our press release. 2011 was a transformational year for Lawson Products. We made significant progress on our key initiatives, and made strong investments for our long-term success.

As most of you are aware, we replaced our outdated legacy systems in the third quarter with SAP. Although we encountered various operational issues that significantly impacted the financial performance in the second half of the year, the new system will provide us with reliable, transparent, and real-time information allowing us to make better decisions and to improve our service to our customers. Now, I'd like to turn the call over to Ron Knutson to provide more details on our financial results, and then I'll come back and update you on our strategic initiatives and our outlook. Ron?

Thanks, Tom, and good morning, everyone. We finished the quarter at $72.9 million in sales compared to $80 million a year ago. This decrease was largely attributable to challenges we encountered following the launch of our ERP system, which caused delays in our supply chain and fulfillment processes, resulting in a buildup of backorders and lost sales. From a sequential average daily sales basis, October sales finished at $1.213 million, November finished at $1.198 million, and December finished at $1.233 million. I'm pleased to say that December average daily sales were the highest since our conversion to SAP. For the quarter, average daily sales were up 3.1% sequentially over the third quarter, primarily driven by increases in our strategic, government, and automotive businesses. For the full year, sales finished at $315 million, which was flat with 2010 on a same-day basis.

We continue to actively pursue larger national and government accounts. For the year, our national or strategic accounts increased 18%, or $4.7 million, as we increased our penetration with existing customers and signed new locations. Government sales declined by $1 million, or 3.7%, due to a decline in military orders and a tightening of the government spend in the latter half of the year. For the quarter, strategic accounts increased 14.5% over a year ago, and 4.9% over the third quarter, which is evidence that this area continues to be an opportunity for us.

We believe that the immediate drop in our sales post-ERP go-live is behind us, as we've seen nice increases in our sequential average daily sales since August. At the same time, we are cautious for the first half of 2012, as we face tough comps from last year.

For the quarter, gross margins finished at 53.5%, compared to 56.5% in Q3 of 2011. The sequential decline in the fourth quarter from the third quarter is primarily due to higher outbound freight costs, and higher labor costs attributable to inventory following our ERP conversion. Gross margins finished at 57.1% for the full year versus 61.5% a year ago.

The expected year-over-year margin decline was primarily driven by three items -- first, increased vendor costs while we held customer pricing constant to facilitate our ERP conversion. Second, higher outbound freight costs as we shipped more single-line orders as a result of our ERP implementation. And third, additional labor costs associated with the processing of inventory.

Selling, general, and administrative expenses decreased by $3.7 million for the quarter, driven by lower commissions as a result of lower sales, as well as lower incentive compensation costs. In addition, in 2010, we had a number of ERP-implementation costs that did not recur in 2011. These savings were partially offset by an increase in our provision for doubtful accounts.

We continue to gain leverage on our selling expenses. For the quarter, selling expenses were 27.7% of sales, as compared to 28.2% in the third quarter, and for the full year decreased to 27.5% versus 27.9% a year ago.

There were two other non-cash items that impacted the fourth quarter that I want to comment on. First, we recorded an impairment charge of $1.1 million to revalue our investment in automatic screw machine parts to its fair value. Second, we established a liability of $1.2 million, which is our best estimate to resolve a tax matter regarding the current classification of our independent agents. For the quarter, our net loss was $5.5 million, including $2.3 million of nonrecurring charges that I previously mentioned, or a loss of $0.65 per diluted share. Excluding the nonrecurring items, our loss per diluted share was $0.45.

The net loss for the year of 2011 was $4.6 million, or $0.54 per diluted share, compared to net income of $6.9 million, or $0.81 per diluted share in the prior year. During the quarter, we paid a dividend of $0.12 per share for an aggregate amount of approximately $1 million, representing an annual yield of approximately 3% at our current stock price.

Let me wrap up my comments by saying that while the second half of 2011 was disappointing from a financial performance, we fully recognize that these shorter-term investments are necessary to continue the transformation of the organization. I'll now turn it back to Tom.

Thank you, Ron. As I said, 2011 truly was a transformational year for our business. In the first half of the year, we reported strong sales, and solid earnings. We did experience operational issues related to our August ERP implementation that impacted our financial performance. We held pricing constant to facilitate our ERP conversion, but we also saw an increase in outbound freight and labor costs as we worked to stabilize our order fulfillment rates following the conversion. We have continued to make progress on resolving many of our ERP operational issues, and are seeing improved service levels. As we expected, the implementation has been challenging, but we have begun to see integration among functional areas that is already improving communication, productivity, and efficiency.

In the long-term, the new ERP system will enhance our ability to respond to our customers' needs, and lead to increased customer satisfaction. The system is critical to provide the platform for our new website, to support the technology requirements of our new distribution center, and to enable enhanced selling solutions. Quite simply, the benefits we will realize through ERP will help improve our customer experience.

We also continue to make steady progress on our other strategic initiatives, including network optimization. Construction has begun on our new state-of-the-art distribution center in McCook, Illinois. Once the facility is operational, we will consolidate operations of three Illinois distribution centers, and have the platform in place to meet our customers' needs. In addition, as we work through our sales and channel transformation initiatives, we are looking forward to the launch of our revamped website this Spring.

As we reflect on the year overall, I believe our fundamentals are solid. Ron discussed the numbers, and you can see that through the first half, our sales were up over 7%. I'm convinced that our second-half results are an anomaly. I have every confidence that we have made important and necessary infrastructure investments to propel the business forward in 2012 and beyond.

Now, I'd like to open up the lines for questions.

(Operator Instructions) Arnie Ursaner, CJS Securities.

I assume a lot of these numbers will be in your K when it's available. But you mentioned you had $1.2 million decrease in your ERP implementation costs. What were the actual costs incurred in the quarter?

Sure, Arnie. This is Ron Knutson. For the fourth quarter of 2011, our ERP implementation costs were right around $300,000. We incurred about $1.5 million a year ago. As you know, we implemented in August and once we went live under the new system, our implementation costs fell off during Q3 and Q4.

Okay. What was your D&A in the quarter, please?

Our D&A for the full-year was $5.7 million. For the quarter, it was about $2 million.

Okay. And your stock-based comp in the quarter?

Let me take a look at that one, Arnie, and I'll come back to that one.

Okay. I know you give us a lot of the numbers and I don't think I caught it. You give us a lot of the year-over-year change in your national and strategic accounts, but what percent of the revenues for the Company in Q4 were from those two areas?

Sure. Let me try and give you a little bit of an overview from a sales perspective. I'm going to talk from an average daily sales basis, which I think will help. For the fourth quarter, just because we had 60 workdays in Q4 of 2011 and there were 61 days in Q4 2010 and then we were actually up against 64 days in Q3 of 2011, so I think it is important to note that Q4 had four fewer days on a selling basis. From an average daily sales basis, our strategic accounts sequentially over the quarter on a ADS basis were up nearly 12%, Q4 over Q3. Government was up about 11% and Kent was up about 4.5%. From an overall percentage or from a total volume standpoint, strategic accounts continue to be right in that 10% range and government is about 9%, and the automotive side of the business is about 11%.

Consolidated, that grew as a percent of your total revenues from the levels you've been at?

It has, yes. When we combine all of those, we're right at about 30%. As you look at the full year, that's really where most of our increases were realized from a top line standpoint.

Okay.

Back to your earlier question, our stock comp expense for the quarter was $280,000.

Okay. I know you are relatively new at making public calls. I assume you're not thinking or planning about giving guidance since it's not in your press release, but just figured I'd ask and double check?

You're correct. At this point, we're not providing any formal guidance.

Okay. Let me turn it back to Tom. You obviously highlighted, several times, the transformational nature of 2011. If you step back and quantify -- first of all, you might want to speak to what you have accomplished in 2011 and what remains in front of you in 2012 as it relates to how we should think about the incremental spend for the ERP system, where you are on your web base, change your sales force compensation. Maybe you could take this opportunity to give us your view, maybe not guidance per se, but your outlook and view for 2012, looking at the various atypical items that impacted you in '11?

Sure. Actually, the ERP system was really the transformational foundation for the business. We have been operating on legacy systems that really inhibited our ability to service our customers in a manner that they expect today. In other words, we've been operating, really, with a single sales channel and with a distribution channel that was good for the industry 10 or 15 years ago, but really has become outdated. It was critical to get that, if you will, technology foundation in place, which really provides us the opportunity to open up a number of things. In addition to the SAP, another critical aspect was we've changed our pricing strategy rather dramatically from, if you will, a rather dispersed pricing strategy that was not based on the market to a tiered pricing strategy that's really based on our customers and our segments and is really much more market-based than it is driven by our internal aspects. That was a very significant move in the Company.

We've also made a very strong push into our strategic accounts. I think as Ron mentioned in the numbers, that's a percentage of our business that's growing dramatically. We're having great success and we've been able to use that new tiered pricing, market-based pricing in our strategic accounts. It was critical for us to be able to continue to grow strategic accounts that have that ERP foundation, because much of what those strategic accounts look for from a service component will be supplied by our ERP system.

We also talked about the consolidation of our Illinois facilities. Again, we were on a fairly antiquated distribution network and we are moving very aggressively into a much more focused approach to our customer needs, looking at much faster delivery times. We've made a lot of progress going forward. The next big step for us really is the introduction or reintroduction of a new website this spring, which actually would be again much more customer-focused than has been in the past, and will enable our customers to deal with us on much more of a 24/7 basis than they have been able to in the past.

Thank you.

Edward Marshall, Sidoti & Co.

We're at March 1. Can you talk about maybe the sales trends that you've seen so far in the first two months of the year? Then, of course, the costs that crept up in the fourth quarter here and did they subside at all going into 1Q?

Yes, Ed, this is Ron Knutson. I mentioned earlier that December was our highest average daily sales since we converted over to SAP. I would say that, without giving specific numbers since we don't generally just disclose monthly sales numbers, January was up over December and February in was just in line with January. We still feel pretty good about some of the additional sales we're seeing, at least here in the first couple of months. I would say, though, that we are up against some pretty tough comps in the first quarter from a year ago. I think our average daily sales in Q1 of last year was like $1.312 million. We are up against some pretty tough comps.

And the costs, have they subsided or is there any changing to the cost side of the business or does it look very similar to 4Q?

Let me try and clarify your question. Are you talking costs relative to ERP? Are you talking costs relative to just overall G&A expenses?

Your labor costs, the additional labor costs that you're incurring, the freight costs that you're incurring. I'm assuming there has continued to be a drag. Is it lessening or is it maintaining the height that it's been so far in the last quarter or two?

We are seeing that it's lessening on a sequential month-over-month basis. We are seeing some positive trends there, even as we moved into January and February as well.

Just to add a little color, this is Tom. During the fourth quarter last year, we added additional shifts to the distribution centers. We added in increased inventory levels that required increased staffing levels for processing. We did put pretty significant effort to try to get back to our service levels, incurred a lot of those costs and those costs are beginning wean down and we've begun to see that in January and certainly February as well.

Any timeline that you can gauge as far as them completely being normalized again and you're back to your normal run rate?

We'll probably see a continual drag to a lesser degree. Our goal is to lessen the impact on a sequential month-over-month basis. But I think for the first half of the year, we'll probably continue to see a bit of a drag, but sequentially decrease on a month-over-month basis.

Just to clarify, it's a bit of a drag, but it's certainly less than it was in the fourth quarter. You're not going to see costs that we had in the fourth quarter continue on going forward.

Have you quantified the fourth quarter costs that, that impact associated maybe --? Is there any way that you can look at the normalized costs versus the costs that you incurred and the differential between the two?

Yes. Probably the two largest areas would be the freight piece and then also the overtime and temporary labor and so forth. Just to put this in perspective, so from a freight standpoint, in the fourth quarter, we lost about $1.3 million in freight and typically, we typically would have a bit of a profit there from at least covering our costs. The other piece of that is our overtime and our temp labor and so forth and that was up about, Q4 over Q3 it was actually up about $1.2 million. We are starting to see both of those pieces come down. Our freight is starting to come back in line.

The operational side of that is, and as Tom commented on it briefly, is the fact that our service levels are starting to improve back to our customers. We are now north of 98% from a service-level perspective. Our goal is to be at 99%. That's a big piece of it. The other big piece of it is that our backorders to our customers, which peaked in Q4, have come down quite dramatically in the first couple of months of the year. And both of those two have a pretty significant impact on freight costs or decreasing freight costs, our ability to decrease freight cost, as well as lower overtime and temp labor within our distribution network.

This is Tom. Just to add to that. Costs are little bit easier to quantify and to get your hands around. Clearly, we lost some revenue during the second half of the year and you can simply look at the fact that the marketplace didn't change dramatically during the third and fourth quarter from the first half of the year. As our revenue declined on a sequential basis, the impact of revenue really can be attributed to the operational issues experienced as part of the ERP conversion and that's a pretty significant aspect of the decline.

Finally, you mentioned doubtful accounts increase of about $1 million and I think it was a reference to the year-over-year number. Did that hit in the fourth quarter or was that in prior quarters?

Yes, Ed, most of that hit in the fourth quarter. We increased our reserve. We went from $1.1 million at the end of 2010 up to $1.9 million at the end of 2011.

Was that one particular customer?

No. It's a reserve that we assess based upon our overall levels of past dues and our outstanding receivables. No, not specific to any large customers, but more of a reserve to cover the past due increase.

Okay. Thanks, guys.

Beth Lilly, Gabelli Investors.

Your revenues were down in the quarter and the industry obviously grew, so is it your sense that you lost share? Those customers had to get their product somewhere else. And with the backup in the inventory and everything, can you just talk about the plans to gain the share back with your customers that potentially you lost?

Yes. I don't know if I would say so much as a share loss, but clearly those customers got product from someplace else during this timeframe. We've made a concerted effort through our sales organization to go back to those customers and begin to report on how we've improved the service level. Part of it is regaining some of that trust, just based on the fact that the backorders, but it's also showing those customers that we have regained the service levels and that they can actually count on us again. I don't view this as a permanent share loss. I certainly believe that they went to other suppliers during this time period, but we do have a very concerted effort on our sales organization to do that.

Most of our losses came within our small customer base. We've had really good retention on the large customers, especially the strategic accounts that we've added during the last two years. A lot of the work has to be with those small accounts that actually have a lot of avenues to go to when you have these operational issues. Does that help?

Yes. Can you remind us, how many distribution centers are you trying to -- I think you probably mentioned this, but I did not catch the number, how many do you want to shrink down to?

We're talking about the Illinois facilities. In Illinois, we have two distribution centers and a repackaging center and we're consolidating those into one large facility that will do both the repackaging the inbound and also act as a master distributor to our other locations. Within Chicago, we're going from three facilities to one.

Okay. What about nationwide though, are closing any of your other facilities?

No. At this time, we have no plans to change other facilities.

Okay.

We will be upgrading some of those facilities. We'll continue to roll out elements of our SAP system into some of those other warehouses over the next [nine]. We are in the midst of doing a network optimization study that will be completed by the middle of this year.

Okay. Then just one other question, so as we go forward, your website's going to be up and live running. When is the new website do you hope to be up and running?

There are two launches. There's a first launch which will impact the capabilities and that should be up in May. We'll have another launch probably in late fall, which will be a substantially improved version, if you will, of the first launch.

Okay. Okay. Great. I know Arnie asked this question, but as you go forward, is there any point in time when you're going to be willing to start to give us any sense of visibility on the business? I know you don't like to give guidance, but any sense of what you think the business is going to be able to do would be helpful.

We're always discussing that possibility and clearly our goal is to be as transparent as possible. As we get a little bit more stabilized, obviously, when you think of the number of issues that we've been going through, it's been a difficult to forecast the near-term. But clearly, we hope that, at some point in the future, we'd be able to give better guidance than we have.

Yes, I would think with the new ERP system and the business being stabilized, just with all the changes that are going on internally, they should be able to give you better visibility.

Yes, exactly. Exactly.

Okay, great. All right. Thanks so much.

Courtney Killion, Cleveland Research Company.

I was just wondering if you could talk a little bit about the price cost dynamics in the quarter and your expectations going forward. I know you talked a little bit about the tiered pricing strategy, but it looks like it was still a negative in the quarter. Just curious if you have any visibility when that comes back to neutral or if you're seeing additional cost increases from suppliers here in the beginning of the year?

Courtney, I want to make sure I understood your question. Really, you're looking at the pricing impact that we were able to put in place versus the vendor costs that we saw coming through on the purchasing side?

Yes. When does that get back to neutral and how does that fit in with your new tiered pricing strategy going forward?

Okay. Okay. For the year, we did see a bit of a lift from a pricing impact. Tom commented that we did hold prices constant to our customers during the ERP conversion as we cut over that data. But on an aggregate basis for the year, we saw about a 3% lift from an overall price standpoint. Really, that was put in place to really stay equal with the costs that we saw coming through from a vendor perspective. Relative to tiered pricing, today we sit with about 55% of our customers under the tiered pricing that we have and our goal is really to increase margin dollars versus increase the margin percent. I know we've talked publicly about this in the past that getting ourselves to more of a market-based approach would allow us to drive additional volume through.

Okay, great. Thank you.

(Operator Instructions) Arnie Ursaner, CJS Securities.

A direct follow-up from the last question. You put in approximately a 5% price increase in October. Is that sticking?

Arnie, this is Ron. We've seen about 50% of that has probably stuck so far. Typically, it takes a little bit of time for that full realization to come through, just given the ordering cycle and so forth. Historically, we generally see about 60% to 70% of that stick as you back out those customers that are strategic, that have some contract-specific pricing and so forth. But we are seeing the majority of that coming through.

Arnie, this is Tom. Just a further comment on pricing strategy per se, ERP gives us a very different ability on pricing strategy. In the past, it took a very long time for us to put pricing into the system and so we would do it sort of in a big bang process. We're able to now to actually put prices in much more based on our segments, our customer segments, and on the marketplace, so that we can move much quicker on pricing and do it, if you will, more strategically and surgically than an overall approach to all products and all customers.

Ron, your cash declined from $19 million to $2 million in the quarter. Can you walk us through the key factors the caused that sequential decline?

Sure. Really there were a couple of items that drilled the majority of it. I commented earlier that we did put up some additional dollars from a receivable reserve standpoint. If you look at our AR balance, even on a year-over-year basis, we're up about $10 million versus where we were a year ago. That's an area that we have significant focus on today to bring that DSO number back down. I would say that we purposely erred on the side of giving our customers some additional flexibility as far as processing our invoices. As we were shipping out multiple shipments for each order, what that did was that created multiple invoices, where in the past the customer would have received one invoice.

That's a piece of the cash. Then the other piece, relative to our service levels, our inventories are up about $8 million versus where we were a year ago. Again, we erred on the side of providing the service level back to our customers and we are anticipating that, that inventory level will come down throughout 2012, as we work through this. However, I would say that we'll probably see a little bit of a bump in the mid-part of the year as we buy up for our McCook facility. Really those two pieces are really the major drivers of the cash.

What is your CapEx expectation for '12 and your D&A expectation for '12, please?

Yes. On a net basis, we're looking at a CapEx somewhere in the $10 million to $13 million range. Then from a depreciation standpoint, currently, we're budgeted about $7.5 million from D&A.

A question I'm sure you'd love to hear, can you give us an update on the Port Trust, that's, frankly, approaching a year? Last year, it was St. Paddy's Day that they went through a two-year process to enable the Port Trust to sell shares and we haven't heard anything since. What are you hearing?

We are hearing that we're going to improve our performance going forward and that's about all we can talk to. We really don't have any information as to what the Port family's intentions are other than what they say it's going to be.

They keep dribbling it out under 144, leaving a major overhang out there until it's resolved?

Right.

I want to make sure I've got this right, I think in Q3 your strategic and national accounts were 17.5% of revenue and I think you said, Ron, it became 30% in Q4? I am looking at the wrong --?

Arnie, that 30% includes Kent. It includes the Kent automotive, so you really have to back that out. In Q4 alone, for government and strategic, we were just north of 18%.

Thank you. Going back to your transition of your sales force, a couple of numbers, your severance expense this quarter was much lower. I'm wondering if you slowed down some of the transition issues? Maybe you can give us a year-end headcount? Then the other issue is, one of your strategic plans was to go with a commission-based sales rep as opposed to salaried, but part of that was a critical element of that would be having the web-based system and I believe you said on the call, you'll do it in two steps, not until May. Is this likely to be a lingering transition issue through at least the middle of the year and is that embedded in your views?

Arnie, this is Tom. The transition really looks at the overall aspect of our sales channels and how we want to populate the sales channels. During the past year, we hired, I believe it was, 60 or so new field sales reps who are employees. They are not independent agents and those employees are based on a salary plus basis, a salary plus commission. It's our intent to continue that transformation.

We've been working with the independent sales force and we are beginning to develop a pilot program to begin to transition existing agents into an employee-based field organization. That will take some time. We believe that we would have that completed by the end of the year. But that's a transition that will not occur all at once, but we'll feather that in as we begin to implement our other sales channels, primarily the web channel.

Okay. In the past, when you've spoken about these transition issues towards more national accounts, you clearly had indicated expect a gross margin decline. But over a reasonable period of time, they would be offsetting reductions in SG&A expense that would equate or lead to flattish or even improving operating margin. Do you see that occurring in 2012?

To some degree, yes. Very clearly -- we can't look at the fourth quarter results because those are so much impacted by the ERP conversion. But very clearly, we're getting good returns on the strategic accounts and the challenge is to begin to move those smaller accounts that are serviced only by the independent channel now, is to move them to a web-base which will help our overall operating margins. That will, again, occur as we begin this transformation of the sales organization and the introduction of the web channel.

Okay, thank you.

At this time this concludes our question and answer session. I would now like to turn the conference call back over to Mr. Tom Neri for any closing remarks.

Great. Thank you all for participating. In closing, I want to reiterate how pleased we are with our progress on our strategic initiatives. From my perspective, the organization managed through our second half challenges very well. Our sales force, our teams within the distribution centers, and our corporate staff in all functional areas continue to step up during the period. We look forward to realizing the benefits of many of our business investments in the years ahead. Thank you very much.

Ladies and gentlemen, today's conference is now concluded. We thank you for attending today's presentation. You may now disconnect your telephone lines.