MSC Industrial Direct Co Inc (MSM) 2004 Q2 法說會逐字稿

At this time I would like to welcome everyone to the MSC Industrial Direct Q2 2004 conference call. (OPERATOR INSTRUCTIONS).

I would now like to turn the call over to Eric Boyriven of Financial Dynamics.

Please go ahead, sir.

Thank you, and good morning everyone.

Again this is Eric Boyriven of Financial Dynamics.

And I would like to welcome you to the MSC Industrial Direct fiscal 2004 second quarter conference call.

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

If you have not received a release, please call our 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 of the conclusion of the call.

It will 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 web site in the Investor Relations section.

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 certain forward-looking statements that are subject to the 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, they can give no assurance that such expectations or any of its forward-looking statements will prove to be correct.

Important risk factors that can cause actual results to differ materially from those reflected in the 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 MSC Industrial Direct Chairman and Chief Executive Officer, Mitchell Jacobson.

Mr. Jacobson, Please go ahead.

Good morning everyone, and thank you for joining us today.

With me are David Sandler, our President and Chief Operating Officer;

Chuck Boehlke, Executive Vice President and Chief Financial Officer; and Shelley Boxer, Vice President of Finance.

I will begin with an overview of the second quarter of '04 and our expectations for the third quarter.

David will cover our fulfillment model and Chuck will provide details on the quarter's financials.

Following Chuck, I will wrap up and then we will open up the lines for Q&A.

MSC grew revenues by 10 percent in Q2, up from Q1's growth rate of 6 percent, and showed increasing momentum through the quarter and into March.

We saw growth rates in sales to the manufacturing sector increase over the first quarter and also gain momentum during the quarter.

We continue to execute on our strategic and operating metrics, and as a result leverage our position as market leader through continued market share growth.

While there has been some improvement from Q1, I would still characterize the macroenvironment as cautiously optimistic.

Industrial customers are not making commitments to investment or to staffing in any significant manner.

They are still under enormous cost pressure.

On a recent trip to our branches in Minneapolis, Detroit and Chicago we visited numerous customers ranging from job shops to national accounts and sites within the government and U.S.

Post Office.

One visit which characterizes the uncertainty among our industrial customers was a job shop which had recently won a contract for a sophisticated machine part.

As I watched the part being produced with MSC tooling the manager of the manufacturer described the free markets auction through which he secured the order.

The auction included bidders from Europe, Asia, including mainland China and the United States.

This specter of increased international competition will continue to put pressure on U.S. manufacturers.

Rest assured that we're well-positioned for two reasons.

First, we have only a tiny share of the industrial market, and second we're well along the path of diversification from our concentration in the durable goods sector.

For the quarter we were pleased to see that favorable product mix and pricing discipline enabled us to exceed our gross margin target for the second quarter, and we once again exceeded our expense control objectives.

Our read through in Q2 was 48 percent, and operating income grew 50 percent versus last year's Q2.

Operating income in the quarter rose to 13 percent of sales.

And we remain committed to returning this business to 15 percent operating margins.

Overall net income grew 45 percent, and EPS increased by 42 percent to 27 cents per diluted share from 19 cents per diluted share in Q2 of FY '03.

Looking outward toward Q3, we expect revenues to be in the range of 248 to $255 million, and earning per diluted -- earnings per diluted share to be in the 29 to 31 cent range.

Please note that the effects of increased investment spending on our sales force, much of which (technical difficulty) today, along with hiring to fulfill increased volume, will likely impact read through going forward.

Of course we continue to expect the minimum of 25 percent read through as discussed last quarter.

Thank you, and now I will turn it over to David.

I will start by sharing what we're hearing and seeing in the field, and sharing some observations from our recent customer visits.

The strengthening we began to see last quarter has continued into Q2, although I would not yet characterize the market as robust.

Customers are gaining confidence, but are generally not yet investing in new equipment or expanding facilities.

Hiring is still spotty.

With business beginning to pick up, MSC is benefiting from staying focused on the execution of our plan over the past few years as we see the share gains begin to be reflected in our growth rate.

Our model helps to reduce our customers' total procurement cost, and that is a very powerful selling tool in this era of severe cost pressures and increased global competition.

This was brought home to me firsthand during my recent travels in the Midwest.

I visited with the general manager of a large plastics fabrication plant.

He was relatively new to the job and had squarely put his focus on reducing his cost to remain competitive.

He explained to me that our field sales associate had presented a compelling case when communicating MSC's values, so he gave us an opportunity to earn his business.

Over the last several months our business with this customer has grown from virtually nothing to $10,000 per month and still growing.

The combination of reducing his vendor base, consolidating orders, reducing their out of stocks, and our e-commerce capabilities was the solution the general manager was looking for.

It is this kind of customer feedback that tells me that our model is perfectly suited for these times and is why I believe we will continue to outgrow the competition.

Overall consolidated MSC growth rates were 8 percent in both December and January, and 14 percent in February.

Our fiscal month of March will not end until this Saturday, but through yesterday our growth rate was 15 percent.

Average transaction size grew to $233 in Q2 from $229 in Q1.

Our program to penetrate the government sector remains on track and is growing nicely.

The ISM trend continues to be very positive with the last five months coming in at above 60, with today's report of 62.5.

Growth in our sales to the manufacturing sector has been accelerating coming at 9 percent in Q2 with sales to the nonmanufacturing sector growing by 12 percent.

Sales to the manufacturing sector represented 73 percent of our business in the second quarter.

Once again, I am pleased to report that the execution of our model continues at very high levels.

Turning to the details for the quarter, overall sell rates continue at about 99 percent.

Our DTs all hit their first pass for rate goals, with the exception of Reno as sales growth outstripped our budget and inventory plan.

Our purchasing team is doing a terrific job of making adjustments to bring this DT back to goal.

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

Call center staffs continued at high-levels as well.

Our call abandonment rate was less than 1 percent, and we averaged 60 calls for associate per day.

We ended the second quarter with 434 field sales associates, up from 412 at the end of Q1.

We continue to successfully execute on our hiring plan, adding many new talented associates to our team.

And we fully expect to meet our goal of 440 to 450 sales associates by the end of this quarter.

We will see the cost associated with those hires in Q3 and in future quarters.

In the second quarter we mailed 7.1 million pieces of mail, about what was initially planned.

We continue to generate excellent overall response rates.

Our total active customer account was 346,000 at the end of the second quarter, compared to 345,000 last quarter and 338,000 in last year's second quarter, representing an increase of 2 percent over last year.

We expect that we will mail approximately 7.1 million pieces in the third quarter versus 8.6 million pieces in the third quarter of last year.

Productivity from our direct-mail continues to increase with average sales per piece growing in each quarter of this fiscal year, and up from last year's Q2 levels as well.

All of our regions grew by approximately 10 percent in the quarter, including the Northeast which has been gaining momentum.

MSCdirect.com's outstanding growth continued in the second quarter.

Sales through the site grew to $30.6 million, representing 13.2 percent of consolidated sales with an annualized run rate of 123 million.

This represents growth of approximately 43 percent over the second quarter of FY '03.

Total e-com revenues also continued at strong growth in Q2.

Given how competitive this marketplace is we have had second thoughts and will no longer be disclosing total e-com revenues in the future.

In conclusion, I'm once again extremely pleased with our performance in the quarter.

We remain confident in our vision to significantly outperform the sector for the foreseeable future.

Our continuing focus on flawless execution is being 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 seven quarters.

The MSC team has consistently delivered outstanding performance, and I would like 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.

Thanks.

And I will now turn the mike over to Chuck.

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

In the second quarter we beat the 25 percent read through yardstick generating 48 percent incremental operating margin on our sales increase.

The high level of read through reflects the gross margin of 45.2 percent, slightly above the expected range due to favorable product mix, as well as the decline of about $650,000 in operating expenses in this quarter when compared to the same quarter last year.

The decline in operating expenses was due to less appreciation than last year, and volume and inflationary cost increases that were offset by improved productivity and expense control.

We expect to see increases in our expenses in Q3 as volume related increases began to outstrip productivity gains.

In addition to the previously announced sales force increase, we're hiring in several areas of the business, such as the DCs, call centers and then operational accounting.

Our commitment for at least 25 percent read through on incremental revenues remains unchanged for the balance of the fiscal year.

Gross margin of 45.2 percent in Q2 was slightly above expectations, and we would expect gross margin to be approximately 45 percent in Q3 as well.

In Q2 operating income rose to 13 percent of sales from 9.6 percent in Q2 of last year.

We're still committed to grow operating income to the mid-teens level by reading through at least 25 percent incremental operating margin on incremental sales.

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

Cash flow for the quarter was slightly below expectations at $2 million, as we invested approximately $19 million into receivables and inventory.

We also made some significant estimated tax payments in the quarter.

Overall working capital, excluding cash, grew $24 million in the quarter.

Inventory turns remain constant at 2.43 annualized turns, and DSOs decreased to 41 from 43 in Q1.

Free cash flow, after capital expenditures of $1.8 million, was $274,000.

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

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

Our invested cash balance grew to 136.8 million at the end of the second quarter and is currently at approximately $150 million.

In summary, we had an excellent quarter financially.

We exceeded our expectations on earnings, read through percentage and improved operating margin as a percentage of sales to the highest level in many years.

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

Spring marks the end of our strategic planning update and the beginning of our rollout for the team.

In June we will present and discuss our plan in-depth with more than 200 MSC leaders.

I can honestly say that although our Company founded in 1941 is 63 years old, we are in the early innings of our growth story.

Our five-year plan is filled with tremendous opportunities.

After the June rollout of the plan we will budget fiscal year '05 in detail.

Rest assured that we will do so with one eye on '05 and the other on the future.

We're pleased about the performance to date this year, but are mindful that we just begun to deliver on the potential of this Company.

And with that I would like to open up the lines, Shelley, if we could go to question and answer.

And thanks for paying attention to our presentation morning.

(OPERATOR INSTRUCTIONS).

David Manthey with Robert W. Baird.

I missed the average order size number.

David, do you have that on hand?

233.

33, okay, great.

And then, Chuck, you mentioned a couple of times the mix and the impact on GP.

I was wondering if you would talk about what type of mix shift that is?

If that is within product categories or if that is private-label product or something else?

Dave, you heard that the manufacturing portion of the business grew at 9 percent during the quarter.

We have been at that -- buying those types of products with those customers buying longer than we have on the MRO side.

It is really just a matter of sales mix.

Okay.

At the end of the conversation you talked about cash flow.

And I am just wondering if you would go a little bit more in depth looking out sort of twelve months or so and think about expectations for AR, inventory and maybe AP CapEx; all the moving parts of free cash flow assuming sort of strong double-digit kind of growth?

Let me for state for this quarter there's a couple anomalies in the cash flow.

There were two estimated tax payments that actually had to be made.

That, combined with the higher than anticipated sales growth we experienced, obviously -- although we are very, very satisfied with our DSOs and our inventory turns added -- required a big chunk of cash, if you will, to go into working capital.

You can tell from the sales range we have given for Q3 that operating income would be higher, and we would expect that obviously to generate some more significant cash than you saw in Q2.

We have just internal metrics to continually improve in the area of DSOs and inventory turns.

So while the absolute value in terms of dollars in some of those areas for receivables inventory will continue to go up, because we have got improvement metrics in place and have been hitting on them so far, we would still anticipate generating in any growth environment positive free cash flow.

Okay, great.

One last question.

Where you mentioned employment and price pressure and things like that, I'm wondering there seems to be disconnect between what we're seeing in the ISM prices paid index and the employment numbers versus what you're saying in terms of competitive price pressures and lack of employment growth.

And I'm wondering if that is just, again, this three to six month delay in what you will ultimately see, or how else are you thinking about that?

David, there is certainly some pockets of pricing pressure in the marketplace.

We have seen a bit of fuel charges out there of which we passed along those energy surcharges to our customers.

But the way that we handle it internally is that we've got a very strong position with our suppliers in that we would ask our suppliers to come to us, present their case, and frankly we won't except any price increases that really can't be justified and that we're not comfortable with the way that justification occurs.

Where possible we do pass them on to our customers.

And certainly that has been factored both into our gross margin guidance on a going forward basis, as well as into our guidance and our OPEX numbers.

I will also tell you that historically anyway inflation and getting a little inflationary pressure into the mix has been profitable for MSC.

David, let me just add on to what David has said.

I think what we're seeing, which is unique in this uptick is this -- I alluded to it in the free markets auction incidence -- really the global visibility that manufacturers have today in sourcing parts.

And while there certainly is some raw material issues in the marketplace, I think we're taking a tough position with our suppliers on increasing prices.

And I think you're seeing that push back from retail channels and the ability to outsource parts production in other parts of the business are having a restraining effect on some of the pressures.

Jeff Germanotta of William Blair & Co.

Congratulations on a great quarter, gentleman.

My question pertains to your incremental operating margin.

With 54 percent in the first quarter, 48 percent in the second quarter, and if I forecast the midpoint of your ranges for the third quarter, that is a mid 30's type incremental operating margin.

It leaves me to wonder if we aren't conservative in the 25 percent estimate for the year, or if you're expecting to substantially back end load the hiring to drive that number down materially in the fourth quarter?

Could you comment on those observations and thoughts?

Sure.

This is Chuck, Jeff.

A couple of things going on.

First of all just to remind everybody we have committed 25 minimum.

That doesn't mean the number can't be better or different, but the minimum commitment has been 25.

I think that the difference between what you see in the back half of the year and will hear from us relative to early in the year -- David talked about the number of sales associates, for example, that we have hired in this quarter that will be onboard full stream, if you will, in the third quarter.

Those operating expenses will now have to be factored in, which would tend to lower to read through percentage relative to what you have seen on a six month to date performance from us.

The second piece is we've had significant, significant productivity on the variable front, particularly as it relates to the cost associated with taking incoming calls for sales orders, and the costs associated with pick, pack and ship of those orders.

We have now hit the point in Q3, and you can tell from what the average daily sales might be from the range that we have given you, where we are going to have to start adding back some to those particular areas, both the call centers and our distribution centers in particular some expenses they were absolutely leverage for the first two quarters.

And they traditionally have been variable expenses for us.

And we found that just a little bit of a step function in that as well during the first two quarters.

So while we have been able to take advantage of that and drive productivity the first six months of the year, in those particular two areas we are going to have to put some money back into that in Q3 and Q4.

That would drive the overall number down from the levels you see in the first couple quarters, but again in no way, shape, or form do we think the number would conceivably drop below 25.

The commitment is that is the minimum, but we have an opportunity to do better than that.

I think, David, just to add on to what Chuck said -- Jeff, I'm sorry, Jeff.

The fourth quarter would not be below 25 percent.

So I guess you're right in your assumption that if we said 25 for the balance of the year in Q3, it is coming up north of that.

And I think our commitment would still be stolid for the fourth quarter on 25 read through.

So if the minimum is 25 in the fourth quarter alone, we should do handsomely better than the 25 average or minimum goal for the year?

If we hit the range that we have positioned yourselves for in Q3, you're correct.

And we're all optimistic you will.

One more question.

You may have mentioned this on the call;

I got distracted.

But did you give the sales growth numbers for December, January and February?

Sure did, Jeff.

Could you repeat that?

Absolutely.

In December and January growth rate was 8 percent;

February was 14 percent; and March through yesterday was 15 percent.

Our fiscal month ends on Saturday.

Thanks very much and keep up the good work.

(OPERATOR INSTRUCTIONS).

Holden Lewis of BB&T.

Can you comment a little bit about the nonmanufacturing side of the business?

And it is nice to hear that manufacturing is getting better, but I guess I was a little bit surprised that nonmanufacturing came back towards 12 sort of a deceleration from 15 percent in Q1, even though frankly the comp got quite a bit easier.

Are there any timing issues in there?

Are you seeing it is a little bit tougher to grow that business for some reason?

What is taking place in that area?

Holden, it is David.

We're actually very pleased with the progress that we're making in that segment of the business as well.

When you get underneath the numbers what actually happened was that in January of '03 we actually saw a significant spike in the growth rate on the nonmanufacturing sector, specifically from tougher comps in our government business.

We had actually received some very significant orders from the military last January that were not repeated this year.

And that is actually what has caused the growth rate in sales to nonmanufacturing manufacturing to be lower by a couple of a percent versus this year.

So otherwise things seem to be pretty much on track there, nothing noteworthy?

Absolutely.

Can you give us a sense of -- you sort of talked about what your theoretical approach towards the pricing pressures are, but we were hearing about pretty sizable increases in things like fasteners and welding equipment on the pricing side.

What was the effect of pricing on the business model?

Was it materially -- a material contributor to the increase in the growth rates, or can you sort of quantify that?

Holden, I think that historically -- I know historically we don't break out – there are many, many different moving parts to the gross margin equation.

Of course internally we manage and strive to manage all of them both in how we operate the business, as well as how we end up putting together our forecast and guidance in that area.

So I wouldn't want to specifically pull out whether -- what increases or decreases we have seen on the product side, what we're seeing on the customer mix side.

And I could go on and on with some of the different pieces to the equation.

But when you look at what most greatly impacted the gross margin surprise of sorts, so you think it was more mix than it was pricing or anything, or any of the other major variables?

Yes.

It clearly was mix.

Of course we're not -- we do follow very carefully products like raw materials and things, petroleum-based products that under more pressure right now, given what is happening with oil, what is happening with steel, etc.

And that is all factored into our planning.

Just to get everything in order, pricing wasn't the negative to the gross margin in the quarter, right, inasmuch as you couldn't pass anything through?

Holden, I think we would characterize it by saying that we are taking a firm position with our suppliers as are many in the marketplace, and really resisting price increases.

Yvonne Varano of Jefferies.

There seems to be a little bit of disconnect between what you're expecting in terms of the growth rate and what you're seeing in regard to the market.

And I was wondering if there's any way you can give us any color in how much of the growth we saw was market driven versus internal growth?

Can you try and repeat the question because we not sure where the conflict is?

It seemed like you were very cautious about the market outlook.

And I was just trying to get a feel for how much of the growth that you're seeing is really market driven versus your internal initiative?

Yvonne, we think it is a combination of the two.

Certainly we have been following our plan now for the last few years.

We think that we are executing very solidly on that plan.

And that plan all along has been to continue to gain market share, so we are very comfortable that our growth is certainly representative of the market share gains that we currently make and that we have been making for the last few years.

But in addition to that, we're also fortunate and pleased to see an ISM index what is reflective of the economy in the marketplace that we play in.

We have always said that we lagged that marketplace -- that indicator specifically by a period of several months, and we are seeing the results of that.

Having said that, while that indicator should -- would make us bullish in and of itself, the fact is that we are very plugged in to our customers, and our customers are still remaining cautiously optimistic, both in the way that they are investing, the way that they are hiring, the way that they, like so many companies certainly including MSC, are very focused on improving productivity and making that an important part of their plan.

So that is all how we, I guess, put it into the mix and characterize things.

I know you said the salesperson number at the end of the quarter, and I just missed it.

It was 424?

434.

434.

Correct.

(OPERATOR INSTRUCTIONS).

At this time there are no further questions.

Management, do you have any closing remarks?

Once again we would like to thank you for your participation and support, and look forward to hopefully bringing you another quarter similar to this one.

We will be speaking to you over the next few months.

This concludes today's conference call.

You may now disconnect.