Distribution Solutions Group Inc (DSGR) 2016 Q3 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Lawson Products third-quarter 2016 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 third-quarter 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, LawsonProducts.com. A replay of the webcast will be available on the website through November 30, 2016. 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 operations and results, and underlying assumptions that are subject to risks and uncertainties that can 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, Michael DeCata.

Good morning and thank you for joining the call. This morning I will comment on the quarter and our overall progress. Ron Knutson will provide a more detailed review of our financial results for the quarter and then we will take questions.

Similar to the second quarter and really much like we've experienced over the past 18 to 24 months, there is still softness in the industrial economy.

However, we are beginning to see some encouraging signs in several of our market segments. Our government business grew over 10% during the third quarter versus the third quarter of last year and is up over 5% year to date, largely driven by state and local government, as we've mentioned in the past.

Government now comprises 10% of our overall revenue. Kent Automotive grew nearly 8% during the third quarter and is up over 7% year to date and comprises 19% of our overall revenue.

Our Canadian business is up in part because of F.B. Feeney acquisition. The addition of sales reps over the past several years and during the three quarters of this year is resulting in some nice incremental growth from new territories.

Unfortunately, these gains are being offset by continued softness in some of our established Lawson customers who are experiencing reductions in machine time utilization and fleet utilization. Overall, sales for the third quarter were roughly unchanged versus a year ago and up 1.2% versus the second quarter.

On an ADF basis, September showed the strongest performance of the three months. Excluding oil and gas, sales grew 1.1% versus the third quarter of 2015 and 0.9% year to date. Oil and gas has also improved recently.

Our three-part growth strategy is unchanged. First, we will continue to add sales reps. However, during this quarter and continuing in the near future, we will sharpen our focus on enabling our sales reps to grow their territories. We have previously discussed the ebb and flow of hiring, followed by a period of onboarding and training to help sales reps become more successful.

We are also focused on performance management. It is likely that our sales rep count will fluctuate but remain on a modest growth trend for the foreseeable future and into 2017. Our sales rep count ended the quarter at 1,006, an increase of 69 year-to-date but down from the 1,020 at the end of the second quarter.

Second, we continue to focus on enabling our seasoned reps to win additional share of wallet and add new accounts in their existing territories. This has been especially challenging this year as our established customers and seasoned reps have borne the brunt of the overall industrial softness.

Third, we remain committed to growth through acquisitions. We have successfully completed three acquisitions over the past year. Each acquisition has been larger than the previous acquisition.

We anticipate that this trend will continue and size will continue to increase. The acquisitions that we have completed are performing very well and are now integrated into our operations. Acquired sales reps are adding new accounts and winning share of wallet by utilizing their access through a broader product offering.

We are also pleased that the pipeline for future acquisitions continues to grow. As planned, we have gained valuable insight through the integration of the three acquisitions that we have already completed. This insight serves to lower the integration risk of future acquisitions and, as well, broaden the list of potential acquisitions.

While Ron will provide more detailed financial review, I wanted to highlight some key areas related to our financial performance. Sales were in line with a year ago and up sequentially from the second quarter. While there was a slight decline in gross profit percent this quarter, it was not caused by either pricing pressure for increases in landed cost. Our product margin has remained stable for the past several quarters.

While operating and net income were down on a year-over-year basis, we did see a significant improvement sequentially over the second quarter.

The full quarter carrying costs associated with the significant number of sales reps added during the second quarter, combined with continued carrying costs of previously added reps, continues to put pressure on our overall operating costs. However, we remain confident these investments will pay off and will position the Company for growth in the future.

Earlier this year we began using a new inventory optimization tool which we implemented to help improve inventory turns while still improving customer order metrics. Our fill rate for customers continues to hover at 99%.

At the same time, we have reduced inventory by $1.3 million during the quarter and $2.7 million year-to-date. Through lean Six Sigma and the hard work of our teammates, we have been able to hold our G&A costs flat through process reengineering. On a side note, our G&A headcount essentially remained flat over the past four years.

We have done this by building a stronger and more robust workforce and enabling teammates to take cross functional positions, participate in new lean Six Sigma projects and participate in the integration of acquisitions. Our employees are working smarter, contributing to the overall success of the organization.

Overall, it was a solid quarter, in particular, the sequential improvements from the second quarter. We continue to invest in our organization despite a challenging environment.

Finally, turning to operations, our distribution centers are continuing to refine their processes and utilize inventory more effectively. Productivity continues to improve and our DC network has capacity to grow sales significantly without adding any extra cost.

We will continue to optimize our DC infrastructure. We are incorporating new customers and products gained organically and as a result of our continuing acquisition efforts.

Our commitment to lean Six Sigma continues. We are completing the data-gathering and pilot phase of the four projects that we discussed several quarters ago. Projects that we began several years ago continue to bear fruit.

For example, we began lean Six Sigma in 2013 and it took 102 days to fill a requisition for a greenfield sales rep position. Recently, that number was 40 days. It used to take 29 hours to complete a quote for a special-sourced item. Today that number is 10 hours.

Lean Six Sigma is enabling us to become more productive and improve customer service while holding G&A costs flat.

Overall, we have confidence in our three-part growth plan. The addition of sales reps and acquisitions will help us grow beyond the market. Our value proposition is more critical than ever in helping customers maximize machine time and achieve maximum labor productivity in their operations.

Looking forward, the fourth quarter is always challenging because of the number of selling days, and this year we lose one day compared to 2015. However, October is showing some encouragement.

Now let me turn it over to Ron for a more detailed financial review.

Thank you, Mike. And good morning, everyone.

As Mike indicated, the margin remains soft. Despite these conditions we continue to invest in the business and make acquisitions that will provide future growth opportunities to expand and increase our geographic density in the large, fragmented MRO marketplace.

Here are some of the highlights for the quarter. First, our adjusted operating income for the quarter, taking into consideration nonrecurring items, improved sequentially to $2.1 million from $687,000 in the second quarter but did decline from the year-ago quarter, impacted by the continuation of our sales force expansion throughout 2016.

Second, sales finished at $70.2 million for the quarter. Average daily sales were up 1.2% from the second quarter and were flat versus the year-ago quarter. Excluding the impact of lower sales to the direct oil and gas customers, sales increased 1.1% over a year ago with the same number of selling days in 2016.

Third, gross margin percentage ended at 60.6% for the quarter.

And fourth, we created net cash flows of $2 million for the quarter. We ended the quarter with $10.7 million of available cash, no outstanding borrowings under our credit facility and an additional availability of $34.8 million under that facility.

Now let me share some of the details. As I just mentioned, we finished the quarter with sales of $70.2 million, flat with a year ago and up versus $69.3 million from the second quarter. The third quarter of both 2016 and 2015, as well as the second quarter of 2016, all had 64 selling days.

As compared to a year ago, our first-quarter sales were impacted by the following. First, the ongoing softness in the MRO marketplace. And second, while the slowdown in the oil and gas segment has moderated a bit, the decline from a year ago negatively impacted our sales by approximately $824,000. This only includes customers directly defined as oil and gas and did not include customers in related industries that were impacted by the segment.

While our customer base is very diverse, energy, which oil and gas is a subset of, approximates 4% of our total business. Excluding this effect, sales were up 1.1% for the quarter and up 0.9% year to date.

From a divisional standpoint, strategic accounts represent approximately 12% of our total volume. Many of our strategic relationships continued with solid growth for the quarter.

Our Kent Automotive average daily sales were up nearly 8% as compared to the year-ago quarter, driven primarily by expanding our existing strategic customer relationships. Kent now approximates 19% of our business.

We also realized solid growth in our government business, primarily driven by additional penetration into local and state opportunities.

From a sequential average daily sales basis, July sales finished at $1.090 million, August finished at $1.081 million and September finished at $1.121 million. As Mike mentioned, we ended the quarter with 1,006 sales reps. As we've said in the past, while adding sales reps negatively impacts our earnings in the short term, adding reps will ultimately drive our total revenues and allow us to further leverage our existing infrastructure.

As we refine our hiring an ongoing process, our overall retention rate improved slightly in late 2015, which has continued into 2016.

As we've mentioned on the previous earnings call, we anticipated a slowdown in our hiring in the second half of 2016, which we realized this quarter. Since we are still adding sales reps, we do not yet have a full run rate of salary expense in our results for the fourth quarter.

Adding sales reps will negatively impact our earnings in the short term; however, over the long term, we fully expect that adding additional reps will drive topline sales and improved earnings.

For the quarter, gross margin was 60.6% compared to 61.3% in the second quarter and 61.7% a year ago. About one half of the decline from Q2 is primarily driven by higher nonrecurring transportation costs into Canada that we do not expect to continue. Our customer service metrics of back orders, order completeness rates and line service levels all continue to be at improved levels.

Looking forward, we believe that our plan to increase strategic customer relationships and to pursue more greenfield sales territories will put some downward pressure on our gross margin percentage. However, we expect this to be partially offset by other procurement opportunities and efficiencies within our DCs. Selling, general and administrative expenses were $40.2 million for the third quarter compared to $40.5 million a year ago and $42.5 million in the second quarter.

We continue to tightly manage our ongoing operating costs, given the flat sales environment. As compared to a year ago, expenses during the third quarter decreased, primarily due to lower stock-based compensation expense and lower performance-based compensation, offset by investments made to hire additional sales reps in 2016 and increased health insurance claims.

Operating income was $2.4 million for the quarter. Adjusted non-GAAP operating income, taking into account stock-based compensation and severance, was $2.1 million for the quarter compared to $3.2 million a year ago and $687,000 in the second quarter.

Net income for the quarter was $1.8 million or $0.20 per diluted share, compared to $2.4 million or $0.27 per diluted share a year ago quarter and $172,000 or $0.02 per diluted share last quarter.

From a balance sheet perspective, we ended the quarter with $10.7 million of cash on hand and no outstanding borrowings under our credit facility. We continue to be pleased with the previous investment in our new inventory forecasting system, as evidenced by our $2.7 million reduction in inventory from year end.

I would also like to take this time to highlight that we recently renewed our existing credit facility, extending the maturity date to August 2020. Under the new facility, we have greater access to capital, reduced the financial covenant requirements and also reduced the fees. Should we need additional capital for growth, in particular to support future acquisitions, we believe that we have many options available to us and gaining access to capital will not be an issue.

CapEx for the quarter was $1 million and $2.6 million year to date. We expect our CapEx for the full year of 2016 to be in the range of $3 million to $3.5 million, primarily in maintenance capital for our distribution network and continued technology enhancements.

Let me now comment on a few items as we look into the next few quarters. First, we expect to continue to operate in a soft MRO market. We expect the market will continue to be challenging during the remainder of 2016 and into 2017, and will manage the business accordingly.

Second, as both Mike and I have mentioned, our rep hiring will slow in the second half of the year as we focus our resources on enabling our expanded sales force to be productive. In the longer term we will continue with our current strategy to expand our sales force while also focusing on existing rep productivity and acquisitions. And third, our adjusted EBITDA was 5.8% for the quarter compared to 4.2% that we reported last quarter.

While we did receive some benefit from reducing performance-based incentive accruals in the quarter, the quarter was also impacted by the expansion of our salesforce in the first half of the year. We are managing the business in a challenging environment while, at the same time, moving in the right direction toward our stated 10% EBITDA goal.

I will now turn it over to the operator for questions.

(Operator Instructions) Kevin Steinke, Barrington Research.

I wanted to start off by asking about the monthly trends that you discuss. You talked about September being the strongest month of the third quarter and also some encouraging signs in October. So I don't know if you could elaborate on that in terms of the stronger September and what you are seeing so far in October?

Let me start with a quick comment. What we are seeing is broad-based encouragement. We wouldn't be commenting in that way if it was one specific customer or one specific large piece of business. So it's across the board. Let me quickly say it's not so encouraging as to say that there's a fundamental trend happening; it just seems like it's stabilizing a little bit off of a pretty anemic base.

Nonetheless, it feels like maybe we are bottoming. It may be, considering our consumable maintenance and small-quantity maintenance business, that at some point even when you are running machines with lesser time utilization or driving your trucks with less over-the-road miles, sooner or later they have to be maintained. And at some point, even at a low level, things start breaking. That could be what's happening. Or there could be a little bit more fundamental encouragement. Time will tell.

Ron, do you want to --

Sure. Kevin, I would just add to that we have seen a little bit of a pickup in our oil and gas customers sequentially during the quarter -- again, not dramatic but a little bit of a lift. I think that drove some of the sequential improvement going into September. Down versus a year ago in that overall segment, but we are starting to see some positive signs in that sector.

Yes. To that point, some of our larger oil and gas customers are bringing back maintenance mechanics that had been furloughed in a couple locations, in particular. So possibly with the increase in price of oil we are starting to see some rig count come back and all of that -- again, it's a good sign.

All right. No, that's helpful. And with this bit of stabilization or improvement, would you attribute any of that as well --? You talked about the incremental sales coming from your aggressive rep hiring. Can you just talk about how much that's contributing to your growth? Obviously still being offset by the overall macro headwinds, but it sounded like there are some encouraging signs in terms of incremental new sales from your repetitions.

So, we continue to add sales reps and have done so throughout 2016. And typically what will happen as they start to mature out, even in their early stages with us, is as they move from quarter one to quarter two to quarter three of their time with us, they will gradually start increasing their sales. You will recall that we hired a significant number of sales reps in the second quarter, and certainly those reps didn't produce probably many sales in Q2. But now we are starting to get some sales from those reps hired in the second quarter spilling into the third quarter.

So there's always a little bit of a lift from the new sales reps. The other piece of the lift that we saw in the third quarter was due to the acquisitions that we made, being the three acquisitions that we have made over the last year. They were certainly not in our numbers a year ago, and we got some lift out of those acquisitions in the third quarter of this year.

And to that point, we look at the acquired reps because what we are primarily acquiring are the sales reps and customers they bring along. And so the way that layers into the business is, as we acquire a rep, they start their first day with us at their mature run rate, whereas a new rep starts, a greenfield rep in particular, starts at zero and very slowly -- and by the way, for the first call it two months there's almost no sales. Because they are being trained, the lean Six Sigma process has them opening, developing new relationships. But almost no sales come out of a rep in the first couple months, a lot of activity that builds and builds to the point where, three and four years into the relationship now we have got an extremely robust territory.

When we acquire a rep, we start at the end of that curve and build from there. And the reason we are building from there with the specific reps that we have acquired is what those reps get is new product categories to sell that they didn't have access to in their previous companies or before the companies were combined.

Right, right, that makes sense. And so you also commented on, given the success in integrating the first three acquisitions, that essentially the pipeline of potential acquisitions is broadening or the type of acquisitions that you can target is broadening. Can you just elaborate on that as well?

Sure. Again, our goal -- and if the world really works as smoothly as this, it will be an interesting situation -- our goal is to keep stepping up in size, and the more acquisitions we do and the more seamless and smoother the integrations go, both it gives us more confidence but also the acquired companies and the owners of the acquired companies become references for the next company on the target list.

So when an acquisition integration goes smoothly and everybody on both sides are extremely pleased that all the promises were kept, it was a smooth transition for the employees, customers, and no customer disruption, that becomes more attractive to the next acquisition discussion.

And when we speak to acquisition targets, we always specifically talk about using the previous acquisitions as a reference. And with their permission we always encourage them to reach out to the people that have already joined us.

So that helps open up the pipeline and step up in size. Now, as you know, we have a lot of acquisition discussions for the very few that actually become realized. And that's our situation as well. But it's an encouraging process. And it is our goal and aspiration to make growth through acquisition a core competency of our Company.

And every one we've done, we've learned things about the integration process. It has opened our horizon to product and process and people. And so it gives us more confidence to be a little more open-minded about future acquisitions. But they have gone very well. And the past three, we track every single week their performance. SKU count is increasing. Additional customers are being gained. We have retained, of course, all the sales reps.

So the three that we have actually completed are performing very, very well, which gives us more encouragement about the future and enables us to talk about that relative to future reps that we would acquire and how they will do even better with us than they were doing with their previous company profile.

Okay, that's good to hear. Ron, I don't know if -- are you tracking what the actual revenue contribution was in the quarter from acquired reps or acquisitions, or are you just not looking to separate that out right now? I'm just wondering if you could quantify, perhaps, what acquisitions or acquired reps contributed in the quarter.

Sure. Yes, we are certainly tracking it. And they contributed about $800,000 to the quarter.

Okay, perfect. And then just last question for me -- what was the delta or the benefit of the lower performance-based comp that you referenced in the quarter?

Sure. So really a combination of incentives to -- our incentive accruals, really, for both our sales team as well as a corporate team. So unfortunately, we are not hitting some of our overall topline plans, and so we brought some of those accruals down in the quarter.

The benefit in the third quarter, I would say, versus a year ago was about $500,000 versus the second quarter, it was a couple hundred thousand dollars. So not dramatic, not huge dollars but it did impact the quarter from an overall operating income standpoint.

If I could also add to that, one of the things that is a core tenet of how we operate is the belief in alignment.

So we are aligned, sales growth, all the executives in the Company. It's a very large number of people on the next tier down aligned around sales growth and growth in EBITDA. And at this time last year, we -- and I believe many in the industry -- were a little bit optimistic that 2016 was going to stabilize and get a bit better.

That clearly didn't materialize, but at this time last year we were far more optimistic than it all turned out. So it didn't feel like we had unreasonable goals, and yet the market has been softer than any of us had anticipated. So with that commitment around alignment, this is what happens when you miss even by a bit.

Okay, makes sense. That's very helpful commentary. Thanks for taking my questions.

Ryan Cieslak, KeyBanc Capital.

Nice quarter. I wanted to just first dive a little bit back into the sales trends in the quarter again. Asking a different way, if it's fair to say that the way that the quarter ended that sales was better than your expectations. And then, two, maybe talk a little bit about what you are seeing. It sounds like the commentary is certainly a little bit better than what you guys have sounded like in the past.

I know there has been some fits and starts through the year. But Mike, is it fair to say that there's something that's different over the last couple months that gives you greater confidence that, at the very least, we've stabilized if not maybe starting to see some improvement?

Let me comment on both parts. First, the question is it better than we had planned -- at this point, last year when we were doing the planning on the quarterly and monthly basis, I would say it's not better than we planned, it's better than it had been previously. But it was still below our aspirations, the ones we set in November 2015. It's just stabilizing off this lower level and improving slightly versus, again, 2015.

Relative to what we are seeing out there, again, it's broad-based. With 70,000 customers, we are still shipping to 30,000 unique ship-to locations per month. So those trends are the same.

What might be happening out there, again on a lot of little incremental bases, is the idea that just considering that we are a small-quantity consumable business with even a little movement we start selling more line items, albeit the number of dollars per line item are still below where they had been in 2014 and 2015. So pretty broad-based.

Yes. I would just add to that, Ryan, that through the quarter and I would say even sequentially within the quarter -- I commented earlier about some of the trends that we are seeing in the oil and gas segment. But also our Kent business continues to grow and really driven by the relationships that we have with many of our strategic customers.

And then the other piece is our government business, which we highlighted in our comments, has been positive as well. So in particular, in the state and local opportunities, it seems like we are continuing to make some nice penetration into those opportunities.

Yes. As an example I think we mentioned maybe one or two quarters ago a contract that we had signed, a buying consortium at the state and municipal level, state and local level. And we are now servicing over 1,700 small municipalities, and they could be something as simple as a small Department of Transportation with a couple of plow trucks for the winter or a library or a police department. So a net pickup for us of about 700 net new customers recently and more than 1,700 locations against this small state and municipal contract.

And we fully expect that will continue to grow as we are able to offer more and more. When you think about the number of small state and local facilities out there across the US, there's a huge market potential for us. And little by little, we are creeping more and more into that.

And Mike, that's really good color. Is there something different about the way you guys are approaching the government end markets right now, or is it more just you are seeing incremental spending coming out of the local and state jurisdictions?

I think it's more about focused than it is incremental spending. A couple years ago, four or five years ago, more of our emphasis was on the Department of Defense and at the federal level. And now more of our emphasis, we still love to pick up that business and we still work toward that business, but more of our business is focused, far more distributed in every community. So it has been a shift of focus but the primary answer is focused, not fundamental spending.

I think we're just able to do a better job of delivering our value proposition on an every-week basis or every-other-week basis to that customer, the same as the small business customer that we service.

Has there been any impact from Hurricane Matthew for you guys? I'm not sure if -- how the exposure there in the Southeast would be or how do we think about that impacting October's trends?

If there's any impact, it's negative. When the roads are flooded and customers can't get to their facilities, in the short term, it was certainly not a positive. I think over the longer term something is going to have to be repaired that was underwater. And some of that might have a positive impact.

But recently it's been a small negative, not a material negative but certainly not a positive.

By the way, when Hurricane Sandy happened, you would've thought that with all those cars underwater that our Kent business would pick up a very big piece of incremental business. But that's not what happened.

What happened was all those cars were totaled and not repaired. So it's kind of a gray area for us, but not material either negative or probably not positive.

Okay, that's good color. The last one from me and then I'll hop back into the queue -- Ron, I know you mentioned on the prepared remarks the gross margins were down. I think you said half of that was related to the incremental freight expense.

One, is that right? And then, two, did you quantify the specific inventory, Canadian tax that you mentioned in the press release?

Sure. So, the impact on the increased cost into Canada really is the additional duties that we are required to pay for the quarter. It was about a couple hundred thousand dollars that was a bit of a catch up.

So that's certainly -- we pay ongoing duties and so forth, but the catch-up piece of it was about 30 bps on the margin side. In the past, we have said we feel pretty comfortable with our gross margins in the 61-ish range. And excluding that, that's pretty much right where we were at.

Okay. And so the incremental freight expense bill -- is that separate from that? I know that has been, seems like it's been in the numbers for a couple quarters now. How do we think about that into the fourth quarter and maybe also into next year?

Yes, it is separate from the Canada dollars I just mentioned, [the end]. Freight is always one of those areas that we manage for it, tightly relative to our ability to charge freight or past freight along to some of our customers. It's nothing really new for us, where we have some customers that like to see that freight as a separate line, others that do not. And it was, I would say, a minor impact for the quarter.

And I think, on a go-forward basis, where we are running today relative to freight, we don't see ourselves taking a big step backwards, relative to our overall freight recoveries.

The other thing relative to freight that is an underlying issue, opportunity for us, really, more opportunity than anything else, is as our order complete continues to creep up, the freight recovery creeps up or the freight costs come down. That's a very slow incremental thing. I think we've mentioned in the past our -- we were, call it four or five years ago, less than 50% of our orders were coming from the distribution center closest to the customer.

What was required five years ago for us was that we might have to ship boxes from two or three distribution centers to complete the order. From the customer's point of view, you still saw high 90s, 98% at that time, 97% of the orders got sent to the customer before the sales rep arrived to put it away.

So the customer never saw this. But it would take three different shipments from three different locations.

Today we are much closer to one shipment for all orders coming from the distribution center closest to the customer. And that has the effect of lowering freight costs and increasing freight recovery for us.

Okay, really good color. I appreciate it, guys.

[Gary Hatton], Granahan Investments.

I was curious; in this slow MRO market you discuss a lot of initiatives that you have been taking for the last period of time. And I was just curious how you measure, if you have any idea, any metrics that suggest that you are gaining share. I assume the initiatives are intended to gain share. And just curious how, in a slow market for everybody, how you measure that?

Yes, I can add a little color there. At the simplest level it's things like customer account, it's number of shipped-to locations per month. Now, one of the things that offsets that is even if you are shipping to the same number of customers or an increasing number of customers -- and by the way, line count also is another view on that, all of those things have been stable or positive for us.

What has been a negative for us is the dollar volume per line, which implies -- it implies that we have the customer's business. But bearing in mind, we are selling the customer very small, maintenance quantities of products.

And because they are consumable products, if they are not being consumed -- let me use an analogy. How many flat washers do you really need if you are not consuming flat washers?

So, as we consume product, we are very quickly, on a weekly basis, refilling. So our greenfield reps are adding new accounts. They are picking up product categories and ship-to locations are going up. All of that is being offset by our seasoned customers and season reps, who, while we have steady-state business, line value is still at a low level. When we see both line level going up, it will imply that our seasoned customers went from two-shift operation to three-shift operation or fleet utilization for the construction equipment rental industry, for example, ticked up a few points.

And now the backhoe is out on rent more days than it was before. That will drive maintenance cost for the customer and volume for us.

Okay, that helps. Are there any publicly traded companies that you look at more closely in terms of how your organic growth numbers compare to them?

It's a little hard because we are narrowly focused in our niche, which is consumable MRO. The other big players in the space we would refer to as broadline MRO. And there's a pretty substantial difference in that consumables, while quantity consumable MRO is a very short cycle -- again, our sales reps are what we call high-service value proposition, which means our sales reps are visiting with the customer every week or every other week.

By contrast, a broadline MRO provider might be selling you ladders and motors and fans and lighting retrofits, and that stuff can be managed by the customer. I can choose to delay those capital purchases or durable goods purchases, I should say. I can do it this quarter or I can push it off till next year. So the short answer is we really don't have anybody just like us who is narrowly focused on consumable MRO as a good comparison.

Okay, thanks a lot.

(Operator Instructions) Larry Pfeffer, Avondale Partners.

So sticking with that last question, do you have the actual numbers for what you are unique ship-tos were in this quarter in terms of a percentage change?

Yes. They are up a little bit. We don't disclose the specific numbers, but it's up a point or so, relative to unique ship-tos -- actually, as we look at the trend over the last, I would say, probably 12 months. And the same thing -- my comment on the number of lines in the line value -- our number of lines are up low single digits. And our line value is down low single digits but to a greater degree of low.

So we are pushing more lines through the distribution center to the DCs. But the average value of those lines is -- or the average number of products coming out of each one of those picks is down a little bit. So I think that's a clear indication of our existing customers purchasing less.

And the other comment I would make is that our average order size coming in from our customers is down slightly as well.

Got you. And obviously you gave some good color on the government side of the business earlier in the call, Kent tracking a little ahead of the year-to-date number in this quarter. Anything move around at all this quarter at Kent in terms of market share gains or just customer interactions picking up? I'm curious if there's any color there.

Nothing fundamental, but our continued focus on our key relationships, our strategic accounts, we work hard to win all the share weekend with them and, in particular, where they have unique and special needs we're in the process of rolling out a very important program to one of our strategic accounts and in the Kent space that we and they are very excited about. It broadens our service proposition. It broadens the solution set that we can provide to them.

And for our strategic accounts, they are very important partners to us. We take guidance from them and that enables us to service them more comprehensively. So we have very close relationships there.

But the upshot is how can we fully service all of their consumable needs. And our best partners help give us guidance as to additional areas that they want us to focus on, and we try and be as responsive and nimble as possible in servicing their needs and, again, working with them hand in glove with their guidance.

Understood. And Ron, just a housekeeping question -- looking at the fourth quarter on G&A expense, I know Q4 can move around. But any sense of what a good run rate for that line would be?

You are right, it can move around a little bit. In particular, given that we have 60 selling days in Q4 versus 64 in Q3 and there were 64 days in Q2 as well. So you will see some of the selling expenses move right along with what sales do on fewer days.

On the G&A side, excluding what I had commented before about some of the lift that we got in the third quarter on some of the incentive accruals, we are expecting that our Q4 expenses would be relatively flat with Q3. In stock-based comp is always a bit of a wild card in there. So excluding stock-based comp, I would say our anticipation would be that we would operate under a flat G&A environment.

Got you. So basically flat sequentially, plus or minus whatever you get in stock-based comp moving around quarter to quarter?

That's right, yes. I think that's fair.

Got you. I appreciate you guys taking the questions. Best of luck on the quarter.

Beth Lilly, GAMCO.

So I have two questions. One is you talked about the slowing of the hiring of reps through the rest of 2016. I just wanted to get a sense of where you view the bigger opportunity in terms of the number of reps you want to try to get to.

Yes, that's a great question. And the slowing is not in any way a change of strategy or backing off the strategy. It's really not at all that. Just like you seen in previous years where we added 49, 110 and 21, it is more about the digestion process, bringing a rep in.

And now we've layered on, starting about a little less than a year ago, a very robust reengineered process -- it came through lean Six Sigma -- around the onboarding process. So hiring of the rep is critical that getting them on the ramp and consistently helping them consistently step up and up and up over three, four, five years to build fully robust territories -- that's really where the rubber meets the road.

So, I think you are going to see this ebb and flow that you've seen in the past. But over time, there are huge numbers of untapped territories that we can continue to fill into, as we've continued to refine our operations processes -- fill rates, back orders, product management. We have more to offer more customers, and what we are seeing is the opportunity to continue to expand into that.

So you will see a little slowdown for the short term. But there will be an upward trend.

Now, the other thing I want to quickly say is that we view acquisitions and the addition of reps as different sides of the same coin. You can hire one rep at a time or you can acquire a multiple of reps at a time.

But unlike others who make acquisitions -- they might be acquiring facilities, they might be acquiring patents and basic technology and new product. Primarily what we are acquiring is reps.

The other, Beth -- and I think you know this and we have talked on previous calls about the productivity of the new sales reps and that it takes generally about 18 to 24 months for them to build out their book of business and become accretive to the organization. And we continue to fund that investment out of our operating cash flow.

So if you look at the quarter, our cash position is -- our net cash position is up about $2 million from the end of the second quarter. And we are up over the end of the year, even taking into consideration that we have made some acquisitions during the year.

So during this state where we are continuing to invest and add more sales reps, we are able to do that through the cash flow that's being generated from operations. And I think that that's an important note to make, relative to how we are funding that expansion as well.

Okay. So do you think the number is 2,000?

It's so far into the distance I wouldn't nail -- I wouldn't say 2,000. But going from call it 1,000 and creeping up and creeping up a little at a time is likely. Now, if we were to make a larger acquisition, you would bolt on the discrete number, whether it's 10 reps or 20 or 30, that would be kind of like a discrete activity that could get the number substantially larger.

But 2,000 reps is a long way away, even at the rate that we are hiring them. That's a long time into the future. But continuing to creep up 10, 50, 11, some -- that independent of acquisition is likely.

My second question is the ever-elusive EBITDA target of 10%. How long do you think it's going to take you to get there? Are you thinking that's a two-your target? Is that a four-year? Can you give us a sense of timing?

Ron will jump in. But let me just say, in 2014 we had to review and the economy had a little bit to do with it, when we've talked about our three-part growth strategy -- adding reps, productivity of our seasoned reps and then acquisitions -- we were a little optimistic that the economy in 2014 was going to continue for a little bit.

Fundamentally, our value proposition is capable of 10% and beyond 10%. It's just that that middle leg of the stool, which is largely influenced by the economy, is making a little more challenging. We can get there; it's just taking longer than we had hoped.

Yes. I would echo Mike's comments relative to, in particular, the middle leg of the stool, which is our existing rep productivity is really the most profitable leg for us. And with the market being soft, the MRO marketplace being soft this year, as Mike commented earlier, those existing sales reps are taking the brunt of that.

And so I think it really depends as to growth in that leg versus adding -- if we really added larger numbers from a rep count standpoint, that's going to put some drag on our earnings in the short term, which we talked about. So, it depends a little bit on where we see the growth.

But certainly that productivity in the middle leg can help us get there a lot faster.

The other thing that's a factor here is that when you start with better than 60% gross margin and if you are able to hold G&A costs flat both through -- while doing acquisitions and adding sales reps, it doesn't take that much topline growth to find its way to the bottom line.

And lean Six Sigma -- we keep talking about that, and we are staying the course. These process reengineering efforts enable us to strip away non-value added work, compress cycle time and enable our existing resource to do more high-quality work, again with the same resource. Over time, that really pays dividends for us.

So again, with the structure, the leverage of the Company, it doesn't take a lot of topline growth for a lot to fall to the bottom line, with the constraints I just put on it.

Yes. Okay, great. Thank you very much.

(Operator Instructions) Kevin Steinke, Barrington Research.

Just one quick follow-up. When looking at the 14-person sequential decline in the rep headcount, I guess we should just think about that as a normalized level of attrition, although I know you said rep retention continues to improve.

So I suppose it's normalized attrition but I'm also wondering if you did actually do any hiring at all in the quarter.

Yes, we absolutely did do hiring. The attrition actually has been pretty steady state. What that number is a reflection of is not a fundamental change in attrition but a slowdown, temporarily, in hiring because of the pull we had to pull a lot of people in previously.

So we could have level loaded the on boarding and the hiring. But we chose to do was pull it forward a little bit. So this is just a slowdown in hiring but not a change in strategy, not a change in our activities.

That kind of variability is noise level for us, but attrition has continued to improve slightly and stay steady state recently. It's more about the onboarding than the attrition.

Given the choice, I would rather retain more high-caliber reps than bring in new reps because it's lower cost to retain and move them along the curve. So our lean Six Sigma activities, our training activities, some other practices that we are very excited about inside the Company is having the effect of making sales reps early on more successful, more quickly. And then it's a far more profitable track to be on, rather than just bringing in sales reps and accepting higher attrition.

Okay, perfect. Thanks for the color. Appreciate it.

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

Thank you. And thank you for joining the call and your interest in Lawson Products. We are confident that our value proposition resonates with our customers. And we are managing in the current environment, which is to say we're making investments that will enable us to outperform the market.

I believe that's the role of management is to beat the market as best we can, and it's my belief that the activities we are engaged in, the actions we are taking, the investments we are making will enable us to outperform the market.

Lastly, I'd like to take this time to thank our teammates for their commitment to excellence and their commitment to superior customer service. Thank you again for joining us today. Have a great day.

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