MSC Industrial Direct Co Inc (MSM) 2003 Q1 法說會逐字稿

Good morning.

My name is Sharette and I will be your conference facilitator.

At this time I would like to welcome everyone to the MSC Industrial Direct First Quarter 2003 Earnings Conference Call.

All lines have been placed on mute to prevent any background noise.

After the speaker's remarks, there will be a question and answer period.

If you would like to ask a question during this time, simply press star and the number '1' on your telephone keypad.

If you would like to withdraw your question, press star then the number 2 on your telephone keypad.

Thank you.

Ms Hatton, you may begin your conference.

Thank you Sharette and good morning everyone.

Thank you for joining us today to discuss MSC Industrial Direct's First Quarter Fiscal 2003 results.

You should all have received a copy of this morning earnings announcement.

If you have not yet received the release please call our offices at (212) 850 5752.

Also an online archive of this broadcast will be available within one hour of the conclusion of the call and will be available for three business days at www.mscdirect.com.

Let me take a minute to reference the safe harbor statement under the Private Securities Litigation Reform Act of 1995.

This conference call may contain forward-looking statements that are subject to significant risks and uncertainties, including the future operating and financial performance of the company.

Although the company believes that the expectations reflected in it's forward-looking statements are reasonable, we can give no assurance that such expectations or any of it's forward-looking statements will prove to be correct.

Important risk factors that could cause actual results to differ materially from those reflected in the company's forward-looking statements are included in today's earnings release and in the company's filings with the Securities and Exchange Commission.

The information contained in this conference call is accurate only as of the dates discussed.

Investors should not assume that the statements made in this conference call remain operative at a later time.

The company undertakes no obligation to update any information discussed in this conference call.

With that said, I would like to introduce you to MSC Industrial Direct's Chairman and Chief Executive Officer, Mitchell Jacobson.

Thanks Lynsey.

Good morning everyone and thank you for joining us today.

With me are David Sandler, Executive Vice President and COO, Chuck Boehlke, Executive Vice President and CFO and Shelley Boxer, VP of Finance.

I will begin with an overview of the first quarter of Fiscal Year 2003 and our expectations for the second quarter.

Then we will cover our performing model and Chuck will provide details on first quarter's financials.

Following Chuck, I will wrap up and open the line for questions.

Before getting into the quarter's results, I would like to congratulate Chuck Boehlke on his promotion to Executive Vice President.

Chuck has played a pivotal role in managing and improving the company's financial operations.

His leadership and professionalism have been essential in strengthening the company's foundation and in positioning MSC for profitable growth.

We are all very proud of Chuck's achievements and this promotion is an acknowledgement of his contribution to our company.

Congratulations Chuck and thank you.

Our results for the first fiscal quarter were excellent.

We exceeded our own expectations delivering 57% growth in net income and approximately 12% growth in revenues, that's compared to the first quarter of 2002.

We generated incremental operating income of 34% of the incremental revenue dollars.

However, please remember that our read-through percentage will vary quarter to quarter, but over time will be in the 25% range.

We exceeded the 25% expectation in the quarter, as our gross margin improved beyond expectations and expenses came in a little below planned.

We are continuing to execute our model, gain share and generate the leverage that is built in to our company.

Chuck will provide more details in his portion of the presentation.

We are now almost six weeks into the second quarter and we have just completed the holiday season.

After a good start to the month of December, sales during the two weeks of Christmas and New Year have declined considerably, as activity in the manufacturing sector was greatly curtailed due to the extended holiday shutdowns.

Several revenues were below our internal forecast by an amount indicating what we believe was an anomaly, but one that limits our visibility on the quarter. ... this week volume is returning close to our forecast for the month.

Lost revenues from the holiday season won't be made up.

If we regain our momentum then we can hit the upside of our guidance or perhaps a bit more.

But if we don't, then we feel that we need to temper expectations, it's just too early for us to know for sure.

Subsequently, we think that second quarter revenues will be in the range of $205m to $210m and EPS for the quarter between 16¢ and 18¢ per share.

We know that this news tempers our success in Q1.

However, we are very confident that although our December was a difficult one, we gained share and that the environment for the smaller distributors that control the market is growing ever more threatening.

Small businesses give bonuses in December as well as raises. 2002 was a very tough year, December had to have exacerbated the difficulty.

We are very confident that as a result we are going to gain share and momentum in January, February and March through recruiting wins as well as the cap wins as our smaller competitors are forced once again to pull back on investment in their business.

Thank you and now I will turn the microphone over to David.

Thank you Mitch.

I would also like to offer my congratulations to Chuck on his promotion.

Chuck's leadership and the progress he has brought to the organization as well as his vision and drive for the future has made him a major contributor to the company.

I can tell you that the synergy that has developed between us will speed the realization of the leverage built into our infrastructure.

Congratulations Chuck.

I would like to start by discussing what we are hearing and seeing in the field.

It's clear to us that the economic recovery has had minimal impact on the industrial sector.

Employment in that area has shrunk for 28 consecutive months and activity is still well below the levels of the fall of 2000.

Recent macro indicators have not been encouraging and while the most recent ISM index was positive, it does not seem to reflect what we are actually seeing in the marketplace.

However, MSC is growing and we are executing our model and taking share.

All of our regions continue to grow in Q1 with the mid-west leading the way with high teens growth rate.

All other regions grew in the vicinity of 10%.

The investments we have made in prospecting, new SKUs, our sales force, our e-commerce platform all locked wrapped into our solution selling approach, are paying off in share growth as we are continuing to invest and to execute our model at historically high levels.

I am confident that this combination will drive excellent sales and earnings growth over the long-term.

This was re-enforced to me during a recent visit to a small hand tool manufacturer in New England.

The owner of the company was striving for ways to reduce his costs and improve profitability.

It was our total cost reduction solution that convinced this customer to consolidate his purchasing to MSC.

As part of that solution we had installed our VMI system at this customer and early results from the program were very encouraging.

As I toured the plant with the owner, he cited the reduced costs from lower inventory investment, elimination of out of stock problems, the significant time savings associated with ordering and the consolidation of invoices and deliveries, coupled with the ability of our sales associates to solve his purchasing and stocking problems, were the major reasons for moving to MSC.

While his overall business is flat versus last year, we expect our business with this customer to double to approximately $100,000 annually.

No doubt, that customer by customer, we are proving that we can save them money and they are responding by giving us more of their business.

These types of wins build the foundation for continued double-digit revenue growth when the sector recovers.

Turning to the details for the quarter.

Once again, I am very pleased to report that the execution of our model continues at very high levels and our metrics are coming in at target levels or better.

Our customers tell us that our service is the best in the business and that is one of the reasons we gain share and ensure future growth.

Overall sale rates continue at 99% and all distribution centers hit their first pass ... rate goals.

Accuracy levels continue to be excellent, with run rates at about one error per thousand.

Call center staff continue their high levels as well.

The call abandonment rate was less than 1% and we averaged 61 calls per associate per day.

We will no longer be reporting the order of call ratio as it has lost its usefulness as a metric as our businesses change.

The advent of electronic commerce and the changes in how we operate our call centers have outmoded this metric.

We are in the process of developing expanded metrics that we can in its place.

As we still view the marketplace with some caution, we will continue to manage our field sales hiring quarter-to-quarter.

We ended the first quarter with 454 associates and plan to maintain approximately this number in the second quarter.

In the first quarter, we mailed 9m pieces of mail, about as expected, as we resumed higher levels of prospecting.

By concentrating our efforts in more productive sectors, we continue to generate excellent overall response rates.

We generated more new customers in the first quarter of this year than we did in last year's first quarter.

Our total customer count was 334,000 at the end of the first quarter compared to 329,000 last quarter and 327,000 in last year's first quarter.

We are implementing some additional process improvements in Q2 and consequently our mailing program will be reduced slightly to approximately 8.6m pieces in the next quarter.

Sales to the manufacturing sector grew by 9% in Q1 and sales to non-manufacturing grew 20%.

The sales split remained at 75%/25%, manufacturing versus non-manufacturing.

And our average order size increased to $223 in the first quarter.

MSCdirect.com continued it's extraordinary growth in the first quarter.

Sales through the site were $20.3m now representing 9.7% of consolidated sales with and annualized run rate of $83m.

This represents growth of approximately 70% over the first quarter of fiscal year 2002.

Our national accounts program also continues to be successful.

Competition in this area is very heated and customer wins are watched by all of us in the marketplace.

As a result, in order to shield our sales team from unnecessary pressure from the competition, we have decided to no longer include detailed information on this program.

We apologize for any inconvenience to our shareholders but assure you that this decision has been made with a view towards the long-term interests of all of you.

In conclusion, I am extremely pleased with our performance in the first quarter.

We executed our plan and gained sales momentum through the quarter.

However, we remain cautious based on the holiday season and what we are hearing from our customers.

I will also take this opportunity to express my thanks and appreciation to all of our MSC associates who continue to stay focused and execute at such high levels.

Thank you and I will now turn the microphone over to Chuck.

Thank you David, Mitch and everyone for the congratulations and the vote of confidence.

In particular, let me say thanks to the finance team whose hard work and efforts have been a significant contributor to our overall progress.

Turning to the quarter, we completed an excellent quarter financially and exceeded our financial goals.

As you know, we have committed to grow operating income by 25% of our sales increase in fiscal year 2003.

As we have said in the past that commitment is based on the entire fiscal year.

Seasonal factors may result in some quarters being either higher or lower than the 25%.

In the first quarter, we beat the 25% yardstick, generating 34% incremental margin on our sales increase.

This was extraordinary and was favorably impacted by higher than expected gross margins and spending that was somewhat less than expected.

The favorable gross margin was helped by modest price increases, favorable product mix, the efforts of our product teams to increase margins through purchasing power and also by higher than expected terms discount.

In the second quarter, we expect to see a modest decline in gross margin.

As noted, our expenses were less than expected in the first quarter and we expect that we will catch up in the second quarter.

Overall, we expect that our marginal increase in operating income in the second quarter will be close to the 25% goal versus Q2 of last year.

Turning to our balance sheet.

We continue to produce excellent results.

Cash flow for the quarter met expectations as we generated $7.8m in free cash flow.

Depreciation and amortization once again exceeded capital expenditures as net fixed assets declined $1.5m.

MSC will continue to generate significant free cash in fiscal year 2003.

Our free cash balance grew to $65m at the end of the first quarter and currently stands at $69m.

Since our last conference call, we have not re-purchased any more company stock, although the program is still active.

Working capital grew in the first quarter reflecting higher levels of sales.

DSOs increased to 43.5 in the first quarter from 41 at the end of last quarter.

We attribute this increase to the late Thanksgiving holidays, which came at the very end of the month.

Inventory terms continued at 2.2 in the first quarter even as we added $8m in inventory.

Our return on average equity significantly exceeds our average cost of capital as pre-tax return on average equity was annualized at 17% in the first quarter, 20% excluding our cash balances.

Summing up, we had an excellent quarter financially.

We exceeded our expectation on improved operating margins, delivered solid cash flow and continued to manage the balance sheet.

Thank you and now I will turn the microphone back over to Mitch for the wrap up.

Thanks Chuck.

The environment may lack visibility but we are not sitting back.

We continue to invest in improved processes in order to remove structural costs from this business, gain share through focused marketing and sales programs and to generate significant amounts of cash.

We are strengthening our platform in order to prepare this company for the growth that will come when the manufacturing environment improves.

Q1 leverage gave us all a window on the type of leverage that is embedded in our business.

We are committed to use this time of uncertainty to relentlessly take share from the market and continue to drive embedded leverage into this business.

Thank you and we will open the line to questions.

At this time I would like to remind everyone, in order to ask a question please press star then the number '1' on your telephone keypad.

We will pause for just a moment to compile the Q & A roster.

Your first question comes from Holden Lewis of BB&T.

Morning gentlemen.

Could you just speak a little bit more on the gross margin side?

I guess I am particularly curious what the costs are that are going to be coming back that might diminish the gross margin a little bit in Q2, just a little bit more detail on that.

Then also some comment with regards to the higher discounts that you were expecting.

You know what kind of volume improvements are you expecting or is there any risk that the estimates you are plugging into Q1, you might need to eat it off of, if demand doesn't come back at all?

Holden, this is Chuck.

The terms discounts relate to the fact as we indicated, if you follow our balance sheet, our inventory backed it up.

We have more purchases in the first quarter, it was strictly a function of higher purchasing generating more discounts than we had originally planned in to our margin and they flow dollar for dollar as soon as we recognized that related to our gross margin.

So that was the circumstances surrounding that.

We did face slight moderation in margin, when we say slight that's what we mean.

We think that the discounts may not be as strong in the second quarter.

We have also taken advantage as we have mentioned on other calls and had significant success in the first quarter regarding some one-time purchases where we have worked with our suppliers who have the opportunity for us to take more volume than a normal purchase, giving us an opportunity to have a very significant purchase price reduction.

I don't know that those will be recurring throughout the quarter.

So we think the fundamentals are still solid in the second quarter, it's some of those minor items that may cause a slight moderation in the second quarter moving forward for the year.

Okay, but on the discount issue.

The discounts that you apply to that increase in inventory, I mean those are agreed upon between you and your vendors at the beginning of the year and are based on some assumed improvement or growth in your purchases from those companies which may not materialize if the revenue grows or the demand doesn't come back.

Is that right?

And if that is right, is there a risk here if market demand does not pick up as the year progresses that you might have to unroll some of those into the second half?

Holden, Chuck again.

No, just to clarify.

You might be thinking of rebate.

These are literally cash discounts, kind of 2% 10 days, 1% 10 days, those kinds of discounts, not any kind of rebate programs that may have been established and set up which would be more along, I believe, what you just described.

So this is more a function of financial discounts for paying bills early or extra discounts that have come about because we are taking additional purchases and volume in exchange for more favorable discounts.

It's not necessarily, not at all actually, the rebate program, which is completely separate.

Okay, great thank you.

You're welcome.

Your next question comes from David Mathy of Robert W Baird.

Hello everyone.

Congratulations Chuck.

Thanks David.

My first question is did you give a number for the December average daily sales and then do you plan on releasing that going forward at some point?

David, it's David, how are you doing?

I'll take the first part of the question.

December actually came in at about 10% versus prior year.

I just want to remind everyone though that the first half of the month, the first two and a half weeks or so, we continued with our first quarter momentum.

But the second half of the month, frankly we fell off a cliff.

I mean the holiday period was very rough.

David this is Mitch.

On the second part of the question on monthly sales, we raised it at our board meeting and the board continues to prefer that the company be looked at over a longer term and has resisted I guess the announcement of monthly sales.

Okay.

In looking at the, I understand your conservatism, but in looking at the numbers for what you have just said here.

December came in at plus 10, the previous three months I believe were also plus 10 and if you had a weak holiday season that would imply that the beginning part of December was stronger.

Then if I look historically from an earnings standpoint, we have never seen EPS in the second quarter lower than the first quarter.

One time, I think it was flat since 1995.

Could you just talk about how things are going here in January?

Are things, I think you said they were okay in the beginning part of January, but you know I am just trying to understand why you are so conservative here in this quarter?

Sure, it's David again.

I mean the big issue that we have is, we are just not certain David, to what level it's going to come back.

I mean we are only three days in from the holiday period and that's the issue that we have is the holidays were so far below plan, frankly they rocked us back.

Certainly we are coming back to our forecast in the first three days, but the problem is that we just don't know yet given the number of data points that we have, at what level they are going to fully return to.

So we wanted to temper expectations and be more conservative and frankly to the extent that you know, they fully come back will be more towards the mid or higher end of the range or hopefully perhaps even higher, but to the extent that they moderate and they don't will be more towards the middle or perhaps the lower end.

Again, the point is since the holiday period ended for us, we have literally only had the three days and it's just not enough data to accurately call it.

So we would rather be what is hopefully on the conservative side, but we will see.

And one last question on share count.

Looking at where the number is today relative to re-purchase and options.

I'm just trying to get a read on, if we saw the stock price here in this range during the next quarter.

About where do you think the share count would be diluted?

It's Chuck.

We've been at this range before so I would say you know rather than trying to predict a price, if you assume that we are approximately where we are right now I think the diluted impact we have picked up at least somewhere in the neighborhood of another million shares on the EPS calculations.

So a million shares between the average for last quarter and where we are today?

Well from where we are today, without predicting what the stock price is going to be obviously during the quarter.

Okay.

If I predicted 18 though, would it be a million shares?

That would be pretty close, yes.

Okay, thank you.

You're welcome.

David, it's Shelly.

Before we go on, I just wanted to go back and tell you what the growth rates were for each of the three months of the first quarter.

September was actually 10.9%, October 10.8%, but November perked up at 13.2%.

Momentum from the early part of December were good and then like a tremendous turnaround over the holiday season and as David said, we are now three days passed it and feeling a significant lack of visibility right now.

So if we were two weeks from now, we would be able to tell you what happened in the early part of January and maybe be a little bit more concise about revenue range.

But for now, I think we want to take call it a temporary outlook on the second quarter.

Okay, that's understandable.

Thank you very much guys.

Once again, I would like to remind everyone, in order to ask a question please press '' then the number '1' on your telephone keypad.

Our next question comes from Greg Bristow of Laurie Agget.

Hi, thank you.

I was wondering about the average order was $223?

Now that seems that it's risen from the previous.

Is there any meaning to that?

Hi Greg, it's David.

Yes, it is up slightly from the previous quarter.

And basically it's a reflection of our mix of business.

We are getting larger order sizes from some of our larger customers and with that all in the mix, that's really what is driving it.

We really don't see that economic activity is largely the factor behind it Greg.

And they didn't order early in December and make some bigger orders and perhaps that's the reason for the fall-off in the second half of December?

No, we think it's largely a mix business with the types of customers buying.

And how many national accounts do you have at this point?

Greg, we've chosen on this call to begin to back off of the details that we have been sharing on the national accounts for competitive reasons.

So we would rather not share that going forward.

Okay.

And on a long-term basis is this, the number of sales associates, do you expect that to stay around 460, 470 something like that?

Certainly what we have said right now is that we are going to continue to maintain the range that we are in right now.

Okay, alright, thanks.

Thank you.

Your next question comes from Peter Lauren of Federated Fund.

Yes, the Port of Hong Kong has reported that US reports to Hong Kong were up dramatically in October about 40% and then again in November about 40%, which made me think the industrial sector was coming around.

Are your customers too small to be participating in that type of export traffic or what?

Peter, I'm not sure that I can really comment on the correlation between our customers' buying patterns and what you are seeing reporting on exports.

What I can tell you is that our customers, large and small across the board, generally speaking are not seeing much in the way of economic recovery.

Certainly there are geographic pockets and also customer segments, but there is a lot of inconsistency.

Frankly there's a lot of uncertainty out there and we are just not seeing the economy really contributing to any type of an uplift right now.

Okay.

Your next question is a follow-up question from Holden Lewis of BB&T.

Great, thank you.

Just to close the books on the accounting issues you guys went through earlier last year.

There are a number of law suites that were filed after the fact and as bogus as they look, is there going to be any, what's going to be the cost of defending yourselves against those law suites at this point?

Just ... the numbers, is it going to be material, is it something you need to watch for?

Holden, Chuck again.

Two things, we incorporate any cost that we believe we would be out of pocket for this entire event in the fourth quarter of last year.

So we believe what we have put away is adequate and for the most part that's behind us.

So we don't anticipate any incremental costs to the P&L moving forward.

Regarding the litigation, it's just started.

It's a process, the complaints have been consolidated and then the complaint has been filed, so we are just basically starting with the process right now and as we understand it, that will take several months before we have any kind of movement on the case one way or another.

Okay thanks.

You're welcome.

Once again, if you do have a question, please press star then the number 1 on your telephone keypad.

At this time there are no further questions.

Okay thank you very much all.

We appreciate you all being on the call this morning.

Bye bye.

Thank you for participating in today's conference call.

You may now disconnect.