UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-Q
 
(Mark One)
ý☒Quarterly Report under Section 13 OR 15(d) of the Securities Exchange Act of 1934
For quarterly period ended September 30, 20172020
or
¨☐Transition Report under Section 13 OR 15(d) of the Securities Exchange Act of 1934
For the transition period from              to             


Commission file Number: 0-10546
LAWSON PRODUCTS, INC.
(Exact name of registrant as specified in its charter)

Delaware36-2229304
(State or other jurisdiction of

incorporation or organization)
(I.R.S. Employer

Identification No.)
8770 W. Bryn Mawr Avenue, Suite 900, Chicago, IllinoisChicago,Illinois60631
(Address of principal executive offices)(Zip Code)
(773) 304-5050
(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:
Title of each classTrading SymbolName of each exchange on which registered
Common stock, $1.00 par valueLAWSNASDAQ Global Select Market
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  ý    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  ý    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer¨Accelerated filerý☒
Non-accelerated filer
¨ (Do not check if a smaller reporting company)
Smaller reporting company¨☒
Emerging growth company
¨

☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) 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  ý
The number of shares outstanding of the registrant’s common stock, $1 par value, as of October 20, 201715, 2020 was 8,888,028.9,030,327.

1

TABLE OF CONTENTS
 
Page #
PART I - FINANCIAL INFORMATION
Page #
PART I - FINANCIAL INFORMATION4
Item 1.
4
Condensed Consolidated Balance Sheets as of September 30, 2017 30, 2020 (Unaudited) and December 31, 20162019
4
5
6
68
79
1320
1828
1828
PART II - OTHER INFORMATION
28
29
1930
SIGNATURES
2031


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Table of Contents

“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:


•the effect of the COVID-19 virus on the overall economy, demand for our products, our supply chain, our employees and our operating results;
•the effect of general economic and market conditions;
•the ability to generate sufficient cash to fund our operating requirements;
•the ability to meet the covenant requirements of our line of credit;
•the market price of our common stock may decline;
•inventory obsolescence;
•work stoppages and other disruptions at transportation centers or shipping ports;
•changing customer demand and product mixes;
•increases in energy costs, tariffs and the cost of raw materials, including commodity prices;
•decreases in demand from oil and gas customers due to lower oil prices;
•disruptions of our information and communication systems;
•cyber attacks or other information security breaches;
•failure to recruit, integrate and retain a talented workforce including productive sales representatives;
•the inability to successfully make or integrate acquisitions into the organization;
•foreign currency fluctuations
•failure to manage change within the organization;
•highly competitive market;
•changes that affect governmental and other tax-supported entities;
•violations of environmental protection or other governmental regulations;
•negative changes related to tax matters;
•Luther King Capital's significant influence over the Company given its ownership percentage; and
•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, 2016.2019 and in this Quarterly Report on Form 10-Q for the period ended September 30, 2020.


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 share data)

September 30, 2017
December 31, 2016September 30,December 31,
   20202019
ASSETS(Unaudited)

ASSETS(Unaudited)
Current assets:


Current assets:
Cash and cash equivalents$19,043

$10,421
Cash and cash equivalents$17,193 $5,495 
Restricted cash800

800
Restricted cash802 802 
Accounts receivable, less allowance for doubtful accounts of $460 and $454, respectively37,290

30,200
Accounts receivable, less allowance for doubtful accounts of $680 and $593, respectivelyAccounts receivable, less allowance for doubtful accounts of $680 and $593, respectively47,902 38,843 
Inventories, net43,341

42,561
Inventories, net62,218 55,905 
Miscellaneous receivables and prepaid expenses3,755

3,788
Miscellaneous receivables and prepaid expenses5,943 5,377 
Total current assets104,229

87,770
Total current assets134,058 106,422 
   
Property, plant and equipment, net26,844

30,907
Property, plant and equipment, net16,596 16,546 
Cash value of life insurance11,623

10,051
Goodwill5,789
 5,520
Goodwill36,428 20,923 
Deferred income taxes20

20
Deferred income taxes20,289 21,711 
Intangible assets, netIntangible assets, net18,727 12,335 
Cash value of life insuranceCash value of life insurance15,400 14,969 
Right of use assetsRight of use assets9,513 11,246 
Other assets905

1,039
Other assets258 277 
Total assets$149,410

$135,307
Total assets$251,269 $204,429 




LIABILITIES AND STOCKHOLDERS’ EQUITY


LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:


Current liabilities:
Revolving line of credit$—
 $841
Accrued acquisition liabilityAccrued acquisition liability$32,476 $0 
Accounts payable12,207

11,307
Accounts payable22,466 13,789 
Lease obligationLease obligation4,509 3,830 
Accrued expenses and other liabilities30,831

27,289
Accrued expenses and other liabilities30,808 39,311 
Total current liabilities43,038

39,437
Total current liabilities90,259 56,930 
   
Revolving line of creditRevolving line of credit0 2,271 
Security bonus plan13,347

14,216
Security bonus plan11,540 11,840 
Financing lease obligation6,710
 7,543
Deferred compensation5,108

4,830
Deferred compensation9,847 6,370 
Deferred rent liability3,473

3,676
Lease obligationLease obligation6,693 9,504 
Deferred tax liabilityDeferred tax liability6,154 6,188 
Other liabilities5,071

4,472
Other liabilities5,522 3,325 
Total liabilities76,747

74,174
Total liabilities130,015 96,428 
   
Stockholders’ equity:


Stockholders’ equity:
Preferred stock, $1 par value:


Preferred stock, $1 par value:
Authorized - 500,000 shares, Issued and outstanding — None—

—
Authorized - 500,000 shares, Issued and outstanding — NaNAuthorized - 500,000 shares, Issued and outstanding — NaN0 0 
Common stock, $1 par value:


Common stock, $1 par value:
Authorized - 35,000,000 shares
Issued - 8,921,302 and 8,864,929 shares, respectively
Outstanding - 8,888,028 and 8,832,623 shares, respectively		8,921

8,865
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
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 value12,335

11,055
Capital in excess of par value19,508 18,077 
Retained earnings51,216

41,943
Retained earnings101,386 86,496 
Treasury stock – 33,274 and 32,306 shares, respectively(711)
(691)
Accumulated other comprehensive income (loss)902

(39)
Treasury stock – 205,981 and 146,400 shares, respectivelyTreasury stock – 205,981 and 146,400 shares, respectively(7,953)(5,761)
Accumulated other comprehensive lossAccumulated other comprehensive loss(919)(1)
Total stockholders’ equity72,663

61,133
Total stockholders’ equity121,254 108,001 
Total liabilities and stockholders’ equity$149,410

$135,307
Total liabilities and stockholders’ equity$251,269 $204,429 
See notes to condensed consolidated financial statements.

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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,
 2020201920202019
Total revenue$90,277 $94,779 $253,458 $282,219 
Cost of goods sold43,052 44,205 118,999 131,679 
Gross profit47,225 50,574 134,459 150,540 
Operating expenses:
Selling expenses19,155 21,255 55,445 64,864 
General and administrative expenses26,069 22,873 57,806 72,063 
Operating expenses45,224 44,128 113,251 136,927 
Operating income2,001 6,446 21,208 13,613 
Interest expense(142)(138)(329)(481)
Other income (expense), net615 (13)15 798 
Income before income taxes2,474 6,295 20,894 13,930 
Income tax expense736 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 outstanding9,017 8,974 9,017 8,971 
Effect of dilutive securities outstanding313 415 312 399 
Diluted weighted average shares outstanding9,330 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 translation398 (427)(918)965 
Net comprehensive income$2,136 $4,347 $13,972 $11,192 

Three months ended September 30, Nine Months Ended September 30,
 2017 2016 2017 2016
        
Net sales$75,651
 $70,199
 $225,274
 $209,258
Cost of goods sold29,646
 27,626
 89,249
 81,700
Gross profit46,005
 42,573
 136,025
 127,558

       
Operating expenses:       
Selling expenses24,354
 23,568
 72,964
 69,525
General and administrative expenses20,561
 16,616
 58,790
 54,446
Total SG&A44,915
 40,184
 131,754
 123,971
Gain on sale of property—
 —
 (5,422) —
Operating expenses44,915
 40,184
 126,332
 123,971
        
Operating income1,090
 2,389
 9,693
 3,587

       
Interest expense(133) (167) (393) (486)
Other income, net843
 66
 953
 439

       
Income before income taxes1,800
 2,288
 10,253
 3,540
Income tax expense479
 463
 802
 526

       
Net income$1,321
 $1,825
 $9,451
 $3,014

       
Basic income per share of common stock$0.15
 $0.21
 $1.07
 $0.34

       
Diluted income per share of common stock$0.14
 $0.20
 $1.04
 $0.34
        
Weighted average shares outstanding:       
Basic weighted average shares outstanding8,880
 8,785
 8,856
 8,778
Effect of dilutive securities outstanding253
 141
 256
 139
Diluted weighted average shares outstanding9,133
 8,926
 9,112
 8,917
        
Comprehensive income:       
Net income$1,321
 $1,825
 $9,451
 $3,014
Other comprehensive income (loss), net of tax       
Adjustment for foreign currency translation139
 (271) 941
 764
Net comprehensive income$1,460
 $1,554
 $10,392
 $3,778

















See notes to condensed consolidated financial statements.

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Lawson Products, Inc.
Condensed Consolidated Statements of Changes in Stockholders’ Equity
(Dollars in thousands)
(Unaudited)

Common StockCapital in Excess of Par ValueAccumulated Other Comprehensive Income (Loss)Total Stockholders' Equity
Outstanding Shares$1 Par ValueRetained EarningsTreasury Stock
Balance at January 1, 20209,043,771 $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, 20208,996,267 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 issued11,144 11 3 — — — 14 
Balance at June 30, 20209,007,411 $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 issued30,283 31 (31)— — — 0 
Balance at September 30, 20209,025,617 $9,232 $19,508 $101,386 $(7,953)$(919)$121,254 


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Lawson Products, Inc.
Condensed Consolidated Statements of Changes in Stockholders’ Equity
(Dollars in thousands)
(Unaudited)
Common StockCapital in Excess of Par ValueAccumulated Other Comprehensive Income (Loss)Total Stockholders' Equity
Outstanding Shares$1 Par ValueRetained EarningsTreasury Stock
Balance at January 1, 20198,955,930 $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 issued6,520 6 (6)— — — 0 
Balance at March 31, 20198,962,450 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 issued20,712 21 (21)— — — 0 
Balance at June 30, 20198,983,162 $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 issued9,649 10 (10)— — — 0 
Balance at September 30, 20198,956,981 $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.
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Lawson Products, Inc.
Condensed Consolidated Statements of Cash Flows
(Dollars in thousands)
(Unaudited)


  Nine Months Ended September 30,
  2017 2016
     
Operating activities:    
Net income $9,451
 $3,014
     
Adjustments to reconcile net income to net cash provided by operating activities:    
Depreciation and amortization 4,940
 6,386
Stock-based compensation 2,722
 (1,332)
Gain on sale of property (5,422) —
Changes in operating assets and liabilities, net of acquisitions:    
Accounts receivable (7,046) (4,547)
Inventories (373) 3,209
Prepaid expenses and other assets (1,562) (388)
Accounts payable and other liabilities 738
 (1,345)
Other 307
 318
Net cash provided by operating activities $3,755
 $5,315
     
Investing activities:    
Purchases of property, plant and equipment $(1,228) $(2,572)
Proceeds from sale of property 6,177
 —
Business acquisitions —
 (2,576)
Net cash provided by (used in) investing activities $4,949
 $(5,148)
     
Financing activities:    
Net payments on revolving line of credit $(841) $(925)
Repurchase treasury shares (20) (18)
Net cash used in financing activities $(861) $(943)
     
Effect of exchange rate changes on cash and cash equivalents 779
 668
     
Increase (decrease) in cash and cash equivalents 8,622
 (108)
     
Cash and cash equivalents at beginning of period 10,421
 10,765
     
Cash and cash equivalents at end of period $19,043
 $10,657








 Nine Months Ended September 30,
 20202019
Operating activities:
Net income$14,890 $10,227 
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization4,660 4,401 
Stock-based compensation(2,767)7,621 
Deferred income taxes1,454 3,252 
Changes in operating assets and liabilities, net of acquisition
Accounts receivable(2,128)(7,785)
Inventories1,101 (1,593)
Prepaid expenses and other assets(725)(2,433)
Accounts payable and other liabilities3,097 (6,193)
Other441 544 
Net cash provided by operating activities$20,023 $8,041 
Investing activities:
Purchases of property, plant and equipment$(1,311)$(1,392)
Cash paid for acquisition(2,300)0 
Net cash used in investing activities$(3,611)$(1,392)
Financing activities:
Net payments on revolving line of credit$(2,271)$(8,628)
Repurchase treasury shares(2,192)(1,361)
Payment of financing lease principal(192)(192)
Proceeds from stock option exercises15 16 
Net cash used in financing activities$(4,640)$(10,165)
Effect of exchange rate changes on cash and cash equivalents$(74)$259 
Increase (decrease) in cash, cash equivalents and restricted cash11,698 (3,257)
Cash, cash equivalents and restricted cash at beginning of period6,297 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 cash802 800 
Cash, cash equivalents and restricted cash$17,995 $9,426 
Supplemental disclosure of cash flow information
Net cash paid for income taxes3,733 458 
Net cash paid for interest295 499 
See notes to condensed consolidated financial statements.

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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, 2016.2019. 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, 20172020 are not necessarily indicative of the results that may be expected for the year ending December 31, 2017.2020.


The Company operates in one reportablehas 2 operating segments. The first segment, as a Maintenance, Repair and Operations ("MRO") distributor of products and services to the industrial, commercial, institutional, and governmentalLawson operating segment, distributes maintenance, repair and operations marketplace.

For("MRO") products to customers primarily through a network of sales representatives offering vendor managed inventory ("VMI") service to customers throughout the three months ended September 30, 2017United States and 2016, stock options to purchase 80,000 and 40,000, respectively,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 Company's common stock were excluded from the computation of diluted earnings per share because they were anti-dilutive. For the nine months ended September 30, 2017 and 2016 stock options to purchase 66,667 and 40,000, respectively, of the Company's common stock were excluded from the computation of diluted earnings per share because they were anti-dilutive.third quarter 2020.


ASU 2016-09, Improvements to Employee Share-Based Payment Accounting

Effective January 1, 2017, the Company adopted Accounting Standards Update 2016-09, “Compensation-Stock Compensation (Topic 718)” (“ASU 2016-09”). Prior to January 1, 2017, the Company recognized excess tax benefits or deficiencies of stock-based compensation expense, to the extent that there were sufficient recognized excess tax benefits previously recognized, as a component of additional paid-in capital. ASU 2016-09 requires the Company to account for excess tax benefits and tax deficiencies as discrete items in the reporting period in which they occur. The adoption was applied on a modified retrospective basis. All deferred tax assets related to stock-based compensation are fully reserved and, therefore, there is no net effect on the Company's balance sheet for the first nine months of 2017.

As a result of including the income tax effects from excess tax benefits in income tax expense, the effects of the excess tax benefits are no longer included in the calculation of diluted shares outstanding, resulting in an increase in the number of diluted shares outstanding. The Company adopted this change in the method of calculating diluted shares outstanding on a prospective basis.

ASU 2016-09 also permits entities to make an accounting policy election related to how forfeitures will impact the recognition of compensation cost for stock-based compensation to either estimate the total number of awards for which the requisite service period will not be rendered, as currently required, or to account for forfeitures as they occur. Upon adoption of ASU 2016-09, the Company elected to change its accounting policy to account for forfeitures as they occur. The change was applied on a modified retrospective basis with a cumulative effect adjustment to reduce retained earnings by $178 thousand, as of January 1, 2017.

Additionally, ASU 2016-09 addressed the presentation of employee taxes paid on the statement of cash flows. The Company is now required to present the cost of shares withheld from the employee to satisfy the employees’ income tax liability as a financing activity on the statement of cash flows rather than as an operating cash flow. The Company adopted this change retrospectively. The Company withheld shares with a value of $20 thousand and $18 thousand to satisfy employee taxes in the first nine months of 2017 and 2016, respectively.

ASU No. 2014-09, Revenue from Contracts with Customers

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (ASU 2014-09), which supersedes nearly all existing revenue recognition guidance under U.S. GAAP. The core principle of ASU 2014-09 is to recognize revenues when promised goods or services are transferred to customers in an amount that reflects the consideration to which an entity expects to be entitled for those goods or services. ASU 2014-09 defines a five step process to achieve this core principle and, in doing so, more judgment and estimates may be required within the revenue recognition process than are required under existing U.S. GAAP. The new standard is effective for the Company's interim and annual periods beginning with the first quarter of 2018. The standard is to be applied using one of two retrospective application methods.



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The Company has established a team to address the effect of the new accounting standard. The team has been reviewing the terms and conditions included in its contracts with customers and has developed a methodology to calculate the impact of the pronouncement on its consolidated financial statements. The Company has not yet determined the impact of adopting the standard. The Company expects to adopt ASU 2014-09 January 1, 2018 using the modified retrospective method. Under this method, a cumulative effect adjustment is recorded based on applying the guidance to the customer contracts that were not completed at the date of initial application. As a result, prior periods are not adjusted to reflect application of the new guidance.

Except for the changes described above, there have been no other material changes in the Company's significant accounting policies during the nine months ended September 30, 2017 as compared to the significant accounting policies described in our Annual Report on Form 10-K for the year ended December 31, 2016.

Note 2 — Restricted Cash- Acquisition


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 3 — Inventories, net

Inventories, net, consisting primarily of purchased goods which are offered for resale, were as follows:
 (Dollars in thousands)
 September 30, 2017 December 31, 2016
Inventories, gross$48,740
 $48,038
Reserve for obsolete and excess inventory(5,399) (5,477)
Inventories, net$43,341
 $42,561

Note 4 - Sale of property

In the second quarter of 2017,On August 31, 2020, the Company completed the sale of its distribution center located in Fairfield, New Jersey,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 utilize excess capacity within it's supply chain network. The Company received net cash proceeds of $6.2 million and recorded a gain onexpand the transaction of $5.4 million.

Note 5 — Acquisitions and Goodwill

Primarily to expand itsCompany's sales coverage, obtainexpand product lines, add experienced sales representatives, and improve its presence in Canada,leverage the Company completed three acquisitions in 2016. In March 2016, the Company acquired the assets of Perfect Products Company of Michigan ("Perfect Products"), an auto parts distributor for approximately $1.3Company's infrastructure.

The purchase price was $35.3 million in cash and $30 thousandthe assumption of certain liabilities. The Company paid $2.3 million of the purchase price in contingent consideration. Incash at closing and will pay the remaining $33.0 million in May 2016,2021. 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. Payment 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 acquiredfinalizes the valuations of the assets acquired and liabilities assumed.

Partsmaster contributed $5.4 million of F.B. Feeney Hardware ("F. B. Feeney")revenue and $0.4 million of operating income in Ontario, Canada, for approximately $1.3 millionthe third quarter 2020 post-acquisition.

A summary of the initial purchase price allocation of the acquisition is as follows (Dollars in cash and $0.1 million in contingent consideration. And, in November 2016, the Company acquired the assets of Mattic Industries Limited ("Mattic"), an industrial parts distributor located in western Canada, for approximately $3.5 million in cash and $0.3 million in contingent consideration.thousands):


Cash paid and payable and liabilities assumed
Cash paid and payable$34,711 
Accounts payable and accrued expenses4,076 
Deferred compensation2,938 
$41,725 
Fair value of assets acquired
Goodwill$15,952 
Inventories7,809 
Accounts receivable7,656 
Customer relationships4,961 
Trade names2,775 
Property, plant and equipment2,201 
Other assets371 
$41,725 

The following table contains unaudited pro forma net salesrevenue and net income for Lawson Products assuming the Perfect Products, F.B Feeney and Mattic acquisitionsPartsmaster acquisition closed on January 1, 2015.2019.

10
 (Dollars in thousands)
 Three Months Ended September 30, Nine Months Ended September 30,
 2017 2016 2017 2016
Net sales       
     Actual$75,651
 $70,199
 $225,274
 $209,258
     Pro forma75,651
 70,978
 225,274
 212,738
        
Net income       
     Actual$1,321
 $1,825
 $9,451
 $3,014
     Pro forma1,321
 2,048
 9,451
 3,662


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(Dollars in thousands)
Three Months Ended September 30,Nine Months Ended September 30,
2020201920202019
Revenue
   Actual$90,277 $94,779 $253,458 $282,219 
   Pro forma101,222 109,174 298,546 332,234 
Net income
   Actual$1,738 $4,774 $14,890 $10,227 
   Pro forma1,982 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 that are more representative of the combined results of the transactions as if the Mattic, F.B Feeney and Perfect Product acquisitionsacquisition of Partsmaster had closed on January 1, 20152019 rather than on the actual acquisition dates.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 condensed 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.



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Disaggregated revenue by geographic area follows:
Three Months Ended September 30,Nine Months Ended September 30,
(Dollars in thousands)2020201920202019
United States$72,030 $75,160 $202,709 $225,327 
Canada18,247 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,
2020201920202019
Fastening Systems22.3 %24.1 %22.7 %24.0 %
Specialty Chemicals13.3 %11.7 %11.7 %11.6 %
Fluid Power12.6 %15.1 %13.2 %15.2 %
Cutting Tools and Abrasives12.2 %13.1 %13.1 %13.1 %
Electrical10.0 %10.4 %10.2 %10.8 %
Safety7.0 %4.7 %6.4 %4.7 %
Aftermarket Automotive Supplies7.0 %7.6 %7.1 %7.9 %
Welding and Metal Repair1.4 %1.3 %1.4 %1.5 %
Other14.2 %12.0 %14.2 %11.2 %
Consolidated Total100.0%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, 2020December 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 20172020 and 20162019 is included in the table below:
 (Dollars in thousands)
Nine Months Ended September 30,
20202019
Beginning balance$20,923 $20,079 
Acquisition15,952 — 
Adjustment to original acquisition allocation0 (12)
Impact of foreign exchange(447)515 
Ending balance$36,428 $20,582 
 (Dollars in thousands)
 Nine Months Ended September 30,
 2017 2016
Beginning balance$5,520
 $319
    Acquisition(73) 2,442
Impact of foreign exchange342
 12
Ending balance$5,789
 $2,773


The reduction in acquisition activityCompany performed a quantitative impairment test on the Bolt goodwill as of $0.1March 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 in 2017 resulted from a non-cash adjustment to the estimated purchase price allocation to inventory originally recorded in 2016.or 16%. As of

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Note 6 — Loan Agreement

In 2012, the Company entered into a Loan and Security Agreement (“Loan Agreement”). The Loan Agreement consists of a $40.0 million revolving line of credit facility, which includes a $10.0 million sub-facility for letters of credit. Certain terms of the original Loan Agreement have been revised by subsequent amendments.

Effective October 3, 2017, the Company entered into a Consent and Ninth Amendment to Loan and Security Agreement that provides the creditor's consent, to the acquisition of all of the issued and outstanding shares of The Bolt Supply House Ltd. ("Bolt Supply House") (see Note 11 - Subsequent Events) and revised the Loan Facility to permit Bolt Supply House to continue its existing line of credit. Additionally, in October, the Company borrowed $16.3 million from its revolving line of credit facility relatedJune 30, 2020 goodwill allocated to the Bolt Supply House acquisition.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 Loan Agreement,gross carrying amount and accumulated amortization by intangible asset class were as amended, expiresfollows:
 (Dollars in thousands)
September 30, 2020December 31, 2019
Gross Carrying AmountAccumulated AmortizationNet Carrying ValueGross Carrying AmountAccumulated AmortizationNet Carrying Value
Trade names$11,022 $(2,436)$8,586 $8,422 $(2,020)$6,402 
Customer relationships12,181 (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 August 2020. Due to the lock box arrangementGeneral and a subjective acceleration clause contained in the Loan Agreement, any outstanding borrowings under the revolving line of credit are classified as a current liability.

Currently, credit available under the Loan Agreement, as amended, is based upon:

a)85% of the face amount of the Company’s eligible accounts receivable, generally less than 60 days past due, and

b)the lesser of 60% of the lower of cost or market value of the Company’s eligible inventory, generally inventory expected to be sold within 18 months, or $20.0 million.

The applicable interest rates for borrowings are at the Prime rate or, if the Company elects, the LIBOR rate plus 1.50% to 1.85% based on the Company’s debt to EBITDA ratio. The Loan Agreement is secured by a first priority perfected security interest in substantially all existing assets of the Company. Dividends are restricted to amounts not to exceed $7.0 million annually.

At September 30, 2017, the Company had no borrowings under its revolving line of credit facility and additional borrowing availability of $36.0 million. The Company paid interest of $0.4 million and $0.5 millionadministrative expenses for the nine months ended September 30, 20172020 and 2016,2019, 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 weighted average interest rateCompany 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 TypeClassificationThree Months Ended September 30, 2020Three Months Ended September 30, 2019
Consolidated Operating Lease Expense (1)
Operating expenses$1,262 $1,190 
  Consolidated Financing Lease AmortizationOperating expenses63 $60 
  Consolidated Financing Lease InterestInterest expense8 10 
Consolidated Financing Lease Expense71 70 
Sublease Income (2)
Operating expenses0 0 
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 3.91%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, 20172020 and 3.50%September 30, 2019 are as follows (Dollars in thousands):

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Lease TypeClassificationNine Months Ended September 30, 2020Nine Months Ended September 30, 2019
Consolidated Operating Lease Expense (1)
Operating expenses$3,630 $3,532 
  Consolidated Financing Lease AmortizationOperating expenses165 159
  Consolidated Financing Lease InterestInterest expense22 23 
Consolidated Financing Lease Expense187 182 
Sublease Income (2)
Operating expenses0 (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 TypeSeptember 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 obligation233 239 
Total current lease obligations$4,509 $3,830 
Total long term operating lease obligation$6,414 $9,133 
Total long term financing lease obligation279 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 LiabilitiesOperating LeasesFinancing LeasesTotal
Year one$4,599 $254 $4,853 
Year two3,780 153 3,933 
Year three1,733 101 1,834 
Year four720 35 755 
Year five175 2 177 
Subsequent years471 0 471 
Total lease payments11,478 545 12,023 
Less: Interest788 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

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The weighted average lease terms and interest rates of the leases held by Lawson as of September 30, 2020 are as follows:
Lease TypeWeighted Average Term in YearsWeighted Average Interest Rate
Operating Leases3.15.08%
Financing Leases2.75.37%

The cash outflows of the leasing activity of Lawson as lessee for the nine months endedending September 30, 2016.2020 are as follows (Dollars in thousands):

Cash Flow SourceClassificationAmount
Operating cash flows from operating leasesOperating activities$3,072 
Operating cash flows from financing leasesOperating activities22 
Financing cash flows from financing leasesFinancing activities192 


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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 Company is required to meet a minimum trailing twelve month EBITDA to fixed charges ratio, as defined in the amended Loan Agreement, if the excess borrowing capacity is below $10.0 million. On September 30, 2017, the Company's borrowing capacity exceeded $10.0 million. Therefore, the Company was not subject to this financial covenant, however, for informational purposes the resultresults of the financial covenant iscovenants are provided below:
Quarterly Financial CovenantCovenantsRequirementActual
EBITDA to fixed charges ratio1.101.15 : 1.003.204.73 : 1.00
Total net leverage ratio3.25 : 1.000.71 : 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.

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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 710 - 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. Payment 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, 20172020 and 20162019 were as follows:
 (Dollars in thousands)
 Nine Months Ended September 30,
 20202019
Balance at beginning of period$909 $359 
Charged to earnings1,520 1,542 
Payments(1,239)(925)
Balance at end of period$1,190 $976 
 (Dollars in thousands)
 Nine Months Ended September 30,
 2017 2016
Balance at beginning of period$1,710
 $697
Charged to earnings595
 714
Payments(1,625) (950)
Balance at end of period$680
 $461


The remaining severance liabilities outstanding as of September 30, 2017 will be substantially paid by the end of 2017.

Note 813 — Stock-Based Compensation


The Company recorded stock-based compensation income of $2.8 million and expense of $2.7 million and a benefit of $1.3$7.6 million for the first nine months of 20172020 and 2016,2019, 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 liability 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 activityissued during the nine months ended September 30, 20172020 follows:


Restricted Stock Performance RightsUnits ("SPRs"RSUs")
SPRs entitle the recipientThe Company issued 6,847 RSUs to receive a cash payment equalkey employees that cliff vest on December 31, 2022. The Company issued 2,500 RSUs to the excess of the market valuean 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 common stock over the SPR exercise price when the SPRs are surrendered. A liabilityBoard of $9.0 million, reflecting the estimated fair valueDirectors with a vesting date of future pay-outs is included as a component of Accrued expenses in the condensed consolidated balance sheets. Activity related to the Company’s SPRs for the nine months ended September 30, 2017 was as follows:
 Number of SPRs Weighted Average Exercise Price
Outstanding on December 31, 2016946,701
 $19.60
Granted78,948
 25.12
Exercised(34,095) 12.99
Cancelled(30,000) 36.71
Outstanding on September 30, 2017961,554
 19.76


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Restricted Stock Awards ("RSAs")
May 12, 2021. Each RSARSU is exchangeable for one share of the Company's common stock at the end of the vesting period. Activity related to the Company’s RSAs for the nine months ended September 30, 2017 was as follows:
Restricted Stock Awards
Outstanding on December 31, 201631,897
Granted83,920
Exchanged for shares(31,897)
Outstanding on September 30, 201783,920


Market Stock Units ("MSUs")
MSU'sThe 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 zero0 to 150% of the underlying MSU,33,426, will be determined based upon the trailing sixty-day weighted average closing price of the Company's common stock on December 31, 2022.
Performance Awards ("PAs")
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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 0 to 16,278, or the equivalent amount in cash, based upon vesting. Activity related to the Company’s MSUsachievement of certain financial performance metrics.

NaN 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, 20172020. 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 as follows:
 Number of Market Stock Units Maximum Shares Potentially Issuable
Outstanding on December 31, 2016149,532
 224,298
Granted98,243
 147,065
Outstanding on September 30, 2017247,775
 371,363

Note 9 — Income Taxes

At each reporting date, Lawson’s management considers new evidence, both positive and negative, that could impact management’s view with regard to the realization of its deferred tax assets and the reversal of the corresponding valuation allowances. Although the Company has generated pre-tax profits over the past three quarters and has begun to utilize a small portion of its net operating loss carryforwards over the past two years, management feels that additional positive evidence is necessary in order to conclude that it is more likely than not that it will be able to realize its deferred tax assets. We believe that there is a reasonable possibility that within the next twelve months, sufficient evidence may become available to allow us to reach a conclusion that a significant portion of the valuation allowance will no longer be needed. As of September 30, 2017, substantially all deferred tax assets remain subject to a tax valuation allowance.

If the Company continues to demonstrate that it can consistently generate income in future quarters, it may lead to a determination that there is sufficient positive evidence to conclude that it is more likely than not that the company will be able to utilize its deferred tax assets to offset future taxable income. This would lead to the reduction of all or a portion of the valuation allowance resulting in an income tax benefit for the period in which the reduction is recorded. The Company will continue to closely monitor all positive and negative evidence and will re-assess its position on a quarterly basis.

Although the Company is in this full tax valuation allowance position, income tax expenses of $0.8 million and $0.5 million were recorded for the nine months ended September 30, 20172019. This effective tax rate was higher than the U.S. statutory rate due primarily to state taxes, income in higher tax jurisdictions and 2016, respectively, primarily due to reservesan inclusion for uncertain tax positions, federal alternative minimum taxes and state taxes.Global Intangible Low Tax Income.

In 2017, the company increased its deferred tax assets and related valuation allowance by $7.2 million that may arise from future settlement of uncertain tax positions in Canada. There was no impact to the Company's consolidated statements of income and comprehensive income, balance sheets or statements of cash flows, as the company had valuation allowances equal to the value of the deferred tax assets.


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, 2017,2020, the Company is subject to U.S. Federal income tax examinations for the years 20142017 through 20162019 and income tax examinations from various other jurisdictions for the years 20112013 through 2016.2019.


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


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Note 1015 — 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. In August 2013,site and the site was enrolled in Alabama'sthe Alabama Department of Environmental Management (“ADEM") voluntary cleanup program. On October 30, 2014, the Company received estimates from its environmental consulting firm for three potential

The remediation solutions.plan was approved by ADEM in 2018. The estimates included a range of viable remedial approaches. The first solution included limited excavation and removal of the contaminated soil along with an extensive monitoring period. The second solution included the first solution plus the installation of a groundwater extraction system. The third scenario included the first and second solutions plus treatment injections to reduce the degradation time. The estimated expenditures over the life of the three scenarios ranged from $0.3 million to $1.4 million. As the Company had determined that a loss was probable and no scenario was more likely than the other at that time, a liability in the amount of $0.3 million was established in 2014.

During 2015, after further evidence had been collected and analyzed, the Company concluded that it was probable that future remediation would be required, and accordingly accrued an additional $0.9 million for the estimated costs.

In the third quarter of 2017 the Company received estimates from its environmental consulting firm for two new remediation solutions based on a chemical injection process. The first solution would consistplan consists of chemical injections throughout the entire site to directly eliminateaffected area, as well as subsequent monitoring of the hazardous substancesarea for three consecutive periods. The injection process was completed in the soilfirst quarter of 2019 and groundwater.the environmental consulting firm is monitoring the affected area. The second solution would consistCompany utilized its remaining liability balance in the third quarter of chemical injections around2020. there may be some additional nominal filing fees that are charged to the perimeter ofCompany by the site to prevent the migration of the hazardous chemicals off-site. Neither solution would require additional excavation or repairsenvironmental consulting firm and ADEM, however these amounts are expected to be made to the property. Additionally, the estimated required monitoring period wouldimmaterial and will be substantially reduced. The estimated expenditures over an 18 month period under the two injection scenarios ranged from $0.9 million to $2.0 million.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.
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Note 17 – Segment Information

The Company operates in 2 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,
2020201920202019
Revenue
Lawson$79,806 $83,461 $224,511 $250,895 
   Bolt Supply10,471 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 Supply4,187 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 Supply889 1,069 2,205 2,123 
      Consolidated total2,001 6,446 21,208 13,613 
Interest expense(142)(138)(329)(481)
Other income (expense), net615 (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 remediation options.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 determined that it will initially proceed withtaken several steps to mitigate the methodpotential negative impacts of injecting chemicals aroundCOVID-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 perimeterMcCook 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 site to preventpreviously furloughed employees. The Company reopened the migration ofSuwanee distribution center in a reduced capacity in the hazardous chemicals off-site. As of September 30, 2017, approximately $1.0 million remains accrued for this remediation in other long-term liabilities on the accompanying consolidated balance sheet. This estimate was based on the information provided to date andthird quarter as the remediation efforts proceed, additional information may impact the final cost. As of September 30, 2017, agreement with Alabama’s voluntary cleanup program on viable treatment of the property has not yet been reached and theoverall business activity increased.

The Company continues to evaluate potential remediation alternatives that could impactmonitor its balance sheet and liquidity position and is taking actions to protect cash flows from operations, while at the ultimate costsame time managing its operating expenses in relation to current sales trends. At September 30, 2020, the Company had $17.2 million of remediation.

Note 11 - Subsequent Events

On October 3, 2017, Lawson Products completed the purchaseunrestricted cash and cash equivalents and an additional $66.0 million of The Bolt Supply House Ltd. ("Bolt Supply House"), an industrial parts distributor located in Western Canada for approximately $32.1 million which was paid using a combinationborrowing capacity, net of cash on hand and borrowingsoutstanding letters of $16.3 million from the Company's existing revolvingcredit, under its committed credit facility. The Bolt Supply House operates thirteen strategically located branches across Alberta, Manitoba and Saskatchewan, Canada. Company recorded a liability of $32.5 million in relation to the acquisition of Partsmaster.

The Bolt Supply HouseCompany will continue to operate separately underclosely monitor the operating environment and will take appropriate actions to protect the safety for its own brand as a subsidiary of Lawson's Canadian operating company.employees, customers and suppliers while continuing to meet its working capital needs and remain in compliance with its debt covenants.





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


Overview

Partsmaster Acquisition
The
In September 2020, we acquired Partsmaster, a leading Maintenance, Repair and Operations ("MRO") distributor from NCH Corporation. Partsmaster has over 200 sales representatives and serves approximately 16,000 customers throughout the United States and Canada. We also assumed the lease on the Partsmaster distribution center located in Greenville, Texas, and we will continue to fulfill orders from this facility as we integrate Partsmaster into our MRO segment operations.

The purchase price of the acquisition was $35.3 million in cash and the assumption of certain liabilities. We paid $2.3 million at the time of the acquisition and we will pay the remaining $33.0 million in May 2021. We plan to pay the remaining portion of the purchase price with cash on hand and, as necessary, any remaining portion using our existing credit facility. The liabilities assumed include approximately $2.9 million relating to deferred employee compensation and $4.1 million of accounts payable and other accrued liabilities.

Assets acquired and liabilities assumed as a result of the acquisition were accounted for at their fair value on the acquisition date. The identified assets include $5.0 million of intangible assets for customer relationships and $2.8 million for trade names with estimated useful lives of 10 years and 5 years, respectively. Goodwill of $16.0 million related to this acquisition reflects the purchase price less the fair market value of the identifiable 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 we finalize the valuations of the assets acquired and liabilities assumed.

Additional information related to the Partsmaster acquisition is provided in Note 2 - Acquisition in the notes to the consolidated financial statements.

COVID-19 Pandemic

In March 2020, the World Health Organization declared a new strain of coronavirus (“COVID-19”) a pandemic. The COVID-19 pandemic continues to negatively impact the global economy by disrupting global supply chains and financial markets and has negatively impacted our operational and financial performance, including the ability of our sales representatives to call on customers in person and perform VMI services at customer locations. The Bolt Supply House saw a decline in sales in the second quarter and third quarter as the ability of customers to visit branch locations was restricted and certain customers temporarily closed. The continued impact of the COVID-19 pandemic on our operational and financial performance, including our ability to execute our business strategies and initiatives in the expected time frame, will depend on future developments, including the duration and spread of the pandemic and related restrictions on travel and transports, all of which remain uncertain. An extended period of global supply chain and economic disruption could materially affect our business, sales, results of operations and financial condition.

Lawson continues to be defined as an essential business by the state of Illinois. 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 some 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 shutdowns of freight carriers could also negatively impact our performance.
The pandemic has negatively impacted our current operations and may negatively impact our future financial results, liquidity and overall performance. Additionally, it is possible that estimates made in support of our 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 economic climate in the third quarter has improved as many nonessential businesses have reopened in both limited capacity and full capacity. The relaxed restrictions have resulted in increased customer contact and more consistent customer visits for Lawson MRO sales representatives and customers were also allowed in 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 of 2020 compared to the second quarter of 2020. However, restrictions related to the COVID-19 pandemic and a downturn in the oil and gas industry has led to lower sales and operating income compared to the third quarter of 2019.

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We continue to take action 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 and incentive awards, canceling travel and award trips, temporarily consolidating our Suwanee distribution center operations into the McCook facility eliminating non-critical capital expenditures and eliminating various positions throughout the Company. In the third quarter we brought back approximately 70% of the previously furloughed employees and reopened our Suwanee distribution center in a reduced capacity as overall business activity increased.

We continue to monitor our balance sheet and liquidity position and take actions to protect our cash flows from operations while at the same time managing our operating expenses in relation to current sales trends. At September 30, 2020, we 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. Our outstanding letters of credit include a letter of credit for $33.0 million for the remaining payment of the Partsmaster acquisition.

We will continue to closely monitor the overall economic and operating environment and we will take appropriate actions to protect the safety of our employees, customers and suppliers while continuing to meet our working capital needs and remain in compliance with our debt covenants. While COVID-19 has negatively impacted our sales, cost control measures and ability to effectively service our customers, we have continued to generate positive cash flow that has enabled us to maintain a strong financial position. We plan to continue to respond to pandemic developments in a prompt and disciplined manner with an emphasis on maintaining our strong financial position.

Sales Drivers

The MRO distribution industry is highly fragmented. We compete for business with several national distributors as well as a large number of regional and local distributors. The MRO business is significantly impacted by the overall strength of the manufacturing sector of the U.S. economy.economy which has been significantly affected by the COVID-19 pandemic. One measure used to evaluate the strength of the industrial products market is the PMI index published by the Institute for Supply Management, which is considered by many economists to be a reliable near-term economic barometer of the manufacturing sector. A measure above 50 generally indicates expansion of the manufacturing sector while a measure below 50 generally represents contraction. The average monthly PMI was 58.6 in the third quarter of 2017 compared to 51.255.2 in the third quarter of 2016, indicating2020 compared to 49.4 in the third quarter of 2019. The third quarter 2020 PMI of 55.2 follows a strong U.S. manufacturing economy.second quarter PMI of 45.7 and a first quarter PMI of 50.0. This high degree of volatility in 2020, primarily reflecting the effect of the COVID-19 pandemic on the current economic environment, makes this indicator more difficult to interpret in measuring year over year economic growth.


Our sales are also affected by the number of sales representatives and their productivity. OurThe acquisition of Partsmaster in September increased our sales force by approximately 200 sales representatives in September 2020 and contributed a weighted average of 67 sales representatives to the sales force consistedhead count in the third quarter 2020. Including the Partsmaster sales representatives, the average sales rep headcount for the quarter was 993 sales representatives in the third quarter of an average of 991 and 1,0072020 compared to 989 sales representatives during the third quartersthird quarter of 2017 and 2016, respectively. Our2019.

Lawson segment sales reprepresentative productivity, measured as sales per rep per day increasedand including the Partsmaster sales reps, decreased 4.6% to $1,212$1,249 in the third quarter of 20172020 from $1,089$1,309 in the third quarter of 2016.2019. Partsmaster contributed $5.4 million in sales in the third quarter. The decrease in sales rep productivity compared to the third quarter of 2019 was primarily driven by the negative impacts of COVID-19 and the downturn in the oil and gas industry. We anticipate moderate growth in the size of our sales force to increase slightly for the remainder of 2017 as we2020, however, the size of our sales force will be influenced by the performance of the overall economy. We also plan to continue to concentrate our efforts on providing training and support to continue to increaseincreasing the productivity of our existing and acquired sales representatives.


In orderNon-GAAP Financial Measure - Adjusted Operating Income

We believe that certain non-GAAP financial measures may provide users of this financial information with additional meaningful comparisons between current results and results in prior operating periods. We believe that these non-GAAP financial measures can provide additional meaningful reflection of underlying trends of the business because they provide a comparison of historical information that excludes certain infrequently occurring, seasonal or non-operational items that impact the overall comparability. These non-GAAP financial measures should be viewed in addition to, utilize excess capacityand not as an alternative for, our reported results prepared in accordance with GAAP.

Adjusted operating income is defined by us as GAAP operating income excluding stock-based compensation, severance expenses and acquisition costs in the period in which these items are incurred.

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Table of our existing supply chain network, we completed a saleContents
Operating income was $2.0 million for the third quarter of our discontinued Fairfield distribution center2020 compared to $6.4 million for the third quarter of 2019. Excluding stock-based compensation, severance expense and acquisition costs, adjusted non-GAAP operating income was $7.7 million in the third quarter of 2020 compared to $8.9 million in the third quarter of 2019, driven by decreased sales due to the COVID-19 pandemic, partially offset by inclusion of Partsmaster adjusted operating income of $0.4 million in the third quarter of 2020. Operating income was $21.2 million for the first nine months of 2020 compared to $13.6 million for the first nine months of 2019. Excluding stock-based compensation, severance expense and acquisition costs, adjusted non-GAAP operating income was $20.5 million in the first nine months of 2017, resulting2020 compared to $22.8 million in the first nine months of 2019.

Reconciliation of GAAP Operating Income to Adjusted Non-GAAP Operating Income (Unaudited)
Three Months Ended
September 30,		Nine Months Ended
September 30,
(Dollars in Thousands)2020201920202019
Operating income as reported by GAAP$2,001 $6,446 $21,208 $13,613 
   Stock based compensation (1)
4,746 2,374 (2,767)7,621 
   Severance expense488 30 1,520 1,542 
   Acquisition costs473 — 555 — 
Adjusted non-GAAP operating income$7,708 $8,850 $20,516 $22,776 

(1)    Expense for stock-based compensation, of which a gain of $5.4 million.

In October 2017 the Company acquired The Bolt Supply House Ltd (See Note 11 - Subsequent Events) which will affect Lawson's operating results beginningportion varies with the fourth quarter of 2017.Company's stock price

Quarter ended September 30, 20172020 compared to quarter ended September 30, 20162019
 20202019
(Dollars in thousands)Amount% of
Net Sales		Amount% of
Net Sales
Revenue$90,277 100.0 %$94,779 100.0 %
Cost of goods sold43,052 47.7 %44,205 46.6 %
Gross profit47,225 52.3 %50,574 53.4 %
Operating expenses:
Selling expenses19,155 21.2 %21,255 22.4 %
General and administrative expenses26,069 28.9 %22,873 24.2 %
Total operating expenses45,224 50.1 %44,128 46.6 %
Operating income2,001 2.2 %6,446 6.8 %
Interest expense(142)(0.2)%(138)(0.1)%
Other income (expenses), net615 0.7 %(13)(0.1)%
Income before income taxes2,474 2.7 %6,295 6.6 %
Income tax expense736 0.8 %1,521 1.6 %
Net income$1,738 1.9 %$4,774 5.0 %
22
 2017 2016
($ in thousands)Amount 
% of
Net Sales
 Amount 
% of
Net Sales
        
Net sales$75,651
 100.0 % $70,199
 100.0 %
Cost of goods sold29,646
 39.2 % 27,626
 39.4 %
Gross profit46,005
 60.8 % 42,573
 60.6 %
        
Operating expenses:       
Selling expenses24,354
 32.2 % 23,568
 33.6 %
General and administrative expenses20,561
 27.2 % 16,616
 23.6 %
Operating expenses44,915
 59.4 % 40,184
 57.2 %
        
Operating income1,090
 1.4 % 2,389
 3.4 %
        
Interest expense(133) (0.1)% (167) (0.2)%
Other income, net843
 1.1 % 66
 0.1 %
        
Income before income taxes1,800
 2.4 % 2,288
 3.3 %
        
Income tax expense479
 0.7 % 463
 0.7 %
        
Net income$1,321
 1.7 % $1,825
 2.6 %



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Net SalesRevenue and Gross Profits

Three Months Ended
September 30,		Increase/(Decrease)
(Dollars in thousands)20202019Amount%
Revenue
Lawson$79,806 $83,461 $(3,655)(4.4)%
Bolt Supply10,471 11,318 (847)(7.5)%
Consolidated$90,277 $94,779 $(4,502)(4.7)%
Gross profit
Lawson$43,038 $46,148 $(3,110)(6.7)%
Bolt Supply4,187 4,426 (239)(5.4)%
Consolidated$47,225 $50,574 $(3,349)(6.6)%
Gross profit margin
Lawson53.9 %55.3 %
Bolt Supply40.0 %39.1 %
Consolidated52.3 %53.4 %
Net
Total sales increased 7.8%decreased 4.7% to $75.7$90.3 million in the third quarter of 20172020 compared to $70.2$94.8 million in the third quarter of 2016 with one less selling day. 2019. Sales were negatively impacted by the effect of the COVID-19 pandemic and a downturn in the oil and gas industry, partially offset by the contribution of $5.4 million of sales from Partsmaster in the third quarter 2020. Sales productivity, measured as sales per rep per day, decreased 4.6% in the third quarter of 2020 compared to the same quarter of 2019, primarily driven by the COVID-19 pandemic. Bolt Supply sales were also negatively impacted by COVID-19 compared to the prior year quarter. Consolidated average daily sales increased on a sequential basis throughout the third quarter, from $1.294 million in July to $1.315 million in August and $1.629 million in September as the economy continued to improve. Partsmaster contributed $0.257 million in average daily sales in September. Average daily sales improved 9.5%declined 4.7% to $1.201$1.411 million in the third quarter of 20172020 compared to $1.097$1.481 million in the prior year quarter. ThePartsmaster contributed $0.085 million of average daily sales in the third quartersquarter 2020. Both the third quarter of 20172020 and 20162019 had 63 and 64 selling days, respectively. Sales were positively impacted by increased productivity of sales representatives and the effect of acquisitions completed in 2016, augmented by the overall improvement in the MRO marketplace. We experienced strong growth in our large national and regional accounts. Average daily sales from the 2016 acquisitions grew 1.0%.days.


Gross Profit


GrossReported gross profit increaseddecreased $3.3 million to $46.0$47.2 million in the third quarter of 20172020 compared to $42.6$50.6 million as a result of the sales decline. Partsmaster contributed $3.6 million to reported gross profit in the third quarter of 2016, primarily due2020 before giving effect to higher sales, and increased slightlyservice costs. Consolidated gross profit as a percent of sales was 52.3% in the third quarter of 2020 compared to 60.8%53.4% in the prior year quarter. Gross profit as a percentage of sales generated by sales representative acquired from 60.6%Partsmaster was 66.8% before giving affect to service related costs. The organic Lawson MRO segment gross margin as a year ago. The increasepercent of sales declined to 58.8% in gross profit margin fromthe third quarter of 2020 compared to 60.9% a year ago was primarily driven by volume related vendor concessionsquarter before giving effect to the service-related costs, as a result of de-leveraging of fixed distribution costs over a lower sales base, a shift to lower margin products in the quarter and lower bins and cabinets provided to our customers which were partially offset by higher sales to larger national customers, who typically generate lower product margins.net transportation costs.


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Selling, General and Administrative Expenses

Three Months Ended September 30,Increase (Decrease)
(Dollars in thousands)20202019Amount%
Selling expenses
Lawson$18,373 $20,402 $(2,029)(9.9)%
Bolt Supply782 853 (71)(8.3)%
Consolidated$19,155 $21,255 $(2,100)(9.9)%
General and administrative expenses
Lawson$23,553 $20,369 $3,184 15.6%
Bolt Supply2,516 2,504 12 0.5%
Consolidated$26,069 $22,873 $3,196 14.0%

Selling expenses consist of compensation and support for our sales representatives. Selling expenses increased to $24.4were $19.2 million in the third quarter of 2017 from $23.62020 compared to $21.3 million in the prior year quarter due primarily to an increase in compensation costs resulting from higher sales, partially offset by lower health insurance expenses. Selling expensesand, as a percent of sales, decreased to 32.2%21.2% from 33.6%22.4% in the third quarter of 2016, as fixed2019. The decrease in selling expenses were leveraged over a higherexpense is primarily related to reduced sales base.compensation driven by lower sales and lower travel related expenses. Partsmaster contributed $1.6 million to selling expense in the third quarter 2020.


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 $20.6$26.1 million in the third quarter of 20172020 from $16.6$22.9 million in the prior year quarter. The increased General and administrative expense was driven by an increase in stock-based compensation expense of $2.4 million, inclusion of Partsmaster expenses of $1.5 million, increased severance of $0.5 million, and acquisition costs of $0.5 million. These items were partially offset by lower compensation costs.

Interest Expense

Interest expense was $0.1 million in the third quarter of 2020, which was flat compared to the third quarter of 2019.

Other Income, Net

Other income, net increased $0.6 million in the third quarter of 2020 over the prior year quarter primarily due to $3.0 million of additional stock-based compensation of which a portion varies with the company stock price and restoring incentive compensation accruals based on improved operating results.

Interest Expense

Interest expense decreased slightly due to lower average borrowings outstanding.

Other Income, Net

Other income, net increased $0.8 million over the prior year quarter, due primarily to the effect of changes in theCanadian currency exchange rate on Canadian transactions.effect.


Income Tax Expense


Primarily due to historical cumulative losses, substantially all of our deferredIncome tax assets are subject to a tax valuation allowance. Although we areexpense was $0.7 million, resulting in a full29.7% effective tax valuation allowance position,rate for the three months ended September 30, 2020 compared to an income tax expense of $0.5$1.5 million and $0.5 million were recorded in the third quartersan effective tax rate of 2017 and 2016, respectively, primarily due to reserves for uncertain tax positions, federal alternative minimum taxes and state taxes.

If the Company continues to demonstrate that it can consistently generate income, we may be able to make a determination that there is a sufficient amount of positive evidence to conclude that it is more likely than not that we will be able to utilize our deferred tax assets to offset future taxable income. This would lead to the reduction of all or a portion of the valuation allowance resulting in an income tax benefit24.2% for the period in which the reduction is recorded. We will continue to closely monitor all positive and negative evidence and will re-assess our position on a quarterly basis.three months ended September 30, 2019.




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Nine months ended September 30, 20172020 compared to September 30, 20162019
 20202019
(Dollars in thousands)Amount% of
Net Sales		Amount% of
Net Sales
Revenue$253,458 100.0 %$282,219 100.0 %
Cost of goods sold118,999 47.0 %131,679 46.7 %
Gross profit134,459 53.0 %150,540 53.3 %
Operating expenses:
Selling expenses55,445 21.9 %64,864 23.0 %
General and administrative expenses57,806 22.8 %72,063 25.5 %
Total operating expenses113,251 44.6 %136,927 48.5 %
Operating income21,208 8.4 %13,613 4.8 %
Interest expense(329)(0.1)%(481)(0.2)%
Other income (expense), net15 (0.1)%798 0.3 %
Income before income taxes20,894 8.2 %13,930 4.9 %
Income tax expense6,004 2.3 %3,703 1.3 %
Net income$14,890 5.9 %$10,227 3.6 %
 2017 2016
($ in thousands)Amount 
% of
Net Sales
 Amount 
% of
Net Sales
        
Net sales$225,274
 100.0 % $209,258
 100.0 %
Cost of goods sold89,249
 39.6 % 81,700
 39.0 %
Gross profit136,025
 60.4 % 127,558
 61.0 %
        
Operating expenses:       
Selling expenses72,964
 32.4 % 69,525
 33.2 %
General and administrative expenses58,790
 26.1 % 54,446
 26.1 %
Total S,G&A131,754
 58.5 % 123,971
 59.3 %
Gain on sale of property(5,422) (2.4)% —
 — %
Operating expenses126,332
 56.1 % 123,971
 59.3 %
        
Operating income9,693
 4.3 % 3,587
 1.7 %
        
Interest expense(393) (0.2)% (486) (0.2)%
Other income, net953
 0.5 % 439
 0.2 %
        
Income before income taxes10,253
 4.6 % 3,540
 1.7 %
        
Income tax expense802
 0.4 % 526
 0.3 %
        
Net income$9,451
 4.2 % $3,014
 1.4 %


Revenue and Gross Profit
Net Sales

Nine Months Ended September 30,Increase/(Decrease)
(Dollars in thousands)20202019Amount%
Revenue
Lawson$224,511 $250,895 $(26,384)(10.5)%
Bolt Supply28,947 31,324 (2,377)(7.6)%
Consolidated$253,458 $282,219 $(28,761)(10.2)%
Gross profit
Lawson$123,031 $138,524 $(15,493)(11.2)%
Bolt Supply11,428 12,016 (588)(4.9)%
Consolidated$134,459 $150,540 $(16,081)(10.7)%
Gross profit margin
Lawson54.8 %55.2 %
Bolt Supply39.5 %38.4 %
Consolidated53.0 %53.3 %
Net sales
Revenue

Revenue for the nine months ended September 30, 2017 increased 7.7%2020 decreased 10.2% to $225.3$253.5 million from $209.3$282.2 million for the nine months ended September 30, 2016.2019. All customer sales categories have been negatively impacted by the effect of the COVID-19 pandemic which began in March 2020. The decrease in sales compared to the prior year was partially offset by $5.4 million of sales from the inclusion of Partsmaster in the third quarter 2020. Average daily sales improved 8.2%decreased 10.7% to $1.179$1.320 million in the first nine months of 20172020 compared to $1.090$1.478 million in the prior year period. The first nine months of 2017 and 2016 had 191 and 192period with one more selling days, respectively.
Salesday in the first nine monthscurrent year to date period compared to the corresponding prior year period.
25

Table of 2017 were positively impacted by increased productivity of sales representatives and the effect of acquisitions completed in 2016, augmented by the overall improvement in the MRO marketplace. The Company experienced growth in all major categories including regional, large national, Kent Automotive and governmental accounts. Average daily sales from the 2016 acquisitions grew 1.4%.Contents

Gross Profit


Gross profit increaseddecreased to $136.0$134.5 million in the first nine months of 20172020 compared to $127.6$150.5 million in the first nine months of 20162019, primarily driven by decreased sales, partially offset by lower service costs classified as cost of goods sold and decreasedthe inclusion of the Partsmaster acquisition. Consolidated gross profit as a percent of sales was 53.0% compared to 60.4% from 61.0%53.3% a year ago. The declineorganic Lawson MRO segment gross margin as a percent of sales was 59.8% in gross profit margin fromthe first nine months of 2020 compared to 60.7% a year ago was primarily driven by higher sales to larger national customers, who typically generate lower product margins, the impact of the 2016 acquisitions, and transportation costs associated with the movement of certain inventory due to the closure of the Fairfield, New Jersey, distribution center.ago.


Selling, General and Administrative Expenses

Nine Months Ended September 30,Decrease
(Dollars in thousands)20202019Amount%
Selling expenses
Lawson$53,222 $62,334 $(9,112)(14.6)%
Bolt Supply2,223 2,530 (307)(12.1)%
Consolidated$55,445 $64,864 $(9,419)(14.5)%
General and administrative expenses
Lawson$50,816 $64,700 $(13,884)(21.5)%
Bolt Supply6,990 7,363 (373)(5.1)%
Consolidated$57,806 $72,063 $(14,257)(19.8)%

Selling expenses increaseddecreased to $73.0$55.4 million for the first nine months of 20172020 from $69.5$64.9 million in the first nine months of 2016, due primarily to increased compensation costs on higher sales. Selling expenses2019 and, as a percent of sales, decreased to 32.4%21.9% in thethe first nine months of 20172020 from 33.2%23.0% a year ago. The decrease in selling expense is primarily related to reduced sales compensation driven by lower sales and a reduction in travel related expenses in the first nine monthsthird quarter. These declines were partially offset by the inclusion of 2016, as fixed$1.7 million of selling expenses were leveraged over a higher sales base.from the Partsmaster acquisition.


General and Administrative Expenses

General and administrative expenses increaseddecreased to $58.8$57.8 million in the first nine months of 20172020 from $54.4$72.1 million in the prior year period primarily due to $4.1 million of additionala decrease in stock-based compensation expense of $10.4 million, a portion of which a portion varies with the companyCompany stock priceprice. Lower employee compensation, travel expenses and restoring incentive compensation accruals dueother cost control measures put in place as a result of COVID-19 also contributed to improved operating results.the decline. These increasedeclines were partially offset partially by lower depreciationthe inclusion of $1.5 million of general and acquisition related expenses.

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Gain on sale of property

In the second quarter of 2017, we received net cash proceeds of $6.2 million and recognized a gain of $5.4 millionadministrative expenses from the sale of our Fairfield, New Jersey distribution center.Partsmaster acquisition.

Interest Expense


Interest expenses decreased $0.1$0.2 million in the first nine months of 2017, over the prior year,2020, due primarily to lowerdecreased average outstanding borrowings oustanding.compared to the prior year.


Other Income (Expense), Net


Other income (expense), net increased $0.5decreased $0.8 million in the first nine months of 2017, over the prior year,2020, primarily due primarily to the effect of favorable changes in theCanadian currency exchange rate on Canadian transactions.effect.


Income Tax Expense


Primarily due to historical cumulative losses, substantially all of our deferredIncome tax assets are subject to a tax valuation allowance. Although we areexpenses were $6.0 million resulting in a full28.7% effective tax valuation allowance position, income tax expenses of $0.8 million and $0.5 million were recorded inrate for the first nine months of both 2017 and 2016, primarily due2020 compared to reserves for uncertain tax positions, federal alternative minimum taxes and state taxes.
If the Company continues to demonstrate that it can consistently generate income, we may be able to make a determination that there is a sufficient amount of positive evidence to conclude that it is more likely than not that we will be able to utilize our deferred tax assets to offset future taxable income. This would lead to the reduction of all or a portion of the valuation allowance resulting in an income tax benefitexpense of $3.7 million and a 26.6% effective tax rate for the period in which the reduction is recorded. We will continue to closely monitor all positive and negative evidence and will re-assess our position on a quarterly basis.


first nine months of 2019.
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Liquidity and Capital Resources


Available cash and cash equivalents were $19.0$17.2 million on September 30, 20172020 compared to $10.4$5.5 million on December 31, 2016.2019. Net cash provided bygenerated from operations was $3.8 million infor the nine months ended September 30, 2017, as2020 was $20.0 million, primarily due to operating earnings and the Company managing working capital. Net cash generated by operating earnings was partially offset by cash invested in working capital, primarily to support the increase in sales. The $5.3 million of cash provided byfrom operations infor the nine months ended September 30, 20162019 was $8.0 million, primarily generateddue to operating earnings offset by operating earnings.an increase in working capital to support higher sales.
In 2017, we completed the salethird quarter of our distribution center located2020, the Company paid $2.3 million in Fairfield, New Jersey, receiving net cash proceeds of $6.2 million.related to the Partsmaster acquisition. Capital expenditures were $1.3 million and $1.4 million for the nine month periods ended September 30, 2020 and 2019, respectively, primarily for improvements to our distribution centers and information technology, were $1.2technology.

We used $4.6 million and $2.6 millionof cash in financing activities in the first nine month periods ended September 30, 2017months of 2020, primarily to repurchase shares of common stock and 2016, respectively.

On September 30, 2017, we had no borrowings on ourto pay down the revolving line of credit and nocredit. No dividends were paid to shareholders in the nine months ended September 30, 20172020 and 2016. Dividends are currently restricted2019.

In 2019, our Board of Directors authorized a program in which we may repurchase up to $7.5 million of our common stock from time to time in open market transactions, privately negotiated transactions or by other methods. In the first quarter of 2020 we purchased 47,504 shares of our common stock at an average purchase price of $36.93, under the Loan Agreement to amounts not to exceed $7.0 million annually.repurchase program. No shares were repurchased under this program in the second and third quarters. In the third quarter of 2020, we repurchased 12,077 shares of our common stock at an average price of $36.07, for the purpose of satisfying tax withholding obligations of certain employees upon the vesting of their Company issued restricted stock units.

Subsequent to the reporting period ended September 30, 2017, we completed the acquisition of The Bolt Supply House Ltd. for for approximately $32.1 million which was paid by using a combination of cash on hand and borrowings of $16.3 million from our existing revolving credit facility.


Loan Agreement


AtOn September 30, 2017,2020, we had additional$66.0 million of borrowing availability remaining, net of $36.0 million. We believe cash provided by operations and funds availableoutstanding letters of credit, under our LoanCredit Agreement. Our outstanding letters of credit include a $33.0 million letter of credit to secure the remaining payment for the Partsmaster acquisition. We had no outstanding borrowing under our Credit Agreement are sufficient to fundas of September 30, 2020.

Along with certain standard terms and conditions of our operating requirements, strategic initiatives and capital improvements throughout the remainder of 2017.

In addition to other customary representations, warranties and covenants, if the excess borrowing capacity is below $10.0 million,Credit Agreement, we are requiredable to meetborrow up to 3.25 times its EBITDA, as defined, and a minimum trailing twelve month EBITDA to fixed chargescharge ratio, as defined, in the amended Loan Agreement. Onof 1.15. As of September 30, 2017, our borrowing capacity exceeded $10.0 million, therefore,2020, we were not subject to this financial covenant. However, for informational purposes we have provided the result of the financial covenant below:in compliance with all covenants.
Quarterly Financial CovenantRequirementActual
EBITDA to fixed charges ratio1.10 : 1.003.20 : 1.00


While we were in compliance with theour financial covenantcovenants included in our Credit Agreement for the quarter ended September 30, 2017,2020, failure to meet thisthe covenant requirementrequirements of the Credit Agreement in future quarters could lead to higher financing costs, increased restrictions, or reduce or eliminate our ability to borrow funds and could have a material adverse effect on our business, financial condition and results of operations.



We believe cash provided by operations and funds available under our Credit Agreement are sufficient to fund our operating requirements, strategic initiatives and capital improvements, including the potential impact of COVID-19 over the next twelve months although we cannot provide assurance that events beyond our control will not have a material adverse impact on our liquidity.

Partsmaster Acquisition Liability

As a part of the Partsmaster acquisition, payment of $33.0 million is due to the sellers in May 2021. The payment has been guaranteed under the Purchase Agreement, which includes the issuance of a $33.0 million irrevocable standby letter of credit. Payment will be made with cash on hand and, as necessary, any remaining portion using our existing credit facility. The $33.0 million obligation has been discounted to present value and is recognized as a current liability of $32.5 million in our condensed consolidated balance sheet as of September 30, 2020.

.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK


There haveITEM 3 of Part I is inapplicable and has been no material changes in market risk at September 30, 2017omitted from that reported in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016.this report.


ITEM 4. CONTROLS AND PROCEDURES


Under the supervision and with the participation of our senior management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of the end of the period covered by this report (the “Evaluation Date”). Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded as of the Evaluation Date that our disclosure controls and procedures were effective such that (i) the information relating to Lawson, including our consolidated subsidiaries, required to be disclosed in our SEC reports (i) is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and (ii) include,includes, without limitation, controls and procedures designed to ensure that information required to be disclosed is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.


The Company is in the process of integrating Partsmaster, which was acquired from NCH Corporation on August 31, 2020, into its overall internal control over financial reporting. Management elected to exclude the internal controls of Partsmaster from its assessment of the effectiveness of internal control over financial reporting for the quarter ended September 30, 2020, as permitted by the SEC's interpretive guidance. Partsmaster constituted 17% of total assets as of September 30, 2020 and 2% of revenue and less than 2% of operating income in the first nine months of 2020.

There were no changes in our internal control over financial reporting during the quarter ended September 30, 20172020 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.


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PART II
OTHER INFORMATION

ITEMS 1, 1A, 2, 3, 4 and 5 of Part II are inapplicable and have been omitted from this report.


ITEM 1A. RISK FACTORS

Other than the risk factor related to a new strain of coronavirus (“COVID-19”) set forth below, there have been no material changes from the risk factors disclosed in our Annual Report in Part I, Item 1A of the Form 10-K filed on February 27, 2020.

COVID-19

The COVID-19 pandemic has resulted in lost revenue to our Company, limitations on our ability to source high demand product, limitations on our sales force to perform certain functions due to state or federal stay-at-home orders, a slow-down of customer demand for our products and limitations of some customers to pay us on a timely basis. The impact of the COVID-19 pandemic on our operational and financial performance includes affecting our ability to execute our business strategies and initiatives in the expected time frame. The extent of the effect will depend on future developments, including the duration and spread of the pandemic and related restrictions on travel, transports and person to person contact, all of which are uncertain and cannot be predicted at the present time. On a broader scale, the COVID-19 pandemic has negatively impacted the global economy, disrupted global supply chains and created significant volatility and disruption of financial markets. An extended period of global supply chain and economic disruption could materially affect our sales, workforce, supply chains, results of operations, and our ability to access our Credit Agreement to fund operations.

In the first quarter of 2020, our business was defined by the state of Illinois as an essential businesses, allowing us 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 shutdowns of freight carriers could also negatively impact Company performance.

Our sales results have been and are expected to be negatively impacted in the future by any social distancing guidelines and government mandated shelter in place orders that would prevent our sales representatives in our MRO business segment from visiting customers in person. Shelter in place orders also reduce customer visits to our Bolt branch locations. The reduction of operations and temporary shut down by many of our customers in response to COVID-19 has also negatively impacted sales
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and our ability to collect on existing credit balances, and we expect to be impacted by those reductions and shut downs in the future. Further, vendors who are negatively impacted by COVID-19 may temporarily shut down operations or have difficulty obtaining inventory, which could negatively impact our ability to fulfill customer orders.

Certain items on our balance sheet require judgments on their valuation, including intangible assets and goodwill. These valuations are based on assumptions that take future financial performance into account. COVID-19 may have a detrimental impact to our future financial performance that would require us to revise assumptions about future financial performance and impair the value of these assets. Although the Company believes that its 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.

All Lawson employees have been encouraged to follow the recommended social distancing guidelines and work remotely whenever possible to reduce the spread of COVID-19 during the pandemic. The increased number of employees working remotely can exacerbate the risks previously mentioned in regards to internal controls and cybersecurity.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

The following table summarizes the repurchases of the Company's common stock for the three months ended September 30, 2020.
 (a) (b) (c) (d)
PeriodTotal Number of  Shares
Purchased (1)		 Average Price
Paid per Share		 Total Number of
Shares Purchased
as Part of Publicly
Announced Plans
or Programs		 
Maximum Number (or
Approximate Dollar
Value) of Shares that
May Yet Be Purchased
Under the Plans or
Programs (2)
July 1 to July 31, 2020357  $31.25  —  $4,512,000 
August 1 to August 31, 202011,720  36.22  —  4,512,000 
September 1 to September 30, 2020—  —  —  4,512,000 
Total12,077   —  

(1)    These shares were purchased for the purpose of satisfying tax withholding obligations of certain employees upon the vesting of market stock units granted to them by the Company.

(2)    In 2019, the Company's Board of Directors authorized a program in which up to $7.5 million of the Company's common stock may be repurchased from time to time in open market transactions, privately negotiated transactions or by other methods. No shares were repurchased in the open market during the third quarter under this program.
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ITEM 6. EXHIBITS
 
Exhibit #
31.1
31.2
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101.INS101
The following financial statements from the Quarterly Report on Form 10-Q for the quarter ended September 30, 2020, formatted in Inline XBRL: (i) Condensed Consolidated Balance Sheets, (ii) Condensed Consolidated Statement of Income and Comprehensive Income, (iii) Condensed Consolidated Statements of Stockholders’ Equity, (iv) Condensed Consolidated Statements of Cash Flows, and (v) Notes to Condensed Consolidated Financial Statements.


104The cover page from the Quarterly Report on Form 10-Q for the quarter ended September 30, 2020, formatted in Inline XBRL
101.INSXBRL Instance Document
101.SCHXBRL Taxonomy Extension Schema Document
101.CALXBRL Taxonomy Extension Calculation Linkbase Document
101.DEFXBRL Taxonomy Extension Definition Linkbase Document
101.LABXBRL Taxonomy Extension Label Linkbase Document
101.PREXBRL Taxonomy Extension Presentation Linkbase Document


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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
LAWSON PRODUCTS, INC.
(Registrant)
Dated:October 29, 2020/s/ Michael G. DeCata
Michael G. DeCata
President and Chief Executive Officer
(principal executive officer)
LAWSON PRODUCTS, INC.
Dated:October 29, 2020(Registrant)
Dated:October 26, 2017/s/ Michael G. DeCata
Michael G. DeCata
President and Chief Executive Officer
(principal executive officer)
Dated:October 26, 2017/s/ Ronald J. Knutson
Ronald J. Knutson

Executive Vice President, Chief Financial Officer, Treasurer and Controller

(principal financial and accounting officer)


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