MSC Industrial Direct Co Inc (MSM) 2004 Q1 法說會逐字稿

Good morning.

My name is Amanda and I will be your conference facilitator today.

At this time I would like to welcome everyone to the SMC Industrial Direct first quarter earnings conference call.

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

After the speakers' remarks there will be a question and answer period.

If you would like to ask a question during this time simply press star then 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.

I like to turn over to Mr. Eric Boyriven.

Sir, you may given your conference.

Thank you and good morning, everyone this is Eric Boyriven of Financial Dynamics and I'd I can like to welcome to the you to the MSC industrial direct fiscal 2004 first quarter con friend call.

You should have received a copy of this morning's earnings Announcement.

If you have not received the release, call the offices at 212-850-5752 and a copy will be sent to you.

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

Certain information pertaining to non-GAAP financial Measures that may arise during this broadcast can also be found at the same website in the investor relations section.

Let me take a minute to reference the Safe Harbor statement under the private security 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 its forward-looking statements are reasonable it can give no assurance that such expectations or any of its forward-looking statements will prove to be correct.

Important risk factors that can cuss actual results to differ material from those reflected in company's forward-looking statements are included in today's earnings release and the company's filings with the securities and exchange commission.

In addition, the information contained in this conference call is accurate only on the day 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 on this call.

With that said I would like to introduce Mr. Mitchell Jacobson.

Thanks for joining me today.

With me are David Sandler our President and Chief Operating Officer, Chuck Boehlke Executive Vice President and CFO, and Shelley Boxer, Vice President of Finance.

I'll begin with an overview of the first quarter of fiscal year '04 and our expectations for the second quarter of '04 David will cover our fulfillment model and Chuck will provide details on the quarter's financials.

Following Chuck I'll wrap up and open the line for questions.

MSC generated accelerating revenue growth in Q1 and has continued into the second quarter.

We saw growth in the manufacturing sector for the first time since the second quarter of last year.

We continue to execute our plans with outstanding results as we maintain our superior customer service model, leverage our position as a market leader, take share, and grow.

Product mix and pricing discipline enabled us to beat gross margin target for the first quarter, and we once again exceeded our expense control objectives.

Our reap during Q1 was 54%.

And operating income grew 32% versus last year' Q1.

We are very pleased to report that operating income rose to 12.1% of sales.

We expect to maintain our operating margins in the double digits as we capitalize on the leverage inherent in the business and our cost reduction initiatives continue to gain momentum.

Overall, net income grew 32% and EPS increased by 26%, to 24 cents per diluted share from 19 cents per diluted share in Q1 of '03.

We generated free cash flow of $11.7 million versus $7.8 million in Q1 of last year thus exceeding our expectations due to the continued success of our asset management program.

We would like to provide guidance for the second quarter of 04.

Affirming of demand in the financial sector is reflected in our expectations.

Consequently, we expect revenues to be in the range of 227 to $233 million with earnings per diluted share in the range of 24 to 26 cents.

Thank you, and I'll now turn the call over to David.

Thanks, Mitch.

Before getting into my usual report, I'd like to quickly address any concerns about my medical condition.

We released this information upon advice of counsel, and in the interests of full disclosure and good corporate governance; however, this is not a life-threatening condition nor must it be treated immediately.

It can be treated by a variety of means, and I'm still continuing to seek medical advice before making any decision.

Should I elect surgery, I fully expect to return to work after a short recuperation.

I have completed confidence that there will be no disruption to our business.

Many thanks to everyone for their concern and support.

Turning now to my update, I will begin by sharing what we are hearing and seeing in the field and sharing some observations from my recent customer visits in the northeast and mid-Atlantic states.

It's clear that the industrial sector is beginning to strengthen.

For some customers more job quoting activity is being generated by their customers which they indicated is a prelude to new orders in the future.

For other customers their order flows have increased.

Some of the businesses that are expected to close for the two-week holiday season shortened or eliminate their expected shutdowns; however there, was still a considerable slowing of activity during that time.

The ISM trend continues to be positive, which is very encouraging, especially considering the strength of the most recent report.

It's also encouraging that manufacturing employment is finally growing.

Our customers say their hiring is still spotty, but it's happening for the first time in quite a while.

We continue to execute our model, take share, and grow.

My recent visits to customers, a distribution center and some branches reinforce my belief that our model is even mow valuable during a recovery.

Small distributors will have more difficulty servicing their customers as they have dramatically reduced their own inventories and their customers often cannot wait for drop shipments from manufacturers.

There is less price shopping going on and more of the need for speedy delivery.

Our smaller customers seem to be holding their own and building a book of business.

Here are some of the things I heard from our customers during my recent visits, and I'll quote. “We're giving more of our business to MSC because the ordering experience is fantastic.” “I can give faster turnaround time to my customers because of your support.” Another customer told me "At the end of the day we must have a tomorrow, and we only trust MSC to do that." still another, "We are transferring almost all of our business to MSC because the breadth and depth of MSC product selection, the overnight delivery, and the one-stop shopping makes MSC the go-to-guy."

I heard these themes over and over again.

While we're clearly not at the stage yet where I can say that things are hot, we are definitely seeing the first signs of firming.

We are seeing growth in sales to the manufacturing sector which grew 2-1/2% in Q1 and remained at 72% of our total business.

Sales for the non-manufacturing sector grew 15% in Q1.

Overall, MSC growth rates were 5% in September and October, 7% in November, and 8% in December.

Average transaction size grew to $229 dollars in Q1 to $224 in Q4.

Our program to penetrate the government sector and the postal service in particular remains on track although it is not yet significant.

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

Turning to the details for the quarter, overall fill rates continue at about 99% and the DC's hit their first pass rate goals.

Accuracy levels continue to be excellent with an error rate of less than 1 per thousand.

Call center staff continued at high levels as well.

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

We ended the first quarter with 412 field sales associates.

The decline in the sales force numbers since the end of Q4 should be the low point, as we set the stage for expansion by hiring outstanding new sales associates.

As we discussed in our last call, our plan is to expand our sales team, and we are still expecting to reach a level of about 440 to 450 sales associates by the end of the third quarter.

In fact, we've recently hired nine new sales associates.

Productivity is definitely increasing, and we’ll continue to grow our sales force within the context of our desired read-through to the bottom line.

In the first quarter we mailed 7.7 million pieces of mail, about what was initially planned.

We continue to generate excellent overall response rates.

Total active customer count was 345,000 at the end of the first quarter compared to 343,000 last quarter and 334,000 in last year's first quarter representing an increase of 3% over last year.

We expect that we will mail approximately 7.3 million pieces in the second quarter versus 8 .7 million pieces in the second quarter last year.

As noted in the last conference call, the improvements we have made over the last two years have allowed us to reduce our regular circulation and prospecting mailings in FY 04.

We have reduced regular mailings to customers to generate marginal sales and we have reduced pro inspect levels below those in '03 but are still above historical levels.

All of our regions continued to grow sale in the first quarter, the southeast was the strongest at 10% followed closely by 8% in the Midwest and west, and the northeast grew at 3%.

Mscdirect.com's outstanding growth continued in the first quarter.

Sales through the site grew to $27.6 million representing 12.4% of consolidated sales with an annualized run rate of $113 million.

This represents growth of approximately 36% over the first quarter of FY '03.

We will now also begin reporting all the E-Commerce revenues as well.

This includes revenues from our other website, our internet alliances and our BMI business as well as MSC direct.com.

Total Ecom revenues in the quarter were $40.2 million or 18% of consolidated sales, up 33% versus last year's Q1 total Ecom revenues of $30.2 million.

In conclusion, I'm extremely pleased with our performance in the first quarter, and we are confident that we can continue to significantly outperform the sector for the foreseeable future.

Our focus on flawless execution has been rewarded in the marketplace and as long as we continue to execute, we will continue to grow and take share, driving outstanding performance.

I'm gratified that we have delivered or exceeded expectations on all of our commitments over the past six quarters.

Our team has consistently stepped up their performance, and I'd look to 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'll now turn the mike over to Chuck.

Thank you, David.

Once again, we have completed an excellent quarter financially and exceeded our financial goals.

In the first quarter we beat the 20% REIT through yardstick generating 54% incremental operating margin on our sales increase.

Compared to the first quarter of fiscal '03 there is a decline of about $800,000 in operating expenses reflecting less depreciation, amortization, as volume and inflationary cost increases were offset by improved productivity and variable expense leverage.

We will experience some increases in operating expenses in Q2 due to sales hires and volume increases.

Gross margin came in at 45%, 10 basis points above the expected range, and we expect Q2 to be approximately the same.

Operating income grew 32% and rose to 12% of sales from 9.7% in Q1 of last year.

We have said previously that we are committed to at least 20% read-through in fiscal year '04.

After interpreting Q1 results and seeing our increasing growth rate we feel comfortable raising the full year commitment to a 25% read-through.

Turning to our balance sheet, we continue to produce excellent results.

Cash flow for the quarter exceeded internal expectations as we generated $13.9 million in operating cash flow and free cash flow after capital expenditures of $2.2 million with $11.7 million.

Depreciation and amortization once again exceeded capital expenditures as net fixed assets declined in the quarter.

We expect free cash flow to continue to be positive in fiscal year '04.

Our free cash balance grew to $133.8 million at the end of the first quarter and is currently at approximately $140 million.

Working capital, excluding cash, increased by $8.8 million in the first quarter reflecting an increase in receivables.

DSO's increased to 43 days in the first quarter from 40 days at the end of last quarter due to the Thanksgiving holiday falling at the end of the fiscal month.

Inventory turns increased to an annualized 2.43 turns in the first quarter from 2.25 for Q4.

In summary we had an excellent quarter financially.

We exceeded our expectations on earnings, read through percentage and improved operating margin.

We delivered excellent cash flow and continued improved balance sheet management.

Thank you, and now I'll turn it back over to Mitchell for the wrap-up.

Thanks, Chuck.

In December of 1995 our company went public.

At that time we had one significant distribution center in Atlanta and about 170,000 SKUs, just over 100 salespeople, and operating systems that required upgrading in order to be leverageable.

But we had one more item which was a bit less tangible.

We had a vision and we had a plan.

We have executed on much of the plan and now have over 540,000 SKUs, more state of the art DCs, 400+ salespeople, scalable systems including a fully integrated website and best of all, a seasoned management team in place.

About a year and a half ago we told our shareholders that the time had come to leverage what we had built, and we set out to do so.

I'm proud to note that we have delivered on that commitment for the last six quarters and expect to continue to do so for the foreseeable future.

Our company is poised for the manufacturing recovery and positioned through our focus on other sectors of the economy to create a platform that will perform more consistently in uneven environments in the future.

We have proved ourselves capable of doing so for the last 18 months.

Our operating margins continue to grow as customers reward our value-added focus.

We expect that trend to continue as we drive our six signal approach to expense control and enjoy the leverage inherent in our infrastructure.

Thanks for your attention this morning, and Amanda can we open the lines to Q&A.

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

Your first question comes from Holden Lewis with BBNT.

Morning, thank you.

Just a little bit of housekeeping business here, you had mentioned the changes or the sales rates for the various months of the quarter.

Could you just go over those again?

And then secondly, can you give a little more explanation why DNA is so much lower than it has been of late and whether it's expected to continue going forward?

And then, you know, why, it looks like the tax rate was a little bit higher than kind of your full year last year.

Is that just early year conservative or what can we expect there?

Sure, it's David, and I'll start first and then Chuck will jump in.

The monthly sales numbers through the quarter was 5% in September, 5% in October, growing to 7% in November, and then building to 8% in December.

Okay.

Thank you.

Holden, from the depreciation point of view, the number was down in the first quarter most definitely because we're realizing now that some of the asset investment we made and the build out particularly of our website in the past years, it's dropped off, and so we would expect that that number that you saw on in the first quarter, the lower depreciation amount, now that that is completely amortized will continue throughout the year.

Regarding the tax rate, we made a catch-up last year strictly based on what we thought the full-year number would look like sometime during the second quarter we had some settlements, some favorable settlements with the IRS.

We had some charitable contributions that were not ongoing events but things that were definitely reflected on the tax rate last year and not this year as those events are not yet known to the normal 39-1/2 that we normally book.

You're expect 39-1/2 for the year.

That's the case right now, yes.

All right.

Thanks.

Your next question comes from Yvonne Forano with CIBC.

I know we talked about the salespeople that you're going to be adding.

Can you give us an idea of how many of those might be dedicated to filling out the Nevada facility?

Yvonne, it's David.

We don't actually talk about how or where we add our sales force for, you know, for all those competitive reasons so I'd rather not go there.

Okay.

The second thing is I know you increased the read-through to 25% from 20%.

Could you give as a little more color on what you're seeing in the business that gives you more confidence that you can achieve the 25% even with the additional sales people going on in.

Right, Yvonne it's Chuck.

Obviously what we saw in the was pretty substantial in the 50s.

We've kind of talked about this in the past and said that really anything above the 25% we would reserve the right in management to either read that through earnings or in some cases reinvest back in the business.

What we have decided to do this year based on what we see is commit to the 25, but as David mentioned, adding back to the sales force taking that back up to 440 and 450 in addition to the salaries, of course, all the normal expenses you would have with potentially relocation and hiring fees, but we're still confident we can make that 25% based on what we've seen both in the first quarter and the expectations that our growth will continue throughout the year.

Yvonne, I think the reason for coming out with the 20% out of the gate was coming off a 3% growth in Q4 of last year and being very conservative about the revenue line, and I think we've consistently said at higher inclines of growth we can do better, and I think that's giving us confidence right now.

Okay.

Thank you.

Your next question comes from Jeff Gramata with William Blair and Company.

Good morning, congratulations on a great quarter.

Can you elaborate more on what's taking place in the field sales force in it's been slowly find winding down sequentially quarter to quarter.

You've changed the sales compensation structure to make it more variable.

Is this -- has this been planned attrition or unplanned attrition.

And you know, what guest you confidence that this is the right time to increase your investment?

Hi, Jeff, it's David.

Actually, I mean, the sales force program you, know, continues to be an important part of our growth plan, and we're very pleased with the performance that we've been seeing, the improved performance and productivity that we're getting from that team.

We've always said that as we saw the opportunity consistent with our read-through goals we would invest when we saw the right time.

We're comfortable that that time is now.

We have upgraded, as you mentioned, our conversation program which we think really fits the changing environment that we're now in.

While we are comfortable with the plan that we had over the last three years, we think that for this and ensuing years we've got an even better plan.

And one that is, you know, really fits the type of environment that we're in now.

We're comfortable with what we're seeing with turnover, most of it, the majority certainly is performance-based.

And that, you know, we expect to add some outstanding associates to an already terrific team that's out there, and I will tell you that for all the time that I spend with the field, I'm very comfortable that we're out there every day taking share and making a lot of good things happen.

Thank you.

Thanks, Jeff.

Your next question comes from David Mancy with Robert W. Baird.

Hi, good morning.

I was wondering if you could talk about big picture growth and profitability maybe over the next three to five years and just in terms of what will this company look like when we get out, say, five years from today in terms of growth, margins, salespeople, branches, things of that nature?

David, hi, it's David.

I guess probably the way I'd want to talk about it is maybe talk a bit about our vision for future growth.

You know, we've leveraged our business over the last couple of years, as you have seen in our financial results, and that's certainly something that we're going to maintain our commitment to expanding our operating margins and continuing to focus on improved productivity and improved growth in the business.

But, you know, the way that I guess we view the world and our vision for the future really remains clear, you know, we look at this whole universe of customer segments.

The full gamit of SIC, literally that are millions of potential customers out there who buy MRO, and for many years as you know we've been expanding our product lines which has given us the ability to further penetrate our core SICs-- in the manufacturing segment but it's also given us the ability that now have the products that customers buy in other segments as we're seeing, for example, in the government which is, you know, one of the important new segments that we have moved into.

It really opens up a whole new world for us, sectors like education I mentioned, government, hospitality, mining, petroleum, really just to name a few, so I mean our strategy is going to be to diversify our business into those segments and over time we fully expect to be the leading industrial distributor in our space.

Okay.

One other question on inflation.

Can you talk about your expectations for next year in terms of commodities prices now skyrocketing, and are you typically able or to what extent do you think you will be able to pass that along to your customers?

You know, David, we have seen in our gross margins, we've got a very strong franchise in terms of value-added proposition that our customers are comfortable paying for.

Historically we've certainly been able to pass along those increases associated with inflationary pressures in the marketplace as manufacturers place them through us.

Having said that, you know, I don't want to speculate and look through a crystal ball or begin to talk more about what could be happening moving forward.

Certainly for the next few quarters we're very comfortable and in fact anything that we're seeing in the landscape in terms of our gross margin guidance.

Okay.

Thank you.

Sure.

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

We do have a follow up with Holden Lewis with BB&T.

Good morning, thank you.

Could you just give a sense, you know, you sort of mentioned what you are expecting to do with regards to sales associates going from the 412 up to 440 to 450 ranges but just in terms of using the modeling involved with this, can you give us a sense of what that should translate into roughly in dollar terms that we should be adding into the SG&A or folding into?

Can you give a little guidance there?

Holden, I think it's more of a function of the sales growth rate as you go out to future quarters.

Obviously we're not going to talk about, you know, the compensation that we pay our sales associates, but we have given you an approximate number of hires that we have to put on the street, and certainly based on how the revenues grow for the back half of the year, that will determine what kind of percentage of sales that that represents to us.

You know, in the first quarter you saw us take the operating margins up to 12% from 9.87.

That's been a matter of what we've talked about all along our ability to leverage the business as we start to grow.

We can tell you that as we continue to see the growth for the rest of year that that kind of leverage should continue to read through the business which is the reason with the sales associates expense we feel confident committing to the 25% read-through.

In order to get the 25%, obviously, it was a very strong first quarter number, you know, that would imply that maybe you would be satisfied Q2 through Q4 coming in below 25% so it all blends out to 25%.

Is that a reasonable interpretation or you also were kind of targeting getting 25% per period, you know, so that in the end you might do a little bit better than that in aggregate?

Holden, I'll say, I usually say, the 25% commitment we've always viewed as a minimal commitment, so we provide that number to you so we have the flexibility should the number be above that to continue to invest in the business and do some other things, so I think it would be erroneous to jump and say the other quarters will be below so it averages 25.

The 25 is a minimal commitment on our behalf to you guys, and if we're above that, again, we'll reserve the right to either invest those funds into further areas or drop it through to earnings.

Got you.

Thank you.

Sure.

At this time there are no further questions.

I will now turn the call back to management.

We thank you all for listening to call this morning and wish you a great day.

Thanks, Amanda.

You're welcome.

Thank you for participating in today's conference call.

You may now disconnect.