MSC Industrial Direct Co Inc (MSM) 2005 Q1 法說會逐字稿

Good afternoon.

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

At this time, I would like to welcome everyone to the MSC first-quarter 2005 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. (OPERATOR INSTRUCTIONS).

Thank you. (technical difficulty) -- Mormon, you begin your conference.

Thank you and good morning, everyone.

This is Christina Mormon of Financial Dynamics and I'd like to welcome you to the MSC Industrial Direct fiscal 2005 first-quarter conference call.

You should have received a copy of this morning's earnings announcement and if you need a copy, 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, 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 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 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 turn the call over to MSC Industrial Direct's Chairman and Chief Executive Officer, Mitchell Jacobson.

Mr. Jacobson, please go ahead.

Thank you, Christine.

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

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

I'll begin with an overview of the first quarter of fiscal 2005 and our expectations for the second quarter.

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

Following Chuck, I will wrap up and then we'll open the line for questions.

MSC sales grew by 18.2 percent in the first quarter of fiscal '05, as compared to the same quarter in fiscal '04.

We continue to fire on all cylinders on core execution metrics.

This, combined with our strategic positioning, assures our continued market share gain in this fragmented market.

These share gains are evidenced by revenue growth far in excess of the growth of the MRO marketplace.

We once again achieved our gross margin target the by combining our unique value proposition with aggressive use of purchasing tools and solid marketing of our private branded products.

Our success in this area continues to be an important differentiator in our market and one that fuels investment and earnings dollars in excess of our peer group.

Finally, we continue to leverage our infrastructure built to process volume well in excess of that which we currently generate.

We have continued to combine that leverage with a relentless focus on process improvement.

The combination of the two have contributed to earnings growth in excess of revenue growth over the past few quarters.

As a result, our read-through in Q1 was 37 percent and our operating income grew 56 percent as compared to last year's first quarter.

Operating income improved to 15.9 percent of sales from 12.1 percent of sales in Q1 of fiscal '04.

As we have stated, we are committed to returning MSC to this level of property margin on an annual basis.

Overall, net income grew 57.7 percent and EPS increased 54 percent to 37 cents per diluted share from 24 cents per diluted share in Q1 last year.

Free cash flow, which we define as cash generated from operations less capital expenditures, grew to 27.8 million in Q1 from 11.7 million in the same quarter last year.

Our revenue forecast for Q2 is more difficult than it has been for prior quarters.

December is not a clear data point for us because the holidays this year fell on more favorable days than they did in prior years.

Therefore, December growth, while outstanding, is not a solid data point from which to forecast the quarter.

You'll hear more about this in David's section.

This, combined with feedback from our customers about limited visibility, makes us cautious as we begin to turn toward more difficult comps in the month to come.

While we continue to be very confident in our business and our continued share gains, we do want to express our caution about using December as a data point for revenue growth.

Given the above, we expect sales for the second quarter to be in the range of 265 million to 273 million and earnings per diluted share to be in the 37 to 39 cent range.

As I have said before, we remain very confident of our business model and we know that we're taking market share and improving our core processes.

We're very excited about our progress and our success to date and even more excited about our future, as we continue to deliver performance far exceeding the sector's.

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

Thanks, Mitch.

Before getting into the results for the quarter, I'd like to share some feedback from customers during my recent field trip.

In general, what I heard about market conditions and visibility were essentially the same as the prior quarter.

That is, people are generally busy and have good order flows.

Their visibility, however, remains limited as backlogs tend to be short.

Customers once again voiced concerns about rising costs and interest rates and how that would affect their ability to compete in the global marketplace.

Those pressures helped to make our model of cost reduction, problem-solving and just-in-time delivery that much more attractive to our customers.

I visited with a plant manager in Illinois, who told me that he had consolidated his vendor base down to a select few and that MSC was getting virtually his entire MRO buy.

He explained that MSC's programs, combined with our local representation, had enabled him to meet some very aggressive cost-control targets and performance goals.

He said that our product selection, same-day shipment, VMI program and billing options were the best he had seen. "No one can match what you do", he told me.

That's a great endorsement of our value statement, and that's why MSC will continue to grow and take share.

Turning to the results for the quarter, MSC sales growth rates were 17.1 percent in September, 19.6 percent in October, and 18 percent in November.

December's growth rate was 24.3 percent but as Mitchell mentioned, holiday costs were favorable this year, as both Christmas and new year's fell on weekends, which was less disruptive to our customers and subsequently resulted in the stronger ordering patterns for us.

Consequently, we do not believe that December growth rates are a solid data point for forecasting the growth in the quarter.

All of our regions continued their solid growth.

The Southeast grew by 21.5 percent, the West at 19 percent.

The Midwest grew at 17.5 percent, and the Northeast grew at 17.2 percent.

It's worthwhile to note that we saw signs of a slowdown in the areas surrounding plants operated by the domestic Big Three automakers.

We believe that this had a modest downward effect on our growth rate in the Midwest.

Average transaction size continues to grow, helped by the growth in our national and government-account businesses.

Average transaction size in Q1 was $252, up from $244 in the prior quarter.

Growth in sales to the manufacturing sector was 18.2 percent in the quarter, while growth in sales to the non-manufacturing sector was 17.4 percent.

Sales to manufacturing represented 72 percent of our business in Q1.

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

Details for the quarter are as follows -- overall fill rates continue at 99 percent.

All of our DCs (ph) hit or exceeded their first (indiscernible) goals and accuracy levels remain excellent with an error rate of less than 1 per 1000.

Call center staff continued at high levels as well.

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

We ended the first quarter with 475 field sales associates, up from 453 last quarter and hitting our stated goal a quarter early.

This is an area where we are accelerating our investment, as we see opportunity in the marketplace and we want to build now to fuel future revenue growth.

Consequently, we expect to be at a level of 485 to 490 by the end of Q3.

In Q1, we mailed 7.7 million pieces of mail, just as initially planned, and we expect to mail 7.2 pieces in Q2, up slightly from last year's Q2 total of 7.1 million pieces.

Direct mail productivity continues to increase, as average sales per piece once again grew in the quarter.

Response rates remain at excellent levels.

Total active customer count was 343,000 at the end of Q1, down slightly from last quarter.

Just as a reminder, this decrease was expected, as we altered our mailing program to eliminate mail to small, nonproductive customers as we concentrated on large customers, such as national accounts and the government, which have many locations but who are often counted as only one customer.

MSCdirect.com continued to track -- I'm sorry, continued its track record of outstanding growth in Q1.

Sales through the site increased to $38.9 million, representing 14.8 percent of consolidated sales revenue, an annualized when rate of $159 million and reflecting growth of 41 percent over Q1 of the prior quarter.

I'd like to take a moment to share some of our thoughts about our direction for the future.

For quite some time, we said that we would grow our operating margins to what we consider to be more acceptable levels.

We are extremely pleased with our progress and are now beginning to do exactly what we said we would always do once we achieve solid, consistent operating margins in the mid-teens.

That is increase our investments and revenue growth drivers.

Our plan is to deliver excellent read-through.

Although given the ramp up in investment, we're much more likely to see a read-through in the low 30s for the balance of the year, than the '40s-plus we delivered in the past.

Our great execution over the past few years has built a company that can sustain a midteens operating margin while increasing the investments necessary to keep jeweling (ph) our sales growth rate as we come up against more difficult comps in the future.

Our first step has been to increase our investments in sales force growth, and we are considering other investments for the future as well.

As we make these decisions, we will share them with you as appropriate.

However, I want to assure you that these investments will be measured, as we remain committed to maintaining or improving our current midteens operating margin levels.

In conclusion, I'm extremely pleased with our performance in Q1.

The results were outstanding, and I believe that as long as we continue to execute at these high levels, we will continue to far outperform the sector.

As I always do, I will take this opportunity to express my thanks and appreciation to all of our MSC associates, whose dedication and focus generated these terrific results.

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

Thanks, David.

Q1 was an excellent quarter financially, as we exceeded our read-through commitment, generating 37 percent of our sales increase as incremental operating margin.

The high level of read-through reflects the slight improvement in our gross margin, combined with the decline in operating expenses as a percentage of sales to 29.2 percent.

The decline in operating expense percentage reflects the leveraging of our fixed cost of our larger revenue base and some increases in our payroll costs due to hiring in our sales force as well as payroll and volume increases that were offset by improved productivity and expense control.

Overall operating expenses rose only $3.5 million, or 4.8 percent, in Q1 of fiscal '05, compared to Q1 of fiscal '04.

Read-through in Q2, at the middle of our guidance range, will be about 32 percent, as we incur a higher level of expense related to the growth in the field sales force.

Gross margin of 45.1 percent was within our guidance range of 45 percent, and our guidance remains unchanged for Q2.

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

Free cash flow generation for the quarter was $27.8 million, up considerably from last year's first quarter's free cash flow of $11.7 million.

Overall working capital, excluding cash, grew only by $2.7 million as inventory turns improved to 2.55 annualized terms and DSOs grew slightly to 42 days.

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

Our invested cash balances grew to $214 million at the end of Q1 and are currently at about $220 million.

In summary, an excellent quarter financially, as we exceeded expectations on earnings, read-through, cash flow, and improved our operating income to 15.9 percent of sales.

Thank you.

I will turn the mic back over to Mitch for the wrap up.

Thanks, Chuck.

MSC continues to execute and deliver excellent results for all of our stakeholders.

Our operating model is the right one for the future, as we can deliver real measurable improvements in total procurement costs for MRO products to our customers.

We are confident that we'll outperform our peers in whatever economy we may see in the future, making MSC the place to make one's career.

We thank you for joining us today.

Rudy, if you can open up the mics to questions, I would appreciate it.

(OPERATOR INSTRUCTIONS).

David Manthey of Robert W. Baird.

Good morning.

My question was regarding the daily or the monthly sales figures.

I'm wondering.

Is that a daily sales amount or is that just simply this month versus the year-ago month?

Are you talking about December or --?

All of them.

They are based on average daily sales.

Okay, so the 24 percent is the daily sales, but you think that ,for whatever reason ,because the holidays were more advantageous, that that's inflated?

David, it's David.

The reason specifically is that we got the benefit of what we think are really easy comps this week -- this year -- given that the December Christmas and the new year's holidays both fell on weekends as opposed to mid-week last year, which meant there was a whole lot more disruption and shutdowns and vacations last year than this, so we think that that significantly contributed to the December -- (technical difficulty) -- certainly great results that we saw.

Right, okay.

The second question is, you mentioned previously that you've reduced or held prices on 250,000 items, and I guess that also means that you've raised prices on another 0.25 million products, but can you talk about what that would be on a sales-weighted basis?

I talked with you before about it on an equal-weighted basis and I think it's a pretty small number, but are you raising prices on the products you sell more frequently or less frequently, that the sales-weighted number would be more or less than just a couple of percent?

David, we actually don't talk about the weighting of the product mix, or the way that prices have moved.

You are right.

Certainly, our September big book -- half of the items reflected the same or reduced prices and half of the items did reflect increases to varying degrees.

I suppose that, without a sales mix, probably overall that looked to be in the range of about 1 percent, but in terms of how it actually played out, there are so many different factors, given what our actuals costs were, the product mix, the customer mix, that that's really as far as we go other than to give assurance in the way that we view it for our gross margin guidance, which I think you've seen us to be pretty good over the last many, many quarters.

Okay.

Then the final question is a wide-open one.

David, a few conference calls back, you talked about strategies specifically in three areas.

You talked about increasing investments for growth but a little bit -- I was wondering if you could talk about the top priorities as we move into fiscal '05.

You talked about going after new segments and these 11 major verticals.

I'm wondering if you could talk about which are the important ones there this year.

Then you talked about higher revenue per customer through deeper relationships, IT and fine-tuning your SKUs and if you just talk a little bit about that.

So just a wide-open question on strategy -- (Multiple Speakers).

Sure.

I actually think you've covered a lot of them, David, very well.

We are excited with the many, many different ways that we are able to grow.

You've seen us investing in areas like our sales force build out.

Certainly, SKU expansion has been one of an ongoing nature for us.

We've been investing, as you know, in the government and national accounts.

In terms of these verticals, we've got many, many more customer segments that we're going to be able to focus on.

When you add that to some of the value-added services and other things that we do, we really see a huge runway for growth in this thing.

The only thing that we're comfortable specifically talking about right now is the fact we're ramping up investment in our field sales force and really for competitive reasons, we don't want to broadcast any other moves right now.

As we make clear decisions and as appropriate, we certainly will share.

But you can expect to continue to see us investing in the myriad of growth drivers that we have in the business, and we are excited about it.

Holden Lewis of BB&T.

Holden, are you there?

We can't hear you.

Sorry about that.

With regards to a lot of these strategy investments you're talking about, you've been doing them for awhile and it certainly hasn't put a halt to the cash buildup.

You know, are we possibly looking at more sort of infrastructure build out, something of more a fixed asset nature?

Also, can you comment?

You've spoken about maybe acquisitions in the past.

Is that something which is becoming more and more likely or attractive in your mind in terms of goals for investment?

It's Chuck.

In terms of infrastructure investments, the answer is no, there's nothing on the horizon that says that we're going to have to (indiscernible) significant infrastructure in or that we want to right now.

There are no plans for new DCs or that of that thing -- nature of capital investment for the future foreseeable future.

We still believe we are in that kind of 10 to 12 million maintenance CapEx type of stuff that would include possibly putting some additional storage in existing facilities, but certainly not significant infrastructure investment beyond that.

So the answer is no to that one.

Acquisitions -- we've said all along should the right thing come along, we would be willing to entertain it and listen and have a discussion about it, but again, we will reiterate that our strategic plan right now, looking out, does not include, in purpose, intentionally going after acquisitions to meet our growth targets.

While that's something that's always open and will be considered, it's not something that has moved up the list priority-wise at all.

Okay.

It just sort of sounds like the tone and message that you're trying to relay is that the things that you are looking at is different than simply hiring more people or adding more SKUs or what have you that you are looking for -- (indiscernible) some things that are more creative.

Is that the message that we should be taking away?

Holden, we always try to keep creative here in the company on how we are fueling our growth.

I think more the message is that we're ramping up our investment.

We've always had new things that are brewing but we've got many, many, many different growth drivers that we can easily turn the dials on and ramp them up further.

That's actually what we are intending to do -- still within the confines of what we said about our read-through, although what we've said is that through the year, we do expect it to be tailing down more towards the low 30s and also within our own confines of maintaining and improving our midteens operating margins so that we're going to continue to maintain that balance in the way that we view the business.

Are there any business channels that maybe you're not in currently that you think might be worthy of some extra investment?

Maybe it's a VMA (ph) or maybe a branch buildup in the West?

Are those the kind of things that we're sort of looking at?

Holden, there's lots of things that we look at and certainly geographic expansion opportunities in both new product segments and new customer segments are all -- actually, I think we've said are all within our long-range plan but we don't like to broadcast our specific moves for competitive reasons.

Fair enough.

Secondly, is there some other way -- since the active clients seem to be flattening out and the argument is that we really -- we have a single client that has a lot of shipping points, so it's kind of misleading.

Is there another way that you can try to make the case for us about what the client coverage or the shipping points or another way to make the same point you've made in the past with your active client list?

Is there a better gauge at this point?

There's a couple of things that we look at internally that we don't share publicly.

Certainly, our customer count is one that we've shared publicly.

The ship-to locations growth is something that is an internal metric that we watch.

But the other part of the equation is that we have actually increased our attrition rate on small ,really non-profitable customers that we have, by design, have called out over the last year or so, and we think that movement is making for a healthier, more profitable customer base long-term.

Okay.

I guess that leaves the question of, I think when you sort of went through this calling process in the past, it had a pretty noticeably positive impact on the gross margin.

You know, you're doing a little bit of that again, plus perhaps the manufacturing is still outgrowing the non-manufacturing.

How come that hasn't translated into a little bit more of a pop to the gross margin?

Well first of all, I think one of the things that -- it's a little bit of apples and oranges.

In the past, I remember at the beginning of the recession, we had made a decision to call out some of the -- many larger, low-profit customers, customers that we didn't believe we were going to be able to profitably grow, that were within our plan.

That was a conscious effort.

This effort is more directed towards the small customers, customers that we believe have little opportunities for future growth and so that has been our focus there on the customer side.

Then all of that translating into gross margin, you know, there's a lot of working pieces to the gross margin.

You know, the fact is you've got changes on the cost side, but you've got these enormous mix issues within the business, whether it's in our product mix and/or our customer mix; all of those things are factors within the way that our gross margin actually shakes out.

So it may seem pretty steady, you know, to someone looking at around 45 percent that we've been able to continue to deliver for many quarters, but I will tell you that this duck is paddling hard underneath the surface when you look at all the activity that goes into maintaining it. (multiple speakers).

We look at profitability not necessarily as just gross margin.

So when we've called in the past, we specifically did talk a little bit about low-margin accounts but in this context, we are also talking about the OpEx necessary to support an account that we don't believe is going to grow profitably for us.

That could relate to direct-mail marketing materials; it could relate to the cost to serve that customer.

There's lots of aspects below the gross margin line that enter into the possibility of a customer.

So, while you may not be seeing significant evidence in the gross margin line, there's some improvement, I will tell you, in the OpEx line related to some of these callings.

Just to close the loop, now you've heard from all three of us, the customers that were called in the past were low gross margin, low operating margin customers.

The customers that are being called now are high gross margin, low or negative operating margin customers, and that's the difference.

I got it.

All right, thank you.

(OPERATOR INSTRUCTIONS).

Brent Rakers of Morgan Keegan.

Good morning.

I guess, first of all, I would love it if you guys could maybe expand upon your comment about the slowdown from the domestic auto companies.

It doesn't seem to really make the Midwest look like an outlier, relative to the other regions, in terms of sequential growth numbers.

I was wondering if maybe you're referring to the December month and maybe going forward there.

Brent, it's David.

We have seen -- I mean, you are right.

When you look at our regional numbers, I guess what we're saying is that the Midwest could have been higher, and we would expect the growth rates to be higher other than the fact that the Big Three, which controls a lot of the business in that territory -- what affects us isn't so much the Big Three but their tier 2, tier 3 and all the job shops that feed off of them in that region, which we are commenting on, that is contributing to that 17 and change percent growth.

I imagine again that's -- I guess that's a pretty short leadtime in terms of visibility that you have in that market?

I mean, yes.

We have limited visibility, actually, throughout our regions.

So I'd love to get more but we hear time and time again from our customers ,not necessarily our automotive-related customers, but in general customers telling us that business is good now, but I work on very short backlog and I'd don't know what the heck to expect a month or two out from now.

That's what we face in trying to forecast our business.

Is there any feel you can give us as to how big exposure might be to the automotive industry in general as a percent of the total business?

You know, I can't give you a number.

I will tell you that, to our business, it's relatively small.

Okay.

Switching gears, it seems like you've talked the last several I guess two or three conference calls about having to increase the personnel and that the operating costs were going up, but they still have been kept under pretty good control.

Are you seeing the staff levels now, since maybe even three or four months ago, go up beyond the sales additions?

With regards to some of the other non-payroll related expenses, whether it's your advertising budget or your healthcare costs or like that, have you pretty much maxed out where you can take those as far as bringing those down?

It's Chuck Boehlke.

I'll answer your last question first.

No, we've got absolutely continuous cost-down programs in place that we're not anywhere near done in terms of identifying the opportunities and negotiating costs.

Maybe to help you a little bit, if you look at the sales last year versus this year, roughly the $40 million sales increase, that by itself would tend you to believe that just the variable expense of the processing the order, the freight, etc., would put an extra 5 or 6 million into our OpEx over and above what we had last year.

As you can see from our results, the OpEx is only up about $3.5 million.

So there is activity going on in cost reduction that behind the scenes is taking that variable expense and been able to mitigate that through process improvements and cost reductions to limit that to a 3, $3.5 million increase, even when the variable expense alone would tend to say the number should be a lot higher on the OpEx side.

Evidence that we're driving some costs out and we've continuing programs to take more out into the future.

From your staffing question point of view, other than the cost of the sales associates which we have hired and some of the support expense being relatively flat, it's a case where we've had to maybe take our DC support levels up to support the higher level of activity, but there's no infrastructure or fixed spending if you will that's been layered on top where we are now.

In fact, that tends to be coming down now as we put these process improvements in place.

Would you think the total companywide headcount numbers by the end of the fiscal year -- are we talking maybe up just a percent or 2 or are we talking more significant company-wide than that?

When we talk about headache (ph), it's going to be a function of the sales.

It is going to be a function of two things actually.

It will be a function of the OSAs and we commented today on the range of where we would be at the end of the third quarter, and then associates required to support the increase in sales, just primarily focused on our distribution center to support the higher level of sales.

So they tend to ramp up on the DC side, although we are taking a lot of costs out there in some relation to the sales.

I can tell you, the back-office type support functions though have not been adding headcount and we don't anticipate any significant change in our support functions, even the higher level of sales we've projected for the rest of the year.

Then last question -- I know you won't talk specifically about what your targets are for the new sales force additions, but can you speak towards maybe what markets are they targeting at the core manufacturing customers, or are they more focused on the non-manufacturing area?

Then maybe is there a certain sized customer or just some more information in terms of what the role of these new sales adds is going to be?

Brent, it's David.

It's really something that, for competitive reasons, we don't like to broadcast, the type of customer that we're going after, the specific markets that our reps are going to be targeting.

So I'd rather just back off and not talk about it.

(OPERATOR INSTRUCTIONS).

There are no further questions at this time.

Are there any closing remarks?

Thank you, everyone, for joining us and we will talk to you again next quarter.

This concludes today's conference call.

You may now disconnect.