Distribution Solutions Group, Inc. - Quarter Report: 2012 June (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

FORM 10-Q

(Mark One)

For quarterly period ended June 30, 2012

or

For the transition period from              to             

Commission file Number: 0-10546

LAWSON PRODUCTS, INC.

(Exact name of registrant as specified in its charter)

(773) 304-5050

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

The number of shares outstanding of the registrant’s common stock, $1 par value, as of July 31, 2012 was 8,597,554.

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“Safe Harbor” Statement under the Securities Litigation Reform Act of 1995:

This Quarterly Report on Form 10-Q contains certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 that involve risks and uncertainties. The terms “may,” “should,” “could,” “anticipate,” “believe,” “continues,” “estimate,” “expect,” “intend,” “objective,” “plan,” “potential,” “project” and similar expressions are intended to identify forward-looking statements. These statements are not guarantees of future performance and involve risks, uncertainties and assumptions that are difficult to predict. These statements are based on management’s current expectations, intentions or beliefs and are subject to a number of factors, assumptions and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements. Factors that could cause or contribute to such differences or that might otherwise impact the business include:

all other factors discussed in the Company’s “Risk Factors” set forth in its Annual Report on Form 10-K for the year ended December 31, 2011 and in this Quarterly Report on Form 10-Q for the period ended June 30, 2012.

The Company undertakes no obligation to update any such factors or to publicly announce the results of any revisions to any forward-looking statements contained herein whether as a result of new information, future events or otherwise.

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PART I - FINANCIAL INFORMATION

ITEM 1 - FINANCIAL STATEMENTS

Lawson Products, Inc.

Condensed Consolidated Balance Sheets

(Dollars in thousands, except per share data)

See notes to condensed consolidated financial statements.

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Lawson Products, Inc.

Condensed Consolidated Statements of Comprehensive Income (Loss)

(Dollars in thousands, except per share data)

(Unaudited)

See notes to condensed consolidated financial statements.

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Lawson Products, Inc.

Condensed Consolidated Statements of Cash Flows

(Dollars in thousands)

(Unaudited)

See notes to condensed consolidated financial statements.

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Note 1 — Basis of Presentation and Summary of Significant Accounting Policies

The accompanying unaudited condensed consolidated financial statements of Lawson Products, Inc. (the “Company”) have been prepared in accordance with generally accepted accounting principles for interim financial information, the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not contain all disclosures required by generally accepted accounting principles. Reference should be made to the Company’s Annual Report on Form 10-K for the year ended December 31, 2011. In the opinion of the Company, all normal recurring adjustments have been made, that are necessary to present fairly the results of operations for the interim periods. Operating results for the three and six month periods ended June 30, 2012 are not necessarily indicative of the results that may be expected for the year ending December 31, 2012.

Certain reclassifications have been made to prior period amounts to conform to current period presentation. Such reclassifications have no effect on net income as previously reported. The effect of restricted share awards and future stock option exercises equivalent to 27 thousand and 34 thousand shares for the three and six months ended June 30, 2012, respectively, would have been anti-dilutive and therefore, were excluded from the computation of diluted earnings per share.

The Company has adopted Accounting Standards Update (“ASU”) No. 2011-05 and 2011-12 regarding the presentation of comprehensive income in the financial statements. No other material changes occured in our significant accounting policies during the six months ended June 30, 2012 as compared to the significant accounting policies described in our Annual Report on Form 10-K for the year ended December 31, 2011. The Company has determined that, except for the new credit facility effective August 8, 2012 (See Note 5 – Credit Facility), there were no other subsequent events to recognize or disclose in these financial statements.

Note 2 — Inventories, net

The Company increased its obsolete and excess inventory reserves $6.5 million for the six months ended June 30, 2012 primarily as a result of the discontinuation of certain products. Components of inventories were as follows:

Note 3 — Sale of assets and property held for sale

In the second quarter of 2012, in conjunction with the construction of a new distribution center in McCook, Illinois and the relocation of the Company’s headquarters to Chicago, Illinois, the Company sold three properties; its Addison, Illinois distribution center, its Vernon Hills, Illinois distribution center and a Des Plaines, Illinois administrative building. The Company received cash proceeds of $8.8 million for the sale of the three facilities, which were included in the MRO segment, resulting in a gain of $2.1 million. Operations currently conducted at the Addison, Illinois and Vernon Hills, Illinois distribution centers will be transferred to the new McCook, Illinois facility during the second half of 2012. The Company has entered into various arrangements to lease these facilities back from the buyer for transition purposes until the second quarter of 2013.

In addition to these three property sales, the Company allowed the lease of another Des Plaines, Illinois facility to expire during the quarter and it is actively marketing its former Des Plaines, Illinois headquarters and packaging facility. The net book value of the former headquarters’ land and building of $1.9 million has been reclassified to Property held for sale in the Condensed Consolidated Balance Sheets and will not be depreciated after being classified as held for sale.

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Note 4 — Goodwill Impairment

As a result of an acquisition in 2001, the Company had goodwill of $28.3 million, all of which related to its MRO segment. On an interim basis, the Company evaluates goodwill for potential impairment by determining if certain qualitative events have occurred or if circumstances have changed that would more likely than not reduce the fair value of the reporting unit below its carrying value. As a result of this evaluation, the Company identified indicators of impairment during the quarter ended June 30, 2012 related to operating losses and reduced market capitalization and, therefore, performed an interim impairment test of goodwill.

The Company estimated the fair value of the MRO reporting unit using a discounted cash flow analysis based on its current internal operating forecast to determine the reporting unit’s fair value. After completing the analysis, the Company concluded that the entire amount of the goodwill was impaired and a non-cash charge of $28.3 million was recorded in the second quarter of 2012.

Goodwill activity for the three and six months ended June 30, 2012 was as follows:

Note 5 — Credit Facility

At June 30, 2012, the Company had a $14.8 million balance outstanding on its revolving line of credit under its Existing Credit Facility (“Existing Credit Facility”). The weighted average interest rate was 1.5% through the first six months of 2012 and the outstanding balance approximates fair value. On June 27, 2012 the Company received a commitment letter from its lender, The PrivateBank, to replace its existing $55.0 million credit facility with a new five-year, $40.0 million credit facility (“New Credit Facility”). The Company entered into the New Credit Facility on August 8, 2012.

At June 30, 2012, the Company was not in compliance with the minimum EBITDA covenant defined in the Existing Credit Facility. However, the Company was in compliance with the remaining financial covenants as detailed below:

The Company received a waiver under the Existing Credit Facility for relief from compliance with the minimum EBITDA covenant for the quarter ended June 30, 2012.

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Note 6 — Severance Reserve

In the second quarter of 2012, as part of a strategic restructuring plan designed to reduce its cost structure, the Company eliminated approximately 120 corporate and distribution positions in its MRO segment. This restructuring resulted in a $6.6 million severance charge which is included in Selling, general and administrative expenses in the Condensed Consolidated Statements of Comprehensive Income (Loss).

The table below shows the changes in the Company’s reserve for severance and related payments as of June 30, 2012 and 2011:

Accrued severance charges are included in the line items of the Condensed Consolidated Balance Sheets at June 30, 2012 and December 31, 2011 as follows:

All severance accrued at June 30, 2012 will be fully paid by June 30, 2014.

Note 7 — Income Tax

During the quarter ended June 30, 2012, the Company’s deferred tax assets increased by $15.8 million to $34.3 million primarily due to non-cash charges related to goodwill impairment and severance. However, due to the cumulative losses it has experienced, the recoverability of substantially all of the deferred tax assets is uncertain. Therefore, the Company recorded an additional valuation allowance of $33.5 million resulting in a net tax expense of $19.5 million for the quarter.

Income tax as a percentage of pre-tax loss for the three months ended June 30, 2012 was negative 46.7% compared to an effective tax rate of 31.3% for the three months ended June 30, 2011. Exclusive of the effect of the increase in the tax valuation allowance, the effective income tax rate would have been 33.7%.

Income tax as a percentage of pre-tax loss for the six months ended June 30, 2012 was negative 41.1% compared to a tax rate of 35.1% for the six months ended June 30, 2011. Exclusive of the effect of the increase in the tax valuation allowances, the effective income tax rate would have been 34.0%.

The Company and its subsidiaries are subject to U.S. Federal income tax as well as income tax of multiple state and foreign jurisdictions. As of June 30, 2012, the Company is subject to U.S. Federal income tax examinations for the years 2009 and 2010, and income tax examinations from various other jurisdictions for the years 2006 through 2010.

Earnings from the Company’s foreign subsidiaries are considered to be indefinitely reinvested. A distribution of these non-U.S. earnings in the form of dividends or otherwise would subject the Company to both U.S. Federal and state income taxes, as adjusted for tax credits and foreign withholding taxes.

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Note 8 — Contingent Liability

One of the Company’s subsidiaries, Drummond American LLC (“Drummond”), is under an employment tax examination for the years 2007 and 2008 of the long-standing treatment of its sales representatives as independent contractors. In January 2012 the Company received a Notice of Proposed Adjustment in the amount of $9.5 million, including penalties, from the IRS challenging Drummond’s position that the sales representatives were independent contractors. Although the Company intends to vigorously defend its position for the treatment of its sales representatives as independent contractors, the Company established a liability of $1.2 million during 2011 as its best estimate of the cost to resolve this matter. An unfavorable outcome of this matter could have a material adverse effect on the Company’s business, financial condition and results of operations.

Note 9 — Non-Cash Items

During the six months ended June 30, 2012, the Company recorded an $8.0 million increase in Property, plant and equipment, along with a corresponding increase in liabilities, related to the build-to-suit lease of the McCook, Illinois distribution center. These non-cash increases have been excluded from the Condensed Consolidated Statements of Cash Flows.

Note 10 — Segment Reporting

The Company has two reportable operating segments: MRO and OEM. The Company’s MRO segment is a distributor of products and services to the industrial, commercial, institutional, and governmental maintenance, repair and operations marketplace. The Company’s OEM segment manufactures, sells and distributes production and specialized component parts to the original equipment marketplace. The Company’s two reportable segments are distinguished by the nature of products distributed and sold, types of customers and manner of servicing them. The Company evaluates performance and allocates resources to reportable segments primarily based on operating income.

The following table presents summary financial information for the Company’s reportable segments:

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The following table presents total assets for the Company’s reportable segments:

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Quarter ended June 30, 2012 compared to Quarter ended June 30, 2011

The following table presents a summary of our financial performance for the three months ended June 30, 2012 and 2011:

Net Sales

Net sales for the second quarter of 2012 decreased 11.7% to $74.3 million, from $84.2 million in the second quarter of 2011. Excluding the Canadian exchange rate impact, net sales decreased 11.3% for the quarter.

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MRO net sales decreased 13.4% in the second quarter of 2012, to $69.8 million from $80.6 million in the prior year period. MRO average daily sales decreased to $1.091 million in the second quarter of 2012 compared to $1.260 million in the second quarter of 2011. The decrease was mainly driven by a sales decline of $3.8 million within the government segment primarily within bases that support troop deployment, lower freight revenues, an increase in small customer account attrition and a decline in sales representatives from a year ago. The decline was partially offset by an increase within the strategic accounts segment.

OEM net sales increased 28.0% in the second quarter of 2012, to $4.5 million from $3.5 million in the prior year period, driven by stronger demand from existing customers.

Gross Profit

Gross profit decreased $11.5 million in the second quarter of 2012, to $36.8 million from $48.3 million in the prior year period. MRO gross profit as a percent of net MRO sales decreased to 51.2% in the second quarter of 2012, compared to 59.1% achieved in the second quarter of 2011, primarily due to lower outbound freight recoveries, $5.8 million of additional inventory reserves primarily as a result of discontinuing certain products, additional labor to support customer service and a shift toward higher volume national customers with lower margins. Strategic accounts represented approximately 12.8% of MRO sales for the quarter versus approximately 10.5% in the prior year quarter.

OEM gross profit increased $0.4 million and increased as a percent of OEM sales to 24.1% in the second quarter of 2012 from 18.3% in the second quarter of 2011. The improvement as a percent of sales was primarily driven by leverage gained from a higher sales volume from existing customers.

Selling, General and Administrative Expenses

Selling Expenses

Selling expenses consist of commissions paid to our independent sales representatives, employee sales expenses and related expenses to support our sales efforts. Selling expenses decreased to $21.8 million in the second quarter of 2012 from $23.0 million in the prior year quarter, primarily due to lower sales. Selling expenses increased as a percent of sales to 29.3% in 2012 compared to 27.3% in 2011 due to the impact of fixed selling costs on decreased sales levels.

General and Administrative Expenses

General and administrative expenses consist of expenses to operate our distribution network and overhead expenses to manage the business. General and administrative expenses increased to $23.7 million in the second quarter of 2012 from $23.3 million in the prior year quarter. The $2.4 million of ERP implementation expenses incurred in 2011 was offset in 2012 by $0.5 million of post ERP implementation expenses, a $1.0 million increase in bad debt expense and an increase of $0.6 million in depreciation and facility costs.

Severance

We recorded severance expense of $6.6 million and $0.5 million in the three months ended 2012 and 2011, respectively. The 2012 severance charge primarily related to a strategic restructuring plan designed to create a simplified organizational structure. The restructuring resulted in the elimination of approximately 120 corporate and distribution positions. The 2011 severance charge primarily related to the realignment of certain responsibilities following the sale of two subsidiaries in 2010.

Goodwill Impairment

During the second quarter of 2012, we assessed the fair value of the $28.3 million goodwill balance related to a 2001 acquisition in our MRO reporting unit. Based on this assessment, we determined that the full amount of the goodwill was impaired and a non-cash charge of $28.3 million was recorded.

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Gain on Sale of Assets

In the second quarter of 2012, in conjunction with the construction of a new distribution center in McCook, Illinois and the relocation of our headquarters to Chicago, Illinois, we sold three properties: our Addison, Illinois distribution center, our Vernon Hills, Illinois distribution center and a Des Plaines, Illinois administrative building. We received cash proceeds of $8.8 million for the sale of the three facilities which resulted in a gain of $2.1 million.

Other Expense, net

Other expense, net of $0.2 million for the three months ended June 30, 2012 consists primarily of interest charged on the outstanding borrowings of our revolving line of credit.

Income Tax Expense

Income tax expense of $19.5 million was recorded in the three months ended June 30, 2012 on a pre-tax loss of $41.7 million, resulting in an effective tax rate of negative 46.7%. During the quarter ended June 30, 2012, our deferred tax valuation allowance was increased by $33.5 million related to the uncertain recoverability of our deferred tax assets. Exclusive of the effect of the increase in the deferred tax valuation allowance, the effective income tax rate would have been 33.7%.

For the three months ended June 30, 2011, income tax expense was $0.5 million on pre-tax income of $1.6 million, resulting in an effective tax rate of 31.3%.

Income (Loss) from Continuing Operations

We reported a loss from continuing operations of $61.1 million or a loss of $7.12 per diluted share in the second quarter of 2012 compared to income from continuing operations of $1.1 million or $0.13 per diluted share in the second quarter of 2011. The 2012 loss was negatively impacted by the impairment of goodwill, the deferred tax valuation allowances, severance expense and additional inventory reserves.

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Six Months ended June 30, 2012 compared to Six Months ended June 30, 2011

The following table presents a summary of our financial performance for the six months ended June 30, 2012 and 2011:

Net Sales

Net sales for the first half of 2012 decreased 9.9% to $150.3 million, from $166.7 million in the first half of 2011. Excluding the Canadian exchange rate impact, net sales decreased 9.6%.

MRO net sales decreased 11.7% in the first half of 2012, to $141.2 million from $159.9 million in the prior year period. MRO average daily sales decreased to $1.103 million in the first half of 2012 compared to $1.259 million in the first half of 2011. The decrease was mainly driven by a sales decline of $8.2 million within the government segment primarily within bases that support troop deployment, lower freight revenues, an increase in small customer account attrition and a decline in sales representatives from a year ago. The decline was partially offset by an increase within the strategic accounts segment.

OEM net sales increased 33.0% in the first half of 2012, to $9.1 million from $6.9 million in the prior year period, driven by stronger demand from existing customers.

Gross Profit

Gross profit decreased $20.0 million in the first half of 2012, to $78.2 million from $98.2 million in the prior year period. MRO gross profit as a percent of net MRO sales decreased to 53.8% in the first half of 2012, compared to 60.6% achieved in the first half of 2011, primarily due to lower outbound freight recoveries, an increase of $6.4 million in our inventory reserves, additional labor to support our customer service and a shift toward higher volume national customers with lower margins. Strategic accounts represented approximately 12.1% of MRO sales for the half versus approximately 10.2% in the prior year half.

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OEM gross profit increased $0.8 million and increased as a percent of OEM sales to 23.3% in the first half of 2012 from 19.0% in the first half of 2011. The improvement as a percent of sales was primarily driven by leverage gained from a higher sales volume from existing customers.

Selling, General and Administrative Expenses

Selling Expenses

Selling expenses decreased to $41.9 million in the first half of 2012 from $45.1 million in the prior year half, primarily due to lower sales. Selling expenses increased as a percent of sales to 27.9% in 2012 from 27.1% in 2011 due to the impact of fixed selling costs on the decreased sales levels.

General and Administrative Expenses

General and administrative expenses increased to $47.5 million in the second quarter of 2012 from $46.6 million in the prior year quarter. The $4.3 million of ERP implementation expenses incurred in 2011 was offset in 2012 by $1.6 million in post ERP go-live expenses, $1.1 million of increased bad debt expense and increased depreciation and facility costs of $1.0 million.

Severance

We recorded severance expense of $6.8 million and $1.2 million in the six months ended 2012 and 2011, respectively. The 2012 severance charge primarily related to a strategic restructuring plan designed to create a simplified and flattened organizational structure. The restructuring resulted in the elimination of approximately 120 corporate and distribution positions. The 2011 severance charge primarily related to the realignment of certain responsibilities following the sale of two subsidiaries in 2010.

Goodwill Impairment

During the second quarter of 2012, we prepared an assessment of the fair value of the $28.3 million goodwill balance related to a 2001 acquisition in our MRO reporting unit. Based on this assessment, we determined that the full amount of the goodwill was impaired and a non-cash charge of $28.3 million was recorded.

Gain on Sale of Assets

In the second quarter of 2012, in conjunction with the construction of a new distribution center in McCook, Illinois and the relocation of our headquarters to Chicago, Illinois, we sold three properties; our Addison, Illinois distribution center, Vernon Hills, Illinois distribution center and a Des Plaines, Illinois administrative building. We received cash proceeds of $8.8 million for the sale of the three facilities which resulted in a gain of $2.1 million.

Other Expense, net

Other expense, net of $0.3 million recorded in the six months ended June 30, 2012 primarily relates to interest charged on the outstanding borrowings of our revolving line of credit. The $0.5 million recorded in the first half of 2011 primarily relates to interest assessed on unclaimed property settlements.

Income Tax (Benefit) Expense

Income tax expense of $18.3 million was recorded for the six months ended June 30, 2012 on a pre-tax loss of $44.6 million, resulting in an effective tax rate of negative 41.1%. During the six months ended June 30, 2012, our deferred tax valuation allowance was increased by $33.5 million related to the uncertain recoverability of our deferred tax assets. Exclusive of the effect of the increase in the tax valuation, the effective income tax rate would have been 34.0%.

For the six months ended June 30, 2011, income tax expense was $1.7 million on pre-tax income of $4.8 million, resulting in an effective tax rate of 35.1%.

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