MSC Industrial Direct Co Inc (MSM) 2004 Q3 法說會逐字稿

Good morning.

My name is Sabrina (ph) and I will be your conference facilitator.

At this time, I would like to welcome everyone to the MSC Industrial Direct third-quarter 2004 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. (OPERATOR INSTRUCTIONS) I would now like to turn the conference over to Lindsey Hatten (ph) of Financial Dynamics.

Ms. Hatten you may begin your conference.

Thank you and good morning everyone.

This is Lindsey Hatten of Financial Dynamics and I would like to welcome you to the MSC Industrial Direct fiscal 2004 third-quarter conference call.

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

If you have not received the 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 and 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 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 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 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 in the Company's filings with the Securities and Exchange Commission.

In addition to 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 Director, Chairman and Chief Executive Officer, Mitchell Jacobson.

Mr. Jacobson, please go ahead.

Thank you, Lindsey.

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 third quarter of fiscal year '04, and our expectations for the fourth quarter.

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

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

MSC revenues grew by 18.4 percent in Q3, 16.6 percent when adjusted for the extra sale day.

We are pleased to note increased momentum from our second quarter's growth rate of 10 percent.

Overall sales growth rates increased through the quarter as did growth rates to both the manufacturing and non-manufacturing sectors.

We continue to execute on our strategic initiatives and our operating metrics.

By focusing on both elements, we have continued to gain market share and leverage our infrastructure.

Pricing discipline and outstanding execution and purchasing, enabled us to meet our gross margin target for the third quarter.

I'm happy to report that through the use of our Six Sigma process, and the focus of the entire MSC team, we once again exceeded our expense control objectives.

Our read through in Q3 was 43 percent, and operating income grew 81 percent versus last year's Q3.

Operating income in the quarter rose to 14.8 percent of sales.

As stated on prior calls, we remain committed to returning this business to 15 percent operating margins on an annual basis.

Overall, net income grew 81 percent and EPS increased 79 percent to 34 cents per diluted share from 19 cents per diluted share in Q3 last year.

We are really excited to report that as projected earlier in the year, we are experiencing increased momentum that was expected based upon the prior six months of a growing ISM index.

In Q4, we expect the revenue growth rate to be in excess of 19 percent.

Please note that you'll have to adjust the absolute sales dollars to account for one less day in Q4 of this year versus last year.

Revenues should be in the range of 243 to $247 million, and earnings per diluted share should be in the range of 29 to 31 cents.

In Q4, we expect to have about 450, 460 field sales associates in place for the entire quarter.

And we will staff our call centers and distribution centers to support expected increased volume in Q1 of fiscal '05.

We must carry that additional overhead through our seasonally slower July and August months and as a result, expect the read through to be in the mid 30s in Q4.

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

Thanks, Mitch.

Jumping right into the outstanding results for the quarter, MSC sales growth rates were 15.4 percent in March, 17.1 percent in April, 17.8 percent in May, and 18.4 percent in June.

All of our regions grew solidly in the quarter led by the Southeast at 21 percent, the Midwest grew at 19 percent, the West at 18 percent, and the Northeast at 15.

Average transaction size grew to $236 in Q3, from $233 last quarter.

The ISM trend continues to be very positive with the last eight months coming in at readings above 60 including the latest report at 61.1 percent.

The manufacturing economy continues to grow and recover.

Growth in our sales to the manufacturing sector has been accelerating, coming in at 17 percent in Q3, with sales to the non-manufacturing sector growing by 15 percent.

Sales to the manufacturing sector represented 73 percent of our business in Q3.

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

Turning to the details of the quarter, overall (inaudible) rates continue at about 99 percent.

RGCs (ph) all hit or exceeded their first (indiscernible) goals with the exception of Reno which was slightly below.

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

Call center staffs continue at high levels as well.

The call abandonment rate was less than one percent and we averaged 63 calls per associate per day.

We ended the third quarter with 457 field sales associates, up from 434 at the end of Q2, and representing significant growth from the 412 we reported at the end of Q1.

We continue to successfully execute on our hiring plan and expect that we will be in the neighborhood of 460 or so by the end of the fiscal year.

We are growing our investment in our future as we add many highly talented people to our sales force.

Given the time that it takes to train and assimilate them into their territories, the new field sales associates that we have added over the last few months will start contributing in FY '05, helping to ensure that MSC meets its strategic goals.

In the third quarter, we mailed 7.0 million pieces of mail about what was initially planned.

We expect that we will mail approximately 6.5 million pieces in the fourth quarter versus 7.2 million pieces in last year's fourth quarter.

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

We continue to generate excellent overall response rates.

Our total active customer count was 346,000 at the end of the third quarter, the same as Q2 and representing an increase of 2 percent over last year.

Given the nature of our strategic initiative to expand into the Government and other large customer sectors, a slowdown in the growth in the absolute number of active customers was expected.

It is important to note that these new customers have large numbers of locations that behave for the most part as if they were separate customers.

However, they are also only counted as one customer in how we measure our active customer count.

For example, the U.S.

Postal Service counts as only one customer but has 45,000 potential locations.

The future opportunity remains very exciting with more than 2 million potential customers throughout the United States that consume MRO products.

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

Sales through the site grew to $35.5 million, representing 13.9 percent of consolidated sales with an annualized run rate of $138 million.

This represents growth of approximately 47 percent over the third quarter of last year.

Before concluding, I would like to share some of our strategy for the next year or so with you.

We have already indicated that we are increasing our investment in growth with the new additions to the field sales force and that we are attacking new customer segments.

We are also continuing to invest in growing revenues per customer by penetrating deeper into the large customer segment, in developing technology which helps our customers improve their productivity and in new, even more productive SKU additions to our product line.

Our mass of SKU buildup over the past several years to over 540,000 items have strategically positioned MSC for future growth.

Adding breadth and depth from the huge universe of SKUs available to us and developing critical mass across most product lines, has enabled MSC to have an MRO product offering capable of serving basic maintenance needs across many customer segments.

We currently carry products in 11 major verticals such as industrial, fasteners, safety, etc. which are important to our customers.

We believe that our offering is the most comprehensive in our segment.

Until recently, our focus on SKU development had been on speed, in order to reach critical mass.

Having reached this goal, our plan for the next couple of years is to focus on refining our product offering and increasing productivity by adding SKUs in a more moderate fashion to increase brand, depth and very importantly, improve our value statement to our customers through the addition of more private brand products.

Doing so will also serve to support our gross margin goals.

We will also continue to remove non-value add SKUs strengthening our foundation for future growth.

This will enhance the usability of our catalog, improve after performance, and maximize the leverage potential in our distribution centers, clearly a win for all stakeholders.

For fiscal '05, we have added approximately 22,000 new high value-added items to our SKU base, which we believe will deliver greater performance and returns on our investment.

Our plan also includes removal of about 22,000 non-productive SKUs.

For the longer-term, we remain excited by the challenge to penetrate the existing 11 verticals and to add new product segments which will bring value to the 2 million customer universe that we have targeted.

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.

I am gratified that we have delivered or exceeded expectations on all of our commitments over the past eight quarters.

I could not be more proud of team MSC who have consistently delivered this outstanding performance.

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.

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.

You have my commitment to maintaining that focus.

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

Thank you, David.

Before reviewing our financials, I would like to share in MSC's success story which I personally experienced on a recent customer visit.

I visited a large national account of ours in the mid-Atlantic region to better understand our customer's thinking on what MSC does well and what improvement opportunities we may have.

Before becoming a national account, this customer used a competitor of ours for the majority of their MRO spend.

They were encouraged by corporate headquarters to change to MSC after the signing of our national account agreement.

All of the customer's associates that I spoke with told me that they had been reluctant to change to MSC from their prior supplier.

They said that after MSC assigned a sales rep to penetrate this account, things began to change.

Our sales were slow at first, the customer was able to get a sense for MSC's unsurpassed delivery and service.

Shortly thereafter, our rep had developed a relationship and earned the trust of both users and requisitioners in the facility.

Our rep was invited to participate in customer teams to recommend solutions to our customer's maintenance needs.

The customer told me that they now consider our rep as one of their own associates.

Now do approximately $400,000 per year in sales with this one facility.

As we continue to build out our sales force and enhance our local field with customers, we will have the same penetration opportunity with many accounts.

Turning to our financials, once again we have completed an excellent quarter and exceeded our financial goals.

In the third quarter, we beat the 25 percent read through yardstick generating 43 percent of our sales increase as incremental operating margin.

The high-level of read through reflects the maintenance of our gross margin at 45 percent, as well as a decline of operating expenses as a percentage of sales in this quarter when compared to the same quarter last year.

The decline in OpEx percentage was due to less depreciation than last year, spreading of our fixed cost over a larger revenue base, and some volume, payroll and inflationary cost increases that were offset by improved productivity and expense control.

Based on the spending levels in effect for Q4, and including the increase in the sales force and the hiring necessary to support increased volumes this fall, we expect the read through to be in the mid 30 percent range for Q4.

Gross margin of 45 percent in Q3 was in line with expectations and we expect gross margin to be about the same in Q4.

In Q3, operating income rose to 14.8 percent of sales from 9.7 percent of sales in Q3 of last year.

Total operating expenses rose only 1.4 percent over the same quarter last year, from an 18.4 percent increase in sales.

Our cost control and process improvement projects are bearing fruit and contributing to the gains in operating income.

We made a slight adjustment in our effective tax rate this quarter, reducing the rate by one-half of one percent to 39 percent.

The catch-up effect in the quarter increased net income by approximately $300,000 or 4/10 if a percent in EPS.

We expect to maintain the effective tax rate at this level for the foreseeable future.

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

Free cash flow generation for the quarter was $26.6 million, even as we invested $12 million into inventory to support higher sales levels.

Overall working capital, excluding cash, was virtually unchanged from the prior quarter.

Inventory turns increased to 2.63 annualized turns and DSOs remained unchanged at 41.

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 Q4.

We purchased 250,000 shares of MSC common stock during the quarter for approximately $6.75 million.

We have now repurchased an aggregate 4.5 million shares in the last two years.

Our invested cash balance grew to $158 million at the end of the third quarter, and currently stands at approximately $170 million.

In summary, we had an excellent quarter financially; we exceeded our expectations on earnings, read through percentage and improved our operating margin as a percentage of sales to the highest level in several years.

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

Thank you, Chuck.

There has never been a more exciting time than today in the 63-year history of our company.

We have a unique opportunity at a $1 billion run rate to be a part of a consolidation of a huge fragmented industry.

When we went public in 1995 we did so in order to fund an ambitious infrastructure build out.

In the last nine years we opened three distribution centers, over 60 branches, recruited and trained hundreds of field sales associates, added 400,000 SKUs, re-wrote or purchased virtually our entire operating and financial systems, and built a management team and group of associates with unmatched talent and depth.

As we close out our first billion dollar run rate quarter, I remain as excited about the growth opportunities inherent in this business as I was in 1976 when I joined the $6 million industrial distributor with new ideas and huge vision.

I want to congratulate the entire MSC team on an outstanding quarter.

We stayed the course through a difficult period and have now really begun to deliver financial performance consistent with our mission statement.

We know that greatness is not achieved by just a few quarters of performance.

It's achieved by consistently outperforming the competition.

That is our goal.

Rest assured we will stay relentlessly focused on that mission, and with that Sabrina, if we could open up the lines for Q&A, I would appreciate it.

(OPERATOR INSTRUCTIONS) Michael Greenwald (ph) with BB&T Capital Markets.

I had a question with manufacturing growth outpacing non-manufacturing growth for the first time since I can recall, since this is an older, more established product line I would expect to see a greater rebate activity, and maybe gross margin sort of improving.

But actually gross margins were sort of flat with prior year, and I guess what I am getting at is can we expect going forward since -- can we expect going forward, will there be sort of a catch up to realize some of the rebates that maybe were not realized in Q3 so can we expect to see maybe a spike in gross margins?

I think probably the best way to answer the question, first of all is that rebate activity and all of the components within our gross margin is not something that we split out and report on separately.

I will tell you that all of the activity between product, customer mix and the many other elements of gross margin have certainly an important component of how we plan and provide guidance.

And the guidance that we provided for this year and actually into next year as well, is what we are going to work hard to maintain approximately that 45 percent gross margin range that we have been producing.

Okay.

Thank you.

Secondly, with the increase in sales associates, it sort of exceeded your expectations that I had in my notes of 450 for the year.

I guess I sort of expected to see a drop-off or I guess an increase in SG&A, but and this one talks about quite a bit on the last calls, but in reality SG&A came in really -- was a really great number.

And I guess I was sort of curious of what else is in there that I guess what else was eliminated to offset the increased upfront costs associated with the new associates?

And going forward, can we expect these great numbers to continue and maybe even drop-off once these up front costs are eliminated?

There is ongoing productivity projects that we have baked in to happen in the third quarter and will continue to happen as we move forward.

Don't forget many of the associates were hired throughout the third quarter; you don't have the full impact of everybody being on board from the beginning of the quarter like you will in Q4.

And into all of next year.

As you can see, the guidance we provided for Q4 was read through in the mid 30s, which is obviously below what we have been tracking on a year-to-date basis, precisely for what you mentioned it will have the full impact of the associates that were hired throughout Q3 and the entire number for Q4.

But rest assured we have got productivity plans and some other things that we're working on to help fund some of those costs, but clearly the range for Q4 at 35 is different from where we had been tracking primarily due to the full impact of those associates.

Okay.

Thank you.

Lastly, can we see, expect a similar stock repurchase in Q4?

As in Q3?

We don't telegraph those moves for obvious reasons.

I wanted to ask.

Okay.

That's all I had.

I appreciate it.

Jeff Germanotta with William Blair & Co.

Good morning and congratulations on a continued fine performance.

Two questions for you.

Now that you got the operating margins in the mid teens range, I would suspect that you will continue to accelerate your investment in sales growth drivers.

Could you provide a little more color on your plans for sales people, branches, products, mailings et cetera out into 2005?

We're not providing specific guidance on our investment program for next year.

We have given you some specifics for Q4.

I will tell you though that we continue to invest in the business both in incremental investments, as well as taking our existing team and resources and focusing them on where we believe we are going to get the biggest return and what is going to produce the most growth and the most profitable growth.

So, I guess rest assured that its going to nail absolute metrics in the way that we report because we don't telegraph every single move for obvious competitive reasons.

But our plan is to focus our team growing on where we believe and focusing our team and investments on where we believe we are going to get the greatest returns and where we see the biggest opportunity.

One of those areas as I said in my script is actually on the large customer segment for those customers that have multiple selling locations that we believe we see a big opportunity in right now.

Also as a general note, we retain our commitment to producing significant read through on revenue increases well into '05.

Any color on what that read through could be in '05?

I think we have not projected out that far at this stage.

We're putting the final touches on our plan for next year, right now we are in the midst of our budget cycle.

We will give you some more guidance at our next call as we will ramp that up of course.

Great.

One more question.

We've heard a lot in the first half of this calendar year about price increases being driven by manufacturers and pushed through by distributors.

Were price increases a meaningful contributor to sales growth and gross profit margin in the third quarter?

And second part of that is what are your expectations as we look out into the next couple of quarters?

I guess I will give you a two-part answer then.

First of all, no, they were not material to our growth in margin results in the current quarter.

We have seen some fragmented energy surcharges, which we have passed along to our customers as I said previously.

And we have also gotten some increases on products where raw materials have gone up considerably.

Having said that, we have taken a very hard line with our supply community on not accepting price increases.

Our policy is not to accept them but where we must, we generally have the opportunity to pass them on to our customers.

So, all of that is impacted into what our gross margin guidance is that we provided, and as you know, Jeff, historically inflationary times have been very beneficial to MSC as we are able to pass along those cost increases.

Thanks very much.

David Manthey with Robert W. Baird.

Good morning, everyone.

I was wondering, David in your monologue I didn't catch the number of calls per associate per day?

Let's check it out, I think it was 63.

63.

Okay.

Thank you.

In terms of the growth strategy going forward, and adding salespeople and so forth, maybe you will not share the plan for the number of salespeople or branches et cetera, but just for our knowledge is there some way you can talk about the financial profile of opening a new branch in terms of what the capital outlay, when they breakeven, how long it takes them to make up the loss, and things like that?

Is that something you could talk with us about?

For competitive reasons we would really rather not share details about some of our investment drivers.

We are clearly pointing ourselves and focused on where we believe we are getting the best returns and where we see the biggest opportunity in the marketplace.

We have got many different growth drivers that we looked at to a large degree in the way we are describing, but it's really not something that we would want to broadcast for competitive reasons on this call.

Okay.

Maybe I can approach it another way.

You have been adding some salespeople.

I am assuming you're still filling in existing geographies.

If you do reach 15 percent EBIT margins, I think in the past you have talked about the potential for opening branches and we really haven't seen that in the past several years here.

Could you just say qualitatively that if you reach a margin level, an EBIT margin level that you feel is pretty satisfactory that you would then turn around and start driving more of that back into branches and sales growth?

David, I guess qualitatively what I can say is that and that is really the way we're managing the business today and the way we will continue to manage the business going forward, which is we're going to balance the level of our investments in growth in all aspects of the business consistent with our expanding operating margin, our read through commitments year-over-year.

And the fact that we want to balance that growth coupled with increasing our earnings.

Okay.

Final question.

Could you talk about Sarbanes-Oxley 404, and what the plan is there?

Sure.

We're actually well ahead of where we need to be.

We embarked on 404 not to outsource this but to actually put the resources in place internally to handle this, thinking that we would get double benefit and learn from it and learn where we can improve.

And we want to plan long before Sarbanes-Oxley compliance deadlines got pushed out to be in a position to be in compliance by August of this fiscal year.

And we have not backed off our plan even though the requirement for compliance has been pushed out by a year or so.

We are a little bit ahead of schedule and we have done it with internal resources, and are in the process with testing things right now that would not technically be required to be done for a year from now, so we feel pretty good about it.

All right, Chuck.

Thanks and thank you and congratulations.

Yvonne Varano with Jeffries.

Good morning.

Mitch I just missed what you said in the beginning of the call when you said sales (inaudible) 18.4 percent (inaudible) and you adjusted for?

One extra day in this quarter, one less day in the next quarter.

Okay.

So that the numbers you gave on the manufacturing and non-manufacturing growth was actually adjusted for the day?

That is correct.

Those are based on average daily sales.

Just on your operating margins, I know we've talked about retaining this 15 percent on an annual basis and we obviously were very close to that in this quarter.

But what is the potential to really exceed that 15 percent?

David said this before, we're going to balance growth and profitability, we don't have -- we are going to stop at 15 or we are going to try to get to 19 or 20.

We are going to look at this from a balanced approach and continue to make sure that we are driving profitability concurrent with driving the top line sales growth.

So, what we have said in the past there is still a lot of runway here in terms of leverage of our fixed cost.

We do not feel there is any significant CapEx that has to be made in the foreseeable future that would cause us to put a lot more fixed cost into the business right now, but there is no magic bullet beyond what we said that we would like to get back to that 15 percent, mid teen operating margin level on a sustainable full year basis.

This is one quarter, we're very proud of it, but it was one quarter.

There are still some things to be done to get us there on an ongoing basis.

Okay.

Thank you.

(OPERATOR INSTRUCTIONS) Mike (indiscernible) with Asset Management.

I wanted to kind of dig in a little bit more on the read through.

It looks like your forecasting somewhere around 35 percent for the quarter and you said the full impact of the spending initiatives in the sales force increases should kick in then.

With the volume increases that you're looking at for next year, it sounds like 35 percent might be a floor (ph) for 2005.

We didn't say that but I will tell you (inaudible) we have always committed to you, you heard Mitchell say it earlier, we're committed to a minimum of 25 percent read through.

Again we're in the planning process for next year, so I would not draw any conclusions from the fourth quarter range.

Okay, and then given that we are seeing kind of accelerating revenue trends here, any reason why that doesn't continue into next year, kind of with the strength of the economy we are seeing?

Certainly what we're seeing with an outstanding ISM for the past eight months and specifically in the last six, looks like it certainly bodes well, and as we look at next year.

But we have given specific guidance certainly in Q4 and we would rather not give guidance beyond that.

Okay.

I will tell you that whatever our growth rate is last year we would expect that our operating income will grow much faster.

Okay.

Just from the standpoint of kind of the geographical thing, the strength was pretty broad base there, anything look like it might be slowing at all, or how long would a typical cycle continue this uptrend?

Hard to say just how long this expansion can occur.

We're certainly encouraged by what we have been seeing over the last six to nine months, and we are hopeful that this thing has many, many quarters and years to go, but we will have to wait and see what the economy actually does.

There is an awful lot of encouraging signs right now and certainly one of the big one is the ISM.

We don't give too much more additional flavor on the regions.

We are very encouraged by what we're seeing in all of our regions.

Within each region there are many different customer segments and industries that are within that region so it's very tough.

While we look at that and while we focus on it internally, I would not want to broadcast competitively which industries are growing most favorably in the Northeast and which are shrinking, but clearly all of that is occurring within each of the regions.

Naturally our job is to focus on where we see the biggest opportunity in each of the regions and that is what our team does.

Okay.

One final question.

The guidance that you gave for the 29 to 31 cents, what is the share count that you are projecting that off of?

Roughly the same as you saw at the end of the third quarter.

Diluted number of shares that were in the calculation for the end of this quarter was 70.082.

Okay.

All right.

Thank you.

(indiscernible) with Atlantic Investment Management.

Just a quick question, you said the beginning of the call what the sales were for each of the months during the quarter and I missed that.

If you could just say that again?

No problem at all.

Going backwards June was 18.4 percent.

May was 17.8 percent.

April was 17.1 percent.

And March was 15.4 percent.

Okay.

I know that we have just begun the month, but can you give us any color on where we are now?

Too early.

I think the color though is just our forecast for the quarter.

At this time there are no further questions.

Will there be any more closing remarks?

No, I just want to say thank you and we will speak to you guys again in the next few months.

Thank you.

This now concludes today's MSC Industrial Direct third quarter 2004 conference call.

You may now disconnect.