Distribution Solutions Group, Inc. 10-Q

ITEM 1 - FINANCIAL STATEMENTS Lawson Products, Inc. Condensed Consolidated Balance Sheets (Dollars in thousands, except share data) September 30, December 31, 2020 2019 ASSETS (Unaudited) Current assets: Cash and cash equivalents $ 17,193 $ 5,495 Restricted cash 802 802 Accounts receivable, less allowance for doubtful accounts of $ 680 and $ 593 , respectively 47,902 38,843 Inventories, net 62,218 55,905 Miscellaneous receivables and prepaid expenses 5,943 5,377 Total current assets 134,058 106,422 Property, plant and equipment, net 16,596 16,546 Goodwill 36,428 20,923 Deferred income taxes 20,289 21,711 Intangible assets, net 18,727 12,335 Cash value of life insurance 15,400 14,969 Right of use assets 9,513 11,246 Other assets 258 277 Total assets $ 251,269 $ 204,429 LIABILITIES AND STOCKHOLDERS’ EQUITY Current liabilities: Accrued acquisition liability $ 32,476 $ — Accounts payable 22,466 13,789 Lease obligation 4,509 3,830 Accrued expenses and other liabilities 30,808 39,311 Total current liabilities 90,259 56,930 Revolving line of credit — 2,271 Security bonus plan 11,540 11,840 Deferred compensation 9,847 6,370 Lease obligation 6,693 9,504 Deferred tax liability 6,154 6,188 Other liabilities 5,522 3,325 Total liabilities 130,015 96,428 Stockholders’ equity: Preferred stock, $ 1 par value: Authorized - 500,000 shares, Issued and outstanding — None — — Common stock, $ 1 par value: Authorized - 35,000,000 shares Issued - 9,231,598 and 9,190,171 shares, respectively Outstanding - 9,025,617 and 9,043,771 shares, respectively 9,232 9,190 Capital in excess of par value 19,508 18,077 Retained earnings 101,386 86,496 Treasury stock – 205,981 and 146,400 shares, respectively ( 7,953 ) ( 5,761 ) Accumulated other comprehensive loss ( 919 ) ( 1 ) Total stockholders’ equity 121,254 108,001 Total liabilities and stockholders’ equity $ 251,269 $ 204,429 See notes to condensed consolidated financial statements. 4 Table of Contents Lawson Products, Inc. Condensed Consolidated Statements of Income and Comprehensive Income (Dollars in thousands, except per share data) (Unaudited) Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 Total revenue $ 90,277 $ 94,779 $ 253,458 $ 282,219 Cost of goods sold 43,052 44,205 118,999 131,679 Gross profit 47,225 50,574 134,459 150,540 Operating expenses: Selling expenses 19,155 21,255 55,445 64,864 General and administrative expenses 26,069 22,873 57,806 72,063 Operating expenses 45,224 44,128 113,251 136,927 Operating income 2,001 6,446 21,208 13,613 Interest expense ( 142 ) ( 138 ) ( 329 ) ( 481 ) Other income (expense), net 615 ( 13 ) 15 798 Income before income taxes 2,474 6,295 20,894 13,930 Income tax expense 736 1,521 6,004 3,703 Net income $ 1,738 $ 4,774 $ 14,890 $ 10,227 Basic income per share of common stock $ 0.19 $ 0.53 $ 1.65 $ 1.14 Diluted income per share of common stock $ 0.19 $ 0.51 $ 1.60 $ 1.09 Weighted average shares outstanding: Basic weighted average shares outstanding 9,017 8,974 9,017 8,971 Effect of dilutive securities outstanding 313 415 312 399 Diluted weighted average shares outstanding 9,330 9,389 9,329 9,370 Comprehensive income: Net income $ 1,738 $ 4,774 $ 14,890 $ 10,227 Other comprehensive income, net of tax Adjustment for foreign currency translation 398 ( 427 ) ( 918 ) 965 Net comprehensive income $ 2,136 $ 4,347 $ 13,972 $ 11,192 See notes to condensed consolidated financial statements. 5 Table of Contents Lawson Products, Inc. Condensed Consolidated Statements of Changes in Stockholders’ Equity (Dollars in thousands) (Unaudited) Common Stock Capital in Excess of Par Value Accumulated Other Comprehensive Income (Loss) Total Stockholders' Equity Outstanding Shares $1 Par Value Retained Earnings Treasury Stock Balance at January 1, 2020 9,043,771 $ 9,190 $ 18,077 $ 86,496 $ ( 5,761 ) $ ( 1 ) $ 108,001 Net income — — — 12,533 — — 12,533 Treasury shares repurchased ( 47,504 ) — — — ( 1,756 ) — ( 1,756 ) Adjustment for foreign currency translation — — — — — ( 2,494 ) ( 2,494 ) Stock-based compensation — — 451 — — — 451 Balance at March 31, 2020 8,996,267 9,190 18,528 99,029 ( 7,517 ) ( 2,495 ) 116,735 Net income — — — 619 — — 619 Adjustment for foreign currency translation — — — — — 1,178 1,178 Stock-based compensation — — 498 — — — 498 Shares issued 11,144 11 3 — — — 14 Balance at June 30, 2020 9,007,411 $ 9,201 $ 19,029 $ 99,648 $ ( 7,517 ) $ ( 1,317 ) $ 119,044 Net income — $ — $ — $ 1,738 $ — $ — $ 1,738 Treasury shares repurchased ( 12,077 ) — — — ( 436 ) — ( 436 ) Adjustment for foreign currency translation — — — — — 398 398 Stock-based compensation — — 510 — — — 510 Shares issued 30,283 31 ( 31 ) — — — — Balance at September 30, 2020 9,025,617 $ 9,232 $ 19,508 $ 101,386 $ ( 7,953 ) $ ( 919 ) $ 121,254 6 Table of Contents Lawson Products, Inc. Condensed Consolidated Statements of Changes in Stockholders’ Equity (Dollars in thousands) (Unaudited) Common Stock Capital in Excess of Par Value Accumulated Other Comprehensive Income (Loss) Total Stockholders' Equity Outstanding Shares $1 Par Value Retained Earnings Treasury Stock Balance at January 1, 2019 8,955,930 $ 9,006 $ 15,623 $ 77,338 $ ( 1,234 ) $ ( 1,560 ) $ 99,173 Change in accounting principle (1) — — — 1,937 — — 1,937 Net income — — — 4,146 — — 4,146 Adjustment for foreign currency translation — — — — — 675 675 Stock-based compensation — — 666 — — — 666 Shares issued 6,520 6 ( 6 ) — — — — Balance at March 31, 2019 8,962,450 9,012 16,283 83,421 ( 1,234 ) ( 885 ) 106,597 Net income — — — 1,307 — — 1,307 Adjustment for foreign currency translation — — — — — 717 717 Stock-based compensation — — 711 — — — 711 Shares issued 20,712 21 ( 21 ) — — — — Balance at June 30, 2019 8,983,162 $ 9,033 $ 16,973 $ 84,728 $ ( 1,234 ) $ ( 168 ) $ 109,332 Net income — $ — $ — $ 4,774 $ — $ — $ 4,774 Treasury shares repurchased ( 35,830 ) — — — ( 1,361 ) — ( 1,361 ) Adjustment for foreign currency translation — — — — — ( 427 ) ( 427 ) Stock-based compensation — — 663 — — — 663 Shares issued 9,649 10 ( 10 ) — — — — Balance at September 30, 2019 8,956,981 $ 9,043 $ 17,626 $ 89,502 $ ( 2,595 ) $ ( 595 ) $ 112,981 (1) The Company adopted the ASC No.842, Leases (ASC 842) on January 1, 2019 using the modified retrospective approach. See Note 7 - Leases for further details. See notes to condensed consolidated financial statements. 7 Table of Contents Lawson Products, Inc. Condensed Consolidated Statements of Cash Flows (Dollars in thousands) (Unaudited) Nine Months Ended September 30, 2020 2019 Operating activities: Net income $ 14,890 $ 10,227 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 4,660 4,401 Stock-based compensation ( 2,767 ) 7,621 Deferred income taxes 1,454 3,252 Changes in operating assets and liabilities, net of acquisition Accounts receivable ( 2,128 ) ( 7,785 ) Inventories 1,101 ( 1,593 ) Prepaid expenses and other assets ( 725 ) ( 2,433 ) Accounts payable and other liabilities 3,097 ( 6,193 ) Other 441 544 Net cash provided by operating activities $ 20,023 $ 8,041 Investing activities: Purchases of property, plant and equipment $ ( 1,311 ) $ ( 1,392 ) Cash paid for acquisition ( 2,300 ) — Net cash used in investing activities $ ( 3,611 ) $ ( 1,392 ) Financing activities: Net payments on revolving line of credit $ ( 2,271 ) $ ( 8,628 ) Repurchase treasury shares ( 2,192 ) ( 1,361 ) Payment of financing lease principal ( 192 ) ( 192 ) Proceeds from stock option exercises 15 16 Net cash used in financing activities $ ( 4,640 ) $ ( 10,165 ) Effect of exchange rate changes on cash and cash equivalents $ ( 74 ) $ 259 Increase (decrease) in cash, cash equivalents and restricted cash 11,698 ( 3,257 ) Cash, cash equivalents and restricted cash at beginning of period 6,297 12,683 Cash, cash equivalents and restricted cash at end of period $ 17,995 $ 9,426 Cash and cash equivalents $ 17,193 $ 8,626 Restricted cash 802 800 Cash, cash equivalents and restricted cash $ 17,995 $ 9,426 Supplemental disclosure of cash flow information Net cash paid for income taxes 3,733 458 Net cash paid for interest 295 499 See notes to condensed consolidated financial statements. 8 Table of Contents Notes to Condensed Consolidated Financial Statements 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, 2019. 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 nine month periods ended September 30, 2020 are not necessarily indicative of the results that may be expected for the year ending December 31, 2020. The Company has two operating segments. The first segment, the Lawson operating segment, distributes maintenance, repair and operations ("MRO") products to customers primarily through a network of sales representatives offering vendor managed inventory ("VMI") service to customers throughout the United States and Canada. The second segment, The Bolt Supply House Ltd. ("Bolt Supply") operating segment, distributes MRO products primarily through its branches located in Western Canada. Bolt Supply had 14 branches in operation at the end of the third quarter 2020. 9 Table of Contents Note 2 - Acquisition On August 31, 2020, the Company acquired Partsmaster from NCH Corporation. Partsmaster is a leading maintenance, MRO solutions provider that serves approximately 16,000 customers with over 200 sales representatives. The acquisition was made primarily to expand the Company's sales coverage, expand product lines, add experienced sales representatives, and leverage the Company's infrastructure. The purchase price was $ 35.3 million in cash and the assumption of certain liabilities. The Company paid $ 2.3 million of the purchase price in cash at closing and will pay the remaining $ 33.0 million in May 2021. The payment obligation has been discounted to present value and is recognized as an accrued acquisition liability of $ 32.5 million in the Company's condensed consolidated balance sheet. P ayment has been guaranteed under the Purchase Agreement, and includes the issuance of a $ 33.0 million irrevocable standby letter of credit. The Company will satisfy the payment obligation with cash on hand and, to the extent necessary, any remaining portion using its existing credit facility. The purchase price of the acquisition was allocated to the fair value of Partsmaster’s assets and liabilities on the acquisition date. The fair market value appraisals of the majority of the assets and liabilities were determined by a third party valuation firm using management estimates and assumptions including intangible assets of $ 5.0 million for customer relationships and $ 2.8 million for trade names, and their estimated useful lives of 10 and 5 years, respectively. The $16.0 million allocated to goodwill reflects the purchase price less the fair market value of the identifiable net assets. The appropriate fair values of the assets acquired and liabilities assumed are based on preliminary estimates and assumptions. These preliminary estimates and assumptions could change significantly during the purchase price measurement period as the Company finalizes the valuations of the assets acquired and liabilities assumed. Partsmaster contributed $ 5.4 million of revenue and $ 0.4 million of operating income in the third quarter 2020 post-acquisition. A summary of the initial purchase price allocation of the acquisition is as follows (Dollars in thousands): Cash paid and payable and liabilities assumed Cash paid and payable $ 34,711 Accounts payable and accrued expenses 4,076 Deferred compensation 2,938 $ 41,725 Fair value of assets acquired Goodwill $ 15,952 Inventories 7,809 Accounts receivable 7,656 Customer relationships 4,961 Trade names 2,775 Property, plant and equipment 2,201 Other assets 371 $ 41,725 The following table contains unaudited pro forma revenue and net income for Lawson Products assuming the Partsmaster acquisition closed on January 1, 2019. 10 Table of Contents (Dollars in thousands) Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 Revenue Actual $ 90,277 $ 94,779 $ 253,458 $ 282,219 Pro forma 101,222 109,174 298,546 332,234 Net income Actual $ 1,738 $ 4,774 $ 14,890 $ 10,227 Pro forma 1,982 4,598 16,312 10,166 The pro forma disclosures in the table above include adjustments for amortization of intangible assets, implied interest expense and acquisition costs to reflect results as if the acquisition of Partsmaster had closed on January 1, 2019 rather than on the actual acquisition date. This pro forma information utilizes certain estimates, is presented for illustrative purposes only and is not intended to be indicative of the actual results of operation. In addition, future results may vary significantly from the results reflected in the pro forma information. The unaudited pro forma financial information does not reflect the impact of future positive or negative events that may occur after the acquisition, such as anticipated cost savings from operating synergies. Note 3 - Revenue Recognition As part of the Company's revenue recognition analysis, it concluded that it has two separate performance obligations, and accordingly, two separate revenue streams: products and services. Under the definition of a contract as defined by ASC 606, the Company considers contracts to be created at the time an order to purchase product is agreed upon regardless of whether or not there is a written contract. Performance Obligations Lawson has two operating segments; the Lawson segment and the Bolt Supply segment. The Lawson segment has two distinct performance obligations offered to its customers: a product performance obligation and a service performance obligation. Although the Company has identified that it offers its customers both a product and a service obligation, the customer only receives one invoice per transaction with no price breakout between these obligations. The Company does not price its offerings based on any breakout between these obligations. The Lawson segment, including the recent Partsmaster acquisition, offers a vendor managed inventory ("VMI") service proposition to its customers. A portion of these services, primarily related to stocking of product and maintenance of the MRO inventory, is provided a short period of time after control of the purchased product has been transferred to the customer. Since some components of VMI service have not been provided at the time the control of the product transfers to the customer, that portion of expected consideration is deferred until the time that those services have been provided. The Bolt Supply segment does not provide VMI services for its customers or provide services in addition to product sales to customers. In previous financial statements, the Company presented the disaggregated components of total revenue: product revenue and service revenue, along with the cost of sales associated with each of these revenue streams as the service revenues exceeded 10% of consolidated sales. Since the Company qualifies as a smaller reporting company, the Company has elected to discontinue disclosure of the disaggregated components of revenue and cost of sales in its c ondensed consolidated statements of income and comprehensive income and in the related notes to the condensed consolidated financial statements. This presentation decision is effective beginning with this Quarterly Report on Form 10-Q for the period ended September 30, 2020. For the three and nine months ended September 30, 2019, service revenue of $ 10.3 million and $ 29.9 million, respectively, were reported as service revenue which have now been combined as reported within total revenue. 11 Table of Contents Disaggregated revenue by geographic area follows: Three Months Ended September 30, Nine Months Ended September 30, (Dollars in thousands) 2020 2019 2020 2019 United States $ 72,030 $ 75,160 $ 202,709 $ 225,327 Canada 18,247 19,619 50,749 56,892 Consolidated total $ 90,277 $ 94,779 $ 253,458 $ 282,219 Disaggregated revenue by product type follows: Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 Fastening Systems 22.3 % 24.1 % 22.7 % 24.0 % Specialty Chemicals 13.3 % 11.7 % 11.7 % 11.6 % Fluid Power 12.6 % 15.1 % 13.2 % 15.2 % Cutting Tools and Abrasives 12.2 % 13.1 % 13.1 % 13.1 % Electrical 10.0 % 10.4 % 10.2 % 10.8 % Safety 7.0 % 4.7 % 6.4 % 4.7 % Aftermarket Automotive Supplies 7.0 % 7.6 % 7.1 % 7.9 % Welding and Metal Repair 1.4 % 1.3 % 1.4 % 1.5 % Other 14.2 % 12.0 % 14.2 % 11.2 % Consolidated Total 100.0 % 100.0 % 100.0 % 100.0 % Note 4 — Restricted Cash The Company has agreed to maintain $ 0.8 million in a money market account as collateral for an outside party that is providing certain commercial card processing services for the Company. The Company is restricted from withdrawing this balance without the prior consent of the outside party during the term of the agreement. Note 5 — Inventories, Net Inventories, net, consisting primarily of purchased goods which are offered for resale, were as follows: (Dollars in thousands) September 30, 2020 December 31, 2019 Inventories, gross $ 67,083 $ 60,500 Reserve for obsolete and excess inventory ( 4,865 ) ( 4,595 ) Inventories, net $ 62,218 $ 55,905 Note 6 - Goodwill Goodwill activity for the first nine months of 2020 and 2019 is included in the table below: (Dollars in thousands) Nine Months Ended September 30, 2020 2019 Beginning balance $ 20,923 $ 20,079 Acquisition 15,952 — Adjustment to original acquisition allocation — ( 12 ) Impact of foreign exchange ( 447 ) 515 Ending balance $ 36,428 $ 20,582 The Company performed a quantitative impairment test on the Bolt goodwill as of March 31, 3020 and June 30, 2020. As of June 30, 2020 the Bolt reporting unit's fair value exceeded its carrying value by approximately $5.4 million or 16%. As of 12 Table of Contents June 30, 2020 goodwill allocated to the Bolt operating unit was $12.8 million. Related to the Lawson reporting unit, the Company performed a qualitative assessment as of March 31, 2020 and June 30, 2020 and determined that it was more likely than not the fair value of the reporting unit exceeded the carrying value of the reporting unit. The Company determined that no triggering event occurred in the third quarter. Although the Company believes the projected future operating results and cash flows and related estimates regarding the values were based on reasonable assumptions, it is reasonably possible that estimates made may be materially and adversely impacted in the near term as a result of the COVID-19 pandemic, including impairment losses related to goodwill. Note 7 - Intangible Assets The gross carrying amount and accumulated amortization by intangible asset class were as follows: (Dollars in thousands) September 30, 2020 December 31, 2019 Gross Carrying Amount Accumulated Amortization Net Carrying Value Gross Carrying Amount Accumulated Amortization Net Carrying Value Trade names $ 11,022 $ ( 2,436 ) $ 8,586 $ 8,422 $ ( 2,020 ) $ 6,402 Customer relationships 12,181 ( 2,040 ) 10,141 7,337 ( 1,404 ) 5,933 $ 23,203 $ ( 4,476 ) $ 18,727 $ 15,759 $ ( 3,424 ) $ 12,335 Amortization expense of $ 1.1 million and $ 1.0 million related to intangible assets was recorded in General and administrative expenses for the nine months ended September 30, 2020 and 2019, respectively. As of September 30, 2020, there were no events or circumstances that indicate the carrying value may not be recoverable and thus no recoverability test was required. Note 8 - Leases The Company leases property used for distribution centers, office space, and Bolt branch locations throughout the US and Canada, along with various equipment located in distribution centers and corporate headquarters. The Company is also a lessor of its Decatur, Alabama property previously used in conjunction with a discontinued operation. The expenses and income generated by the leasing activity of Lawson as lessee for the three months ended September 30, 2020 and September 30, 2019 are as follows (Dollars in thousands): Lease Type Classification Three Months Ended September 30, 2020 Three Months Ended September 30, 2019 Consolidated Operating Lease Expense (1) Operating expenses $ 1,262 $ 1,190 Consolidated Financing Lease Amortization Operating expenses 63 $ 60 Consolidated Financing Lease Interest Interest expense 8 10 Consolidated Financing Lease Expense 71 70 Sublease Income (2) Operating expenses — — Net Lease Cost $ 1,333 $ 1,260 (1) Includes short term lease expense, which is immaterial (2) Sublease income from sublease of a portion of the Company headquarters. The sublease was terminated in June 2019 and the Company has no other subleases. The expenses and income generated by the leasing activity of Lawson as lessee for the nine months ended September 30, 2020 and September 30, 2019 are as follows (Dollars in thousands): 13 Table of Contents Lease Type Classification Nine Months Ended September 30, 2020 Nine Months Ended September 30, 2019 Consolidated Operating Lease Expense (1) Operating expenses $ 3,630 $ 3,532 Consolidated Financing Lease Amortization Operating expenses 165 159 Consolidated Financing Lease Interest Interest expense 22 23 Consolidated Financing Lease Expense 187 182 Sublease Income (2) Operating expenses — ( 160 ) Net Lease Cost $ 3,817 $ 3,554 (1) Includes short term lease expense, which is immaterial (2) Sublease income from sublease of a portion of the Company headquarters. The sublease was terminated in June 2019 and the Company has no other subleases. The value of the net assets and liabilities generated by the leasing activity of Lawson as lessee as of September 30, 2020 and December 31, 2019 are as follows (Dollars in thousands): Lease Type September 30, 2020 December 31, 2019 Total Right Of Use ("ROU") operating lease assets (1) $ 8,938 $ 10,592 Total ROU financing lease assets (2) 575 654 Total lease assets $ 9,513 $ 11,246 Total current operating lease obligation $ 4,276 $ 3,591 Total current financing lease obligation 233 239 Total current lease obligations $ 4,509 $ 3,830 Total long term operating lease obligation $ 6,414 $ 9,133 Total long term financing lease obligation 279 371 Total long term lease obligation $ 6,693 $ 9,504 (1) Operating lease assets are recorded net of accumulated amortization of $ 5.1 million and $ 2.4 million as of September 30, 2020 and December 31, 2019, respectively (2) Financing lease assets are recorded net of accumulated amortization of $ 0.4 million and $ 0.2 million as of September 30, 2020 and December 31, 2019, respectively The value of the lease liabilities generated by the leasing activities of Lawson as lessee as of September 30, 2020 were as follows (Dollars in thousands): Maturity Date of Lease Liabilities Operating Leases Financing Leases Total Year one $ 4,599 $ 254 $ 4,853 Year two 3,780 153 3,933 Year three 1,733 101 1,834 Year four 720 35 755 Year five 175 2 177 Subsequent years 471 — 471 Total lease payments 11,478 545 12,023 Less: Interest 788 33 821 Present value of lease liabilities $ 10,690 $ 512 $ 11,202 (1) Minimum lease payments exclude payments to landlord for real estate taxes and common area maintenance $ 0.7 million 14 Table of Contents The weighted average lease terms and interest rates of the leases held by Lawson as of September 30, 2020 are as follows: Lease Type Weighted Average Term in Years Weighted Average Interest Rate Operating Leases 3.1 5.08 % Financing Leases 2.7 5.37 % The cash outflows of the leasing activity of Lawson as lessee for the nine months ending September 30, 2020 are as follows (Dollars in thousands): Cash Flow Source Classification Amount Operating cash flows from operating leases Operating activities $ 3,072 Operating cash flows from financing leases Operating activities 22 Financing cash flows from financing leases Financing activities 192 Note 9 — Credit Agreement In the fourth quarter of 2019, the Company entered into a five-year credit agreement led by J.P. Morgan Chase Bank N.A, as administrative agent and including CIBC Bank USA and Bank of America, N.A. as other lenders. The credit agreement matures on October 11, 2024 and provides for $ 100.0 million of revolving commitments. The credit agreement allows borrowing capacity to increase to $ 150.0 million subject to meeting certain criteria and additional commitments from its lenders. The Credit Agreement consists of borrowings as alternate base rate loans, Canadian prime rate loans, Eurodollar loans, and Canadian dollar offered rate loans as the Company requests. The applicable interest rate spread is determined by the type of borrowing used and the Total Net Leverage Ratio as of the most recent fiscal quarter as defined in the Credit Agreement. The covenants associated with the Credit Agreement restrict the ability of the Company to, among other things: incur additional indebtedness and liens, make certain investments, merge or consolidate, engage in certain transactions such as the disposition of assets and sales-leaseback transactions, and make certain restricted cash payments such as dividends in excess of defined amounts contained within the Credit Agreement. In addition to these items and other customary terms and conditions, the Credit Agreement requires the Company to comply with certain financial covenants as follows: a) The Company is required to maintain an EBITDA to Fixed Charge Coverage Ratio of at least 1.15 to 1.00 for any period of four consecutive fiscal quarters ending on the last day of any fiscal quarter; and b) The Company is required to maintain a Total Net Leverage Ratio of no more than 3.25 to 1.00 on the last day of any fiscal quarter. The maximum Total Net Leverage Ratio will be allowed to increase to 3.75 to 1.00 after certain permitted acquisitions. The Credit Agreement also includes events of default for, among others, non-payment of obligations under the Credit Agreement, change of control, cross default to other indebtedness in an aggregate amount in excess of $5.0 million, failure to comply with covenants, and insolvency. In addition to other customary representations, warranties and covenants, the results of the financial covenants are provided below: Quarterly Financial Covenants Requirement Actual EBITDA to fixed charges ratio 1.15 : 1.00 4.73 : 1.00 Total net leverage ratio 3.25 : 1.00 0.71 : 1.00 The Company was in compliance with all covenants as of September 30, 2020. During the third quarter of 2020 the Company entered into an amendment to the Credit Agreement which among other items increased the letter of credit basket from $ 15.0 million to $ 40.0 million until August 31, 2021 and authorized the Company to incur indebtedness in an amount up to $ 36.0 million for the acquisition of Partsmaster. 15 Table of Contents The Company had no outstanding borrowings under its Credit Agreement and $ 66.0 million of availability under its revolving line of credit facility. The weighted average interest rate was 2.64 % and 4.54 % for the nine months ended September 30, 2020 and 2019, respectively. Note 10 - Accrued Acquisition Liability On August 31, 2020, Lawson acquired Partsmaster from NCH Corporation. As part of the purchase price the Company agreed to pay $ 33.0 million in May 2021. The payment obligation has been discounted to present value using an implied interest rate of 1.8% and is recognized as a current liability of $ 32.5 million in the Company's condensed consolidated balance sheet. P ayment has been guaranteed under the Purchase Agreement which includes the issuance of a $ 33.0 million irrevocable standby letter of credit. The accrued acquisition liability is included as outstanding debt in the quarterly financial covenant calculations. Note 11 - Stock Repurchase Program In the second quarter of 2019, the Board of Directors authorized a program in which the Company may repurchase up to $ 7.5 million of the Company's common stock from time to time in open market transactions, privately negotiated transactions or by other methods. In the first quarter of 2020 the Company purchased 47,504 shares of common stock at an average purchase price of $ 36.93 under the repurchase program. No shares were repurchased in the second or third quarters of 2020 under the Company stock repurchase plan. Note 12 — Severance Reserve Changes in the Company’s reserve for severance as of September 30, 2020 and 2019 were as follows: (Dollars in thousands) Nine Months Ended September 30, 2020 2019 Balance at beginning of period $ 909 $ 359 Charged to earnings 1,520 1,542 Payments ( 1,239 ) ( 925 ) Balance at end of period $ 1,190 $ 976 Note 13 — Stock-Based Compensation The Company recorded stock-based compensation inc ome of $ 2.8 million and expense of $ 7.6 million for the first nine months of 2020 and 2019, respectively. A portion of stock-based compensation is related to the change in the market value of the Company's common stock. Stock-based compensation lia bility of $ 10.4 million as of September 30, 2020 and $ 14.9 million as of December 31, 2019 is included in Accrued expenses and other liabilities. A summary of stock-based awards issued during the nine months ended September 30, 2020 follows: Restricted Stock Units ("RSUs") The Company i ssued 6,847 RSUs to key employees that cliff vest on December 31, 2022. The Company issued 2,500 RSUs to an executive that cliff vest on March 2, 2023 and 3,000 RSUs that cliff vest on March 9, 2023. The Company issued 10,965 RSUs to certain members of the Company's Board of Directors with a vesting date of May 12, 2021. Each RSU is exchangeable for one share of the Company's common stock at the end of the vesting period. Market Stock Units ("MSUs") The Company issued 22,284 MSUs to key employees that cliff vest on December 31, 2022. MSUs are exchangeable for the Company's common stock at the end of the vesting period. The number of shares of common stock that will be issued upon vesting, ranging from zero to 33,426 , will be determined based upon the trailing sixty-day average closing price of the Company's common stock on December 31, 2022. Performance Awards ("PAs") 16 Table of Contents The Company issued 10,852 PAs to key employees that cliff vest on December 31, 2022. PAs are exchangeable for the Company's common stock ranging from zero to 16,278 , or the equivalent amount in cash, based upon the achievement of certain financial performance metrics. No stock options were excluded from the computation of diluted earnings per share for the three months ended September 30, 2020 or the nine months ended September 30, 2019. Note 14 — Income Taxes The Company recorded income tax expense of $ 6.0 million, a 28.7 % effective tax rate for the nine months ended September 30, 2020. The effective tax rate is higher than the U.S. statutory tax rate due primarily to state taxes, recording of reserves for uncertain tax positions, and an inclusion for Global Intangible Low Taxed Income. Income tax expense of $ 3.7 million, a 26.6 % effective tax rate was recorded for the nine months ended September 30, 2019. This effective tax rate was higher than the U.S. statutory rate due primarily to state taxes, income in higher tax jurisdictions and an inclusion for Global Intangible Low Tax Income. 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 September 30, 2020, the Company is subject to U.S. Federal income tax examinations for the years 2017 through 2019 and income tax examinations from various other jurisdictions for the years 2013 through 2019. 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 may subject the Company to foreign withholding taxes and U.S. federal and state taxes. Note 15 — Contingent Liabilities In 2012, the Company identified that a site it owns in Decatur, Alabama, contains hazardous substances in the soil and groundwater as a result of historical operations prior to the Company's ownership. The Company retained an environmental consulting firm to further investigate the contamination including the measurement and monitoring of the site and the site was enrolled in the Alabama Department of Environmental Management (“ADEM") voluntary cleanup program. The remediation plan was approved by ADEM in 2018. The plan consists of chemical injections throughout the affected area, as well as subsequent monitoring of the area for three consecutive periods. The injection process was completed in the first quarter of 2019 and the environmental consulting firm is monitoring the affected area. The Company utilized its remaining liability balance in the third quarter of 2020. there may be some additional nominal filing fees that are charged to the Company by the environmental consulting firm and ADEM, however these amounts are expected to be immaterial and will be expensed as incurred. The Company does not expect to capitalize any amounts related to the remediation plan. Note 16 — Related Party Transaction During the three and nine months ended September 30, 2020 the Company purchased approximately $ 0.7 million and $ 0.9 million, respectively, of inventory from a company owned by an immediate relative of a Board member at fair market value. The Company paid substantially all of the amount owed in the third quarter and therefore immaterial remaining liabilities exist as of September 30, 2020. 17 Table of Contents Note 17 – Segment Information The Company operates in two reportable segments. The businesses have been determined to be separate reportable segments because of differences in their financial characteristics and the methods they employ to deliver product to customers. The operating segments are reviewed by the Company’s chief operating decision maker responsible for reviewing operating performance and allocating resources. The Lawson segment primarily relies on its large network of sales representatives to visit the customer at the customers' work location and provide VMI service and produce sales orders for product that is then shipped to the customer. Given the nature of the acquired Partsmaster business, it is included in the Lawson segment for reporting purposes. The Bolt Supply segment primarily sells product to customers through its branch locations. Bolt Supply had 14 branches in operation at the end of the third quarter of 2020. Financial information for the Company's reportable segments follows: Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 Revenue Lawson $ 79,806 $ 83,461 $ 224,511 $ 250,895 Bolt Supply 10,471 11,318 28,947 31,324 Consolidated total $ 90,277 $ 94,779 $ 253,458 $ 282,219 Gross profit Lawson $ 43,038 $ 46,148 $ 123,031 $ 138,524 Bolt Supply 4,187 4,426 11,428 12,016 Consolidated total $ 47,225 $ 50,574 $ 134,459 $ 150,540 Operating income Lawson $ 1,112 $ 5,377 $ 19,003 $ 11,490 Bolt Supply 889 1,069 2,205 2,123 Consolidated total 2,001 6,446 21,208 13,613 Interest expense ( 142 ) ( 138 ) ( 329 ) ( 481 ) Other income (expense), net 615 ( 13 ) 15 798 Income before income taxes $ 2,474 $ 6,295 $ 20,894 $ 13,930 Note 18 - COVID-19 Risks and Uncertainties There is substantial uncertainty as to the overall effect the COVID-19 pandemic will have on the results of the Company for 2020 and beyond. Various events related to COVID-19 have resulted in lost revenue to our Company, limitations on our ability to source high demand products, limitations on our sales force to perform certain functions due to state or federal stay-at-home orders, slow-down of customer demand for our products and limitations of some customers to pay us on a timely basis. On March 27, 2020, Congress enacted the Coronavirus Aid, Relief, and Economic Security ("CARES") Act to provide certain relief as a result of the COVID-19 outbreak. The Company has elected to defer the employer side social security payments in accordance with the CARES Act. The Company will continue to evaluate how the provisions of the CARES Act will impact its financial position, results of operations and cash flows. The Company has utilized the Canadian Emergency Wage Subsidy ("CEWS") Act for both Lawson Canada and Bolt for assistance with hourly employee costs. The CEWS is a program that provides a subsidy of certain eligible wages commencing March 15, 2020 through December 31, 2020 subject to meeting certain criteria. During the second quarter of 2020 the Company recorded $ 0.9 million in subsidies from the CEWS program which is recognized as a reduction to selling, general and administrative expenses in the consolidated statement of income and comprehensive income. No subsidies were recognized in the three months ended September 30, 2020. In the first quarter of 2020, the government of the state of Illinois defined essential businesses, allowing Lawson to operate during the pandemic. A change in this status could result in the temporary closure of our business. Additionally the COVID-19 pandemic could result in a temporary closure of any or all of our distribution facilities or the Bolt branch locations, which would negatively impact our operations. Other disruptions to our supply chain such as reduced capacity or temporary 18 shutdowns of freight carriers could also negatively impact Company performance. The pandemic is negatively impacting sales and operations currently and may negatively impact future financial results, liquidity and overall performance of the Company. Additionally, it is reasonably possible that estimates made in the financial statements may be materially and adversely impacted in the near term as a result of these conditions, including delay in payment of receivables, impairment losses related to goodwill and other long-lived assets, and inability to utilize deferred tax assets. The Lawson MRO business model relies upon customer interaction as well as a consistent schedule of onsite visits by our sales representatives to customer locations. The Bolt business model relies on foot traffic in its branch locations. The onset of the COVID-19 pandemic, as well as social distancing guidelines and government mandated shelter in place orders, have negatively impacted the ability of our sales reps to visit our customers and for foot traffic to return to our Bolt branch locations, resulting in an overall negative impact on our business. The second quarter 2020 financial performance of the Company was substantially negatively impacted as state and local governments throughout the United States and Canada imposed strict COVID-19 related restrictions, including shutdowns of nonessential businesses and stay-at-home orders, particularly in April. These restrictions were relaxed in May and June, and were further relaxed throughout the third quarter. The economic climate in the third quarter improved as non-essential businesses reopened in both limited capacity and full capacity. The relaxed restrictions resulted in increased customer contact and more consistent customer visits for Lawson MRO sales representatives, as well as increased customer visits to Bolt branch locations. The improved economic climate and increased activity of the Lawson MRO and Bolt segments led to a sequential improvement in financial results in the third quarter 2020 compared to the second quarter 2020. The Company has taken several steps to mitigate the potential negative impacts of COVID-19. The actions taken included, but are not limited to, furloughing employees, reducing base salaries for a period of time, canceling travel and award trips, temporarily consolidating its Suwanee distribution center operations into the McCook facility, eliminating non-critical capital expenditures and eliminating various positions throughout the Company. In the third quarter the Company brought back approximately 70% of the previously furloughed employees. The Company reopened the Suwanee distribution center in a reduced capacity in the third quarter as overall business activity increased. The Company continues to monitor its balance sheet and liquidity position and is taking actions to protect cash flows from operations, while at the same time managing its operating expenses in relation to current sales trends. At September 30, 2020, the Company had $ 17.2 million of unrestricted cash and cash equivalents and an additional $ 66.0 million of borrowing capacity, net of outstanding letters of credit, under its committed credit facility. The Company recorded a liability of $ 32.5 million in relation to the acquisition of Partsmaster. The Company will continue to closely monitor the operating environment and will take appropriate actions to protect the safety for its employees, customers and suppliers while continuing to meet its working capital needs and remain in compliance with its debt covenants. 19