MSC Industrial Direct Co Inc (MSM) 2004 Q4 法說會逐字稿

Good morning.

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

At this time I would like to welcome everyone to the MSC Industrial Direct Company Inc. report on fiscal 2004 fourth quarter results.

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 one, on your telephone keypad.

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

Thank you.

Miss Mormon, you may begin your conference.

Thank you, and good morning, everyone.

This is Christine Mormon of Financial Dynamics, and I'd like to welcome you to the MSC Industrial Direct conference call.

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

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

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 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 earnings release and in the forms filed with the Securities and Exchange Commission.

In addition, the information contained in this conference call is accurate only on the date 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'd like to introduce the MSC Industrial Direct's Chairman and Chief Executive Officer, Mitchell Jacobson.

Mitchell, please go ahead.

Thanks, Christine.

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

With me are David Sandler, our president and chief operating officer, Charles Boehlke, executive vice president and chief financial officer, and Shelley Boxer, vice president of finance.

I will begin with an overview of the fourth quarter of FY '04 and our expectations for the first quarter of FY '05.

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 Direct grew revenues by 20% in Q4 adjusted for one less sales day than the previous year.

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

By focusing on our strategic initiatives and operating metrics, we continue to gain market share and realize financial and operating leverage from prior investments and infrastructure.

We once again maintained our pricing discipline in Q4.

That discipline, combined with outstanding execution in purchasing, enabled us to meet our gross margin target for the fourth quarter.

Finally, we've continued to execute on process improvements and have stayed focused on cost control.

We are pleased to note that increasing revenue momentum has not diverted us from our committment to drive cost reduction throughout our business.

As a result, our read-through in Q4 was 37.8%, and operating income grew 66% versus last year's Q4.

Operating income in the quarter was 14.6% of sales, as compared to 10.3% in last year's Q4.

As stated on prior calls, we remain committed to returning this business to mid-teens operating margins on an annual basis.

Overall, net income grew 62.6%, and EPS increased 60%, to 32 cents per diluted share, from 20 cents per diluted share in Q4 last year.

In sum, this was an exceptional quarter for our company.

Looking forward to the first quarter of fiscal '05, we expect that sales should be in the range of 260 to 265 million dollars, and earnings per diluted share to be in the 35- to 37-cent range.

Our outlook for Q1 is solid, but we remain unable to forecast future quarters due to uncertainty on the part of our customers.

Customers continue to express concern about order flow due to rising energy prices, raw material availability and cost, and a general feeling of uncertainty.

However, this is not new.

It has been with us for the prior eight quarters.

We have become adept at managing this business by re-forecasting weekly and gauging operating staff based upon trends.

Once again, we remain confident that we are gaining market share and improving our core business processes.

We are very excited about our progress, and we are continuing to deliver performance far exceeding that in our segment.

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

Thanks, Mitch.

Before jumping into the results for the quarter, I'd like to share what I heard from customers that I visited with during my recent field trips.

People are busy right now, and our values have translated well to our customers.

One long-time customer told me that he gives us a substantial portion of his business because we have improved his productivity and reduced his costs.

Another customer prefers us because of our ultra-dependable service and outstanding in-stock levels.

A third is focused on consolidating their vendor base and lowering their overall cost by moving a substantial portion of their business to MSC.

One message I heard time and again from our customers, is that their customers are demanding cost reductions and shorter cycle times -- two things that are needed to remain competitive in ran increasingly global economy.

Our model is based on overall cost reduction and just-in-time delivery to meet our customers' needs.

That makes MSC more and more the vendor of choice as globalization accelerates.

Everyone that I talked to is busy, but they are also concerned about the impact of energy cost increases, rising raw material prices, rising interest rates, and the outcome of the election.

When I asked one long-time customer about the future, he smiled and said to me, "I've been busy, and I'm busy now, but who knows what next month will bring?"

This message of a general lack of visibility was repeated by many of the customers I visited.

There's generally broad based strength now, and the summer was better than most people had expected.

Our values are translating well into the marketplace and the continued strength of the ISN is a good indicator of continued solid growth.

Turning to the results for the quarter, MSC sales growth growth rates were 18.4% in June, 20.3% in July, 21.9% in August, and 17.1% in September.

Through this past Tuesday, our growth rate in October was 19.2%.

All of our regions grew solidly in the quarter, led by the West at 22.9%.

The Southeast grew at 22.7.

The Midwest grew at 20.4, and the Northeast grew at 19.1.

Average transaction size grew to $244 in Q4 from $236 last quarter.

Growth in our sales to the manufacturing sector was 21% in Q4 with sales to the non-manufacturing sector growing by 16%.

Sales to the manufacturing sector represented 73% of our business in Q4.

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

Turning to the details for the quarter, overall fill rates continue at about 99%.

Our DCs all hit or exceeded their first fast fill rate goals.

Accuracy levels continue to be excellent, with an error rate of less than 1 per 1,000.

Call center staffs continued at high levels as well.

The abandonment rate was less than 1%.

And we averaged 61 calls per associate per day.

We ended the fourth quarter with 453 field sales associate, down slightly from Q3, and just shy of our projected goal of 460 due to the timing of hiring.

Our sales force is currently at 463.

We will continue to expand the size of our field team and expect to be in the range of 475 to 480 by the end of the second quarter.

In the fourth quarter, we mailed 6.5 million pieces of mail, about what we initially planned.

We expect that we mail approximately 7.7 million pieces in the first quarter, the same as last year's first quarter.

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 Q4 levels as well.

We continue to general excellent response rates.

Our total active customer count was 344,000 at then end of the third quarter, down slightly from Q3, and up slightly from last year.

There are dynamics taking place in our customer base that I wanted to share in order to explain what is happening to the gross number of customers.

The first relates to the execution of our strategic initiative to grow our business in the government and national account sectors.

These new customers have large numbers of locations that behave, for the most part, as if they consider separate customers.

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

The second relates to a change in our mailing strategy to small customers who do little business with us.

We have been mailing regularly to those customers and started culling back about a year ago.

We have identified this sector as as one where we were spending more on advertising than we were earning from their sales.

These customers have now begun to drop out of our active customer base as they've stopped buying from us.

Economically, these customers have no significant growth potential, and as a result, we're making more money by not doing business with them, and believe that we're not giving up anything for the future.

This explains the slight overall drop in our customer numbers.

We generated many new customers this year and hit our goals in this area.

We have experienced a mixed change to larger customers with multiple locations that count as one customer.

Finally, we saw attrition pick-up as we stopped mailing to the non-productive customers, reducing our overall customer count, but improving profitability.

The future opportunity for customer growth remains very exciting, with more than 2 million potential customers throughout the United States to consume MRO products.

MSC direct.com's outstanding growth continues in the fourth quarter.

Sales through the site grew to $36 million, now representing 14.6% of consolidated sales with an annualized run rate of $145 million.

This represents growth of approximately 48% over the fourth quarter of fiscal '03.

In conclusion, I am once again extremely pleased with our performance in this quarter and for the entire fiscal '04.

The results have been nothing less than outstanding.

We continue to significantly outperform the sector, and it's our vision to do so for the foreseeable future.

I'd 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 levels.

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

You have my commitment to maintaining that focus.

Thank you, and I'll now turn the mic over to Chuck.

Thank you, David.

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

In the fourth quarter, we beat the 25% read-through yardstick, generating 37.8% of our sales increase as incremental operating margin.

The high level of read-through reflects the maintenance of our gross margin at 45% 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 operating percentage was due to less depreciation than last year, spreading of our fixed costs over a larger revenue base, and some volume, payroll and inflationary cost increases that were offset by improved productivity, savings in our medical benefits program, and expense control.

In the first quarter of fiscal 2005, we expect the read-through to be north of 30%, but less than Q4's read-through, as we will be incurring a higher level of operating expenses related to the impact of more sales associates.

Gross margin of 45% in Q4 was in line with expectations, and we expect gross margin to be the same in Q1 of FY '05.

In Q4, operating income rose to 14.6% of sales from 10.3% in Q4 of last year.

Total operating expenses rose only 4.6% over the same quarter last year on an 18.1% increase in revenues.

Cost control, process improvements and leveraging, are contributing to the gains in operating income as operating expenses declined to 30.4% of sales in Q4.

The full year 2004 operating expenses only increased $3 million over full year 2003 on a $111 million sales increase.

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

Free cash flow generation for the quarter was $19.7, bringing our bringing our free cash flow for all of 2004 to $58 million.

Overall working capital, excluding cash, grew by approximately $9 million in the quarter, as we added $5 million into inventory for our new SKUs. and to support anticipated first quarter sales growth.

Inventory terms were 2.41 annualized, and DSOs remain unchanged at 41 days.

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 Q1 and throughout fiscal 2005.

Consequently, our board of directors has voted to increase the quarterly dividend from 8 cents per share to 10 cents per share.

Our invested cash balance grew to $183 million at the end of the fourth quarter, and currently stands at approximately $210 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.

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

Thank you, Chuck.

The fourth quarter of fiscal '04 represents the conclusion to an outstanding year for MSC.

We delivered on all our promises, including sales growth, read-through, expense control, operating margin, cash flow, and balance sheet management.

We are pleased to have met or exceeded these commitments for the last several quarters.

Most importantly, we have continued to strategically position ourselves to outperform our industry well into the future.

I'd like to take a minute to thank our entire MSC team, some of whom are listening to this call today.

I know that I speak on behalf of all our associates when I say we feel very fortunate to be part of a company that is only in the first inning of what will be a long and successful growth story.

Our trip from our founding to our $1 billion run-rate has positioned us to penetrate the $140 billion U.S.

MRO market.

There are few companies that can refer to the wonderful legacy that we have built over over 53 years in business, and still feel young, aggressive and well-positioned enough to know that our story has just begin.

Depth of our culture combines with our ongoing commitment to mission, makes MSC a very special place to fulfill our career aspirations.

Thank you, and we'll now open the line for Q&A.

Lois, can you open the phone?

Yes, sir.

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

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

Your first question comes from John Inch of Merrill Lynch.

Thank you.

Good morning.

Hey, hurricanes this quarter.

Could you guys give us a sense of what the impact was, both in terms of revenues and profits, and just a little bit more color there?

Hey, John.

It's David.

Good morning.

We actually did the analysis on the hurricanes, and what we found is that we got a bit of an uptick in hurricane-related product sales, but the positive effect of that was negated by many customers that shut down.

So net/net, the overall impact was negligible.

Okay.

The other question I had for you, was I know that you guys have have embarked upon a series of cost-saving initiatives internally, some of which you culled out ,which have shown themselves to be of significant benefit.

How should we think about the contribution in the coming year from these various internally through systems and other things, and annually, what kind of an '05 benefit could we be realizing versus the last year.

John, this is Charles Boehlke.

The initiatives we indicated really manifest themselves in the read-through percentage which you've seen be obviously, north of 40 for the last two years, and we can talk a little bit here about where we expect the first quarter to be based on guidance.

But it's really a case of if the volumes continue to go up, a lot of those cost reductions, which are process improvements to our variable cost structure, are actually paying more dividends as the volume goes up.

So they're actually imbedded in the read-through percentages that you've been seeing us put on the board and will continue to do as we go forward.

That being said, the read-through for the guidance that we spoke of in the script here, you can infer from the guidance we've given the mid-point of the range is roughly 35% for the first quarter.

So absolutely, we would expect that some of these cost-down efforts are part of the 35% that we have laid out in our guidance for Q1.

Okay, and in some respects though, these process improvements are yielding, I mean, I think if I'm understanding, cost avoidance as your sales continue to ramp up.

Is that the way to think about it, and if so, is there a way to, I don't know, put some sort of ballpark number on what realized cost avoidance or actual cost saving benefit annually, you think you're getting from these initiatives?

John, I don't think we feel comfortable about talking about the specific of each of the individual initiatives and what they bring to the party.

But, again, to elaborate, yes, I'd say cost avoidance, we've taken things like credit card fees we've been successful in reducing the percentage of sales.

Obviously if the sales go up, clearly there's more credit card fees, but we're not adding it anywhere near at the rate we would be adding had we not taken those actions to reduce costs.

And that's an example of one of several areas, where we're, you know as the volume goes up, the costs are going up at a much lower rate than they otherwise would be had we not taken those costs down.

I was going to say also, in addition to some process things, a lot of our fixed-fee type stuff we've gone back and had the ability to renegotiate and take some cost out.

So why that's not moving up and down with sales, that's absolutely affecting our leverage factor and been a factor in our increasing operating income percentages you've seen the last few quarters.

Would you say these initiatives are mostly accomplished, or we're still working our way through opportunities here?

What do you think about that.

Absolutely still working our way through opportunities.

We're taking the lowest-hanging fruit, so we've got more work on the future ones, but the well is certainly not dry.

There's plenty of opportunities in that.

We expect to continue as part of on-going our process to continue to identify and execute on them.

Okay, and just one last question.

We had a seasonally cool summer in the northeast.

Did that impact your results in any discernible way in this recent quarter?

John, the feedback that we have gotten is that the summer in general seemed to be pretty strong for our customers.

Probably a bit stronger than originally expected.

So normally in the summer, the seasonal impact of summer-related products wouldn't have been expected to have been that material, is that kind of how to think about it?

Um, sure.

Okay.

Great.

Thank you.

Your next question comes from Michael Greenwald of Brent Capital Markets.

Hi.

Good morning.

I was -- you provided the incremental margin expectations for the quarter.

Are you willing to share sort of your feel of what you're expecting for the full year?

I know you mentioned visibility is limited, but sort of a ballpark figure of what you guys are looking at for the full-year number.

Hi Mike, this is Chuck again.

We could -- we haven't given guidance obviously to put the read-through in place, we'd have to give guidance on revs and so forth.

We haven't done that.

Clearly, with the first quarter, midpoint of the guidance being near 35, something in the 30, north of 30 range, something that is absolutely possible for this year.

I want to caution you that we have always talked about having the ability and the discretion of management to reinvest anything above the 25% read-through threshold.

So should we choose to accelerate growth spending or other areas, there is absolutely a possibility we'd be active in that area for anything above 25.

Okay, thank you.

And what about -- can you be a little more specific, to sort of follow up on the last comments, can you be a little more specific about what are some of these cost-savings initiatives you have going forward in the year.

You said you had a bagful.

So, uh --

I think they continue.

In the process area.

So I can't be more specific in laying out for competitive reasons where our areas of attack are, but they are process areas and contract negotiations where we're actively looking at taking out costs wherever we can.

But specifically beyond that, we're not comfortable specifically giving areas of attack for competitive reasons.

Okay.

And you mentioned the goal for the sales force is now for 475 to 480.

Is this -- is the hiring process going the be lagged or it is going to more weighted toward the first quarter, is it going to be even, or more heavy towards the second quarter?

Can you go into a little more details about that?

As I said in my script, we're at 463 right now.

Through the second quarter, we're targeting to be in the range of 475 to 480.

It's not a perfect science in the way that associates end up getting hired.

We want to make sure that you know, we're hiring only the best people to add to our already very high quality team.

But I will tell you that we're getting inflow.

Lots of folks want to join MSC, so we're very comfortable with where we're headed.

Okay, and just lastly, can you break out, just want to make sure I did the math correctly, can you break out the number of days in each quarter for me?

To make sure I've got that right.

For 2005?

Yeah, please.

Okay.

The first quarter, 62; second quarter, 63; third quarter, 65; fourth quarter 63.

Okay, great.

That's all I have for you.

Thanks a lot.

Thank you.

Your next question comes from Adam Drake of Robert W. Baird.

Good morning, gentlemen.

Good morning.

Good morning.

My question is on the read-through, and before you mentioned that 25% is sort of the minimum benchmark that you're shooting for.

And it sounded like the first quarter, are you saying that 30%, by the implied guidance, I guess it would be 30% for the first quarter, and then given your limited visibility to the rest of the year, are you still staying 25%, or are you saying 30% for balance of the year?

Adam, actually the mid-point in the range for the first quarter would imply about 35% for the first quarter.

But as had David mentioned, because of the increase in sales hires, and so forth, there's other variables that'll come into play throughout the rest of the year.

So, again, the minimal commitment is 25.

Again, we reserve the right to invest above that, but with the first quarter out of the gate at 35%, yeah, we feel good that the number could be above 25.

But frankly, again, we reserve the right to spend a piece of that, and you're seeing evidence of that as we talk about our sales increase -- sales hire increase.

And that expense would be in the numbers for the remainder of the year.

It would tend to, it would have an impact on the read-through percentage.

Adam, it's Shelley, if you're getting to the fact that you're looking for an offset, so if you have one quarter at 35, does it mean you'll have a quarter at 15?

The answer is no.

We're looking at minimum of 25 in each quarter.

That's great.

Thank you.

And the next question I had is on capital expenditures going forward.

Do you see anything that would need to happen relativity soon?

Can you put color on the capacity?

Adam, this is Chuck again.

Our maintenance Cap Ex really is in the, you know, $10 million or so range.

There is nothing on the horizon now that says we have to invest for capacity expansion purposes beyond that for the foreseeable future.

Great.

My last question, I was wondering if you could quantify a little bit or put some more color on what the impact of commodity prices for you, your ability to pass them through, and related to that, how fuel prices are affecting you right now.

Sure.

Adam, it's David again.

Yeah, we've seen some freight and energy surcharges which we have passed along to our customers, and we're also seeing pressure on steel-based products of all types right now.

But I will tell you we have taken a hard line with our suppliers and, in fact, our policy is to not accept price increases.

Having said that, where we must, we generally are able to pass those along to our customers.

So all of the increases, and what we're seeing in the landscape right now, are factored into our operating expense and gross margin planning projections.

And at this point, we don't see any material impact in our overall business.

And, you know, I guess, as reminder, historically, inflationary times have been very beneficial to MSC, and all of that is factored into our margin guidance.

I guess I do have one other quick one.

Last quarter you talked about SKU optimization.

Can you give us progress on that -- progress on that program?

Sure.

We talked, Adam, about SKU optimization being a part of our strategy over the next couple of years.

We just finished our completion of this past year, we roughly added 22,000 SKUs and deleted 22,000.

Those 22 that we added, we think are going to be SKUs that give us a higher return on our investment based the great process improvement that our product and merchandising teams have made.

On the other hand, we're also focused on optimizing/removing SKUs that add little or no value to our customers, and that's also helping us be that much more efficient and produce productivity gains in the future.

So we continue to maintain that direction.

The team is focused on it, and we're doing a great job and will continue to do so.

Thanks, gentlemen.

Sure, Adam.

Your next question comes from Brent Rakers of Morgan Keegan.

Good morning.

I guess to hit upon a couple of the employee issues, you have talked the last two conference calls, I believe, about having to staff up a little bit on the support level.

Could you first comment on that?

Hi, Brent, this is Chuck Boehlke.

The support level is more than there is variable types of costs to support the higher activities we're talking about.

So there where associates in our DCs, associates many the call center, those types of expenditures, not a whole lot of more -- of fixed infrastructure or fixed overhead, if you will, from a salary and wages point of view to support the increased volume.

But those are active more related to the sales increase.

Clearly, the sales associates is a conscious decision to expand the field sales associates on the front end.

And obviously that's a different animal than the support expenses required to take care of the higher sales level.

And I guess to follow-up on that, on a go-forward basis, it's a similar mix again, to staff up and proportion on the variable level, but not necessarily a major fixed expansion there?

Correct.

Nothing major.

Other fixed expenses are stepped functions at some point in time.

You may have to add another recruiter if you're actively recruiting more associates for the sales team, and so forth, but nothing of significance related to additional overhead expenditures to support the higher expenses to sales volume other than those are sales/support-type functions.

And then on to the, I guess, the sales force expansion, you have added about, I guess, 10% or so to the sales force the last three quarters.

I was wondering what, I don't think, you're probably not going to quantify specifically what revenue impact they've contributed, but I was hoping to get some sort of time line on when they would be expected to ramp up to a normalized production level.

Hi, it's David.

You're right, we don't quantify.

We're actually delighted with the results that we're seeing from our entire sales force, and that's actually been an important part of our ongoing continued growth, and, you know, the results that we've been putting on the board.

So --

Okay.

Any sort of comment on at what point they kind of reach that same standard as the existing sales force?

We don't quantify that.

We've always said, though, that it takes time to assimilate our reps into our culture and to our customer base.

So there's, you know, that's a many month process, which is why we hire now and expect those hires to actually impact future results.

Okay.

Great.

And just last question, if you could comment just real briefly on the depreciation level, I guess, the sequential drop there?

Right.

Year-over-year, certainly, and in the quarter, the numbers were down fairly significantly year-over-year.

Depreciation for the full year down about 2.7 million in '04 versus '03.

Going forward, the number probably flattens out for this year and probably similar '05.

It's a number we had in total D&A for '04.

That being said, it still exceeds our CapEx investments, so once again we anticipate a drop in our fixed assets.

And just a quick last question.

Any estimate as to when the 10K will be filed?

November 8th or 9th.

Okay.

Thanks a lot.

Thank you.

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

At this time, there are no further questions.

Mr. Jacobson, are there any closing remarks?

Thank you, Lois.

We'd like to thank everybody for joining us on the call, and we will speak to you in another few months.

This concludes today's conference call.

You may now disconnect.