MSC Industrial Direct Co Inc (MSM) 2005 Q3 法說會逐字稿

At this time, I would like to welcome everyone to the MSC Industrial Direct third-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.

At this time, I would like to turn the conference call over to Mr. Eric Boyriven of Financial Dynamics.

Sir, you may begin your conference.

Thank you and good morning, everyone.

This is Eric Boyriven of Financial Dynamics.

I would like to welcome you to the MSC Industrial Direct fiscal 2005 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.

An online archive of this webcast 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 on the same website 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 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 in 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 would like to introduce MSC Industrial Direct's Chairman and Chief Executive Officer, Mitchell Jacobson.

Mr. Jacobson, please go ahead.

Thank you, Eric.

Thanks, everyone, for joining us today.

With me are David Sandler, Chuck Boehlke and Shelley Boxer.

We will be adding some color to today's press release, and then we will open the lines for questions.

I would like to begin by saying just a few words about my father, our founder.

Sidney Jacobson was an extraordinary visionary and leader.

While many point to his innovations in catalog marketing, information technology and distribution, it was some of his softer attributes that will, over time, prove to be his most valuable contributions.

Our culture is our most important differentiator.

Through his behavior, he taught us to respect our fellow associates, keep commitments, honor our word and to give credit and take responsibility.

He also taught us how to delegate authority and manage without ego.

Some people are natural musicians, some are natural athletes.

My dad was a natural leader and visionary.

He will be missed and remembered by all in our industry.

Returning to the quarter, I am pleased with the financial results that the Company reported today.

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

I would like to give some guidance for Q4.

We expect that sales will be in the range of 274 to 279 million and earnings per diluted share will be in the range of $0.39 to $0.41.

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

Thanks, Mitch.

I would like to share some of the things that our customers are telling us, as well as what I heard and saw on my recent trip out West.

Market conditions are similar to those we reported to you in the last conference call.

Customers tell us that business is generally good.

There is the usual mix of some customers and segments which are doing better than others, but nothing different from what our experience has been over the last several months.

We have seen the ISM come down from its lofty levels of last year, which is reflected in the slower growth rates in the manufacturing segment of our business.

Customers are still concerned about higher energy and raw materials costs.

All of this is consistent with an economy that is still growing, albeit at a slower pace.

My recent trip to California gave me the opportunity to visit with our new Los Angeles area sales team.

I was very impressed with their diverse background and solid experience and how they have embraced and are assimilating into the MSC culture.

I can tell you firsthand that this team is talented, energized and focused on winning.

I also spent time with some customers who, like customers throughout the United States, were very receptive to MSC's model and our approach to reducing supply chain costs.

The Western US is an important part of our growth program, and we will continue to add branches and field sales associates as part of our geographic expansion strategy.

At the end of the third quarter, our field sales force had grown to 498 associates, well ahead of our plan, and we now expect to have around 510 field sales associates by the end of our fiscal year.

That would represent growth of more than 10% in the sales force over the prior year end.

In fiscal 2006, we intend to continue to grow the sales force nationally and continue to expand in the West.

Our new Big Book catalog for 2006 will be released in early September, and we will have added 21,000 new and, we think, highly productive SKUs.

We also removed about 25,000 SKUs that were nonproductive, as we maintain our focus on enhancing productivity.

In our efforts to continue to fuel the growth we have seen from MSCdirect.com, we have just introduced a new, even faster keyword search function.

Initial customer reaction has been very positive, as item retrieval response time has improved due to the new functionality.

Our Q4 guidance reflects the normal seasonality in our business, when many of our customers shut down for summer vacations and maintenance.

Our mid-range growth rate of 12% represents about a 1% decline in average daily sales from Q3, which is consistent with last year's experience.

Starting today with this quarter's report, we will post all of the usual operating metrics on our website in the investor relations section instead of reading them to you.

They should be there now, and they will be updated each quarter, coinciding with the earnings release.

In that way, I can spend more time providing color on the call rather than reading statistics.

All of the metrics were excellent, and we continue to execute at very high levels.

I'm delighted with our Q3 performance.

The results were outstanding, and I want to thank all of our MSC associates, whose continuing dedication and hard work produced these great results.

Thanks.

And I will now turn the mike over to Chuck.

Thanks, David.

Before we get into the details of Q3, I have some comments I would like to share regarding fiscal 2006.

David noted that we intend to continue to invest in our sales force and in geographic expansion.

We expect to pay for that increase in growth investments with increased gross margin.

There are price increases in our new 2006 catalog that will catch us up to current market pricing.

This will also drive a read-through percentage in the low to mid 30's in fiscal 2006 and improve operating margins, as well.

Our five-year strategic plan anticipates that we will spend an average of $12 to $14 million annually in CapEx.

Some years could be higher, some lower.

In 2006, we will expand the storage capacity in our Reno distribution center to accommodate the anticipated increase in West Coast business.

That investment is included in our CapEx plan.

The strategic plan also anticipates that free cash flow will be substantial over the five-year period.

Turning to the quarter, in Q3, we exceeded all of our financial goals.

In addition, we will have returned $190 million to our shareholders through the special dividend to be paid in August and through the purchase of almost 3 million shares of MSC stock.

Sales, gross margin and read-through were as expected and, most notably, operating margin grew to 17% of sales.

That allowed us to report that diluted earnings per share were at the high end of the guidance range.

We expect that gross margin will remain at about 46% in Q4.

Operating expenses increased about $3 million over the prior quarter, representing the impact of higher volumes and the sales force expansion.

The increase in operating expenses of approximately 7 million over last year's Q3 represents the effect of higher volume, spending on the growing sales force and continued high levels of spending on medical benefits.

Cash flow from operations was excellent, coming in at $53 million for the quarter and bringing cash flow from operations to 88 million for the year to date.

Free cash flow for the quarter was $51 million and $80 million for the year to date.

Balance sheet management contributed to this result, as inventory turns rose to an annualized rate of 2.6 turns and accounts receivable days sales outstanding were 40 days.

We expect to have in the neighborhood of $60 to $70 million invested cash at our fiscal year end.

Our read-through in Q4 will be impacted by the change in direction of our fringe benefit costs, most notably in medical expenses.

Last year's Q4 results reflected exceptionally good experience for medical costs relative to our experience this year.

Consequently, we estimate that we will incur approximately $3 million more in fringe benefit expense in Q4 this year than last year's Q4.

The $3 million of additional expense will reduce Q4's read-through by approximately 10 points, putting it in the low 20's.

Even with the lower Q4 read-through, we still will generate read-through in the low 30's for all of fiscal year 2005.

Thank you, and now I will open it up for Q&A.

(OPERATOR INSTRUCTIONS).

Holden Lewis, BB&T.

I just wanted to get a little bit more color about the split.

If you are expecting sort of a read-through next year for fiscal 2006 of around 30%, how much of that do we expect to be in gross margin?

How much of it is SG&A leverage?

And that, I guess, gets to some color about the degree of pricing in the Big Book.

Can you just speak in a little bit more detail on those things?

The read-through that we anticipate, as you mentioned, will be pretty similar to this year's number, in that 32 to 33 for planning purposes.

But we are not finished with our full-year planning for next year yet, in terms of being able to split that out by gross margin and OpEx.

As always, the guidance right now is for the read-through.

And we will leave it to you guys to look at the sales number and work your models that would generate that kind of read-through to the bottom line.

But you do expect that the gross margin will step up beginning in Q1?

I mean, that is the expectation?

This is not just leverage at this point; there is definitely going to be a significant and noticeable gross margin impact?

We will definitely have a gross margin impact higher than where we are right now, as the Big Book rolls out in September, which will contain the pricing that is more indicative of where the market is going right now.

That's correct.

And pricing is the substantial cause behind that?

There is no other operational issues which are big movers?

No, it's pricing in the marketplace that will be taken to catch us up, frankly, to the pricing that is out there now.

Dan Leben, Robert W. Baird.

Just to talk about the catalog a little bit, could you give us an indication of the level of the price increases -- you know, just there if there is an average that you could talk about over the course of (technical difficulty) catalog?

We are actually not ready to talk about that.

As Chuck said, we are still in the planning mode for what we expect to happen throughout all of '06.

I can tell you that you will see a margin increase, both in Q1 and throughout, a total increase overall for all of FY '06.

And was there any impact from pricing in this quarter?

No, there was not.

(OPERATOR INSTRUCTIONS).

Bob Missel (ph), MS Sass Investor Services.

I have a couple of broad questions.

The first one -- I wonder if you could update us on the progress of diversifying your markets to moderate the sales cycle?

Sure, Bob.

We are making a lot of progress in what we are actually doing there, focusing on the segments that we have talked about historically in government and national accounts.

We are making a lot of progress there, and our plan is also to continue to focus on additional segments that we would target both now -- we are in the process of identifying the next one that we want to attack, and that is going to continue to be part of our focus over the next several years, actually.

The numbers have not moved much, just based on the solid manufacturing growth rate that we have seen over the last several quarters, in terms of the mix of business.

Right now, it's 73% manufacturing, 27% nonmanufacturing.

But over time that needle we expect to move.

The second question I had -- I wondered if you could comment on whether you are seeing any impact of industry consolidation causing, perhaps, competitive pricing pressure.

The consolidation that we see -- certainly, customers are under pressure out there to improve their businesses, reduce their costs.

We think that that is a reason why our model bodes so well, why we are growing so nicely and why we are so excited about our future.

And your pricing pressure, you feel, is not a problem?

You are able to raise prices to the degree you want to, I take it?

Yes.

Certainly, there is pricing pressure out there, but I guess we have historically said that inflationary times are very good ones for MSC, and I guess that is reflected in our guidance, both for what you can expect in Q1 from us and also throughout all of 2006, with our gross margins.

You implied earlier, commenting on your September catalog, that you will be matching market prices.

Is there someone out there who is the price leader?

Bob, we do a lot of benchmarking throughout the industry.

That is something that I would not want to disclose any further.

I can tell you that we are very plugged into market and who we benchmark and where we believe the market pricing is and where we should be setting ours.

We have seen opportunity there, and that is going to be evidenced by our direction for an improved margin in '06.

Adam Ohlman (ph), FTN Midwest.

I was just wondering, how should we think about the pace of the new buyback authorization?

The last one took almost three years.

Are you looking to be more or less aggressive than the prior plan, given the growth program that you are undertaking?

There is no defined strategy or path as to when and how that stock gets repurchased.

We did use up the 5 million authorization we had outstanding, and the Board replenished that for us, but there is no defined strategy as to how we will or won't do that.

Suffice it to say it has now been replenished.

We have the opportunity to do it when we think it's the right time to do it.

We have talked a little bit about the cash flow and our strategic plan, which is definitely a driver in what we see going forward for the next five years, and giving us the level of comfort to do what we just did for shareholders.

So, short of that, there is no pre-described formula for how that might happen.

And then, the other question I had was the sales growth rates in the Midwest have really held up quite well, despite the tougher comps and what I would presume is a weaker geography of the overall economy, given the automotive exposure in the Midwest.

Could you elaborate a little bit more on what you are seeing from your customers in a general sense by (inaudible) geography?

We see that business conditions are generally good.

I will tell you that there is a lot of, I guess, diversity among our customers, in terms of some customers that are just booming off the charts, can't hire fast enough, and others, frankly, that are scraping, trying to find their next order.

Part of that depends on the segment that they serve, and part of that just depends on how they also just manage their own business and how they focus their business.

In addition to that, we see differences in geographic pockets.

Some markets are busier than others, and we kind of see that across the entire country.

I will tell you in the Midwest that automotive certainly is an industry that is in decline.

In fact, we have seen it continue to decline, and that does impact our Midwest growth rate.

But, as we have said in the past, that overall automotive is not a significant factor on our business in total.

And I guess the only other comment that I would make is, in general, given the tiny market share that we have, we feel like we're just getting started in this business.

Dan Leben, Robert W. Baird.

Two quick follow-ups.

I just had a chance to look at the nonfinancial data on the website, and it looked like the Southeast region had a difficult comp but the sales growth was up a lot.

Was there anything going on there, or was it just the tough, difficult comp?

No.

I think it's just a combination, Dan, of tougher comps.

You see it in the Southeast, you see it across, really, all the regions.

That, coupled with, certainly, I guess, the change economically in growth slowing down -- certainly, that also impact our customers.

Still growing, of course, but at a slower pace.

And then, what have you seen so far in June?

It looks like May was off of April, because that probably benefited from not having Easter in there, I'm assuming?

Well, you have seen May posted at roughly 12% growth.

June, just so you will know, through Tuesday we're actually also at 12% growth.

We finished June this Saturday.

Through Tuesday we're at 12, which, as you know, is in the midpoint of our guidance for Q4, also at 12%.

Sarah Beyrich, Artemis.

I was wondering if you would just talk about transportation costs and whether, year over year, you are seeing any changes there?

Sarah, transportation costs, freight and so forth is an area that has been increasing.

There actually has been a lot of pressure based on higher energy, and we are seeing that.

Fortunately, we are able to generally pass that through to our customers, and all of that is factored into our operating expense and our gross margin guidance, both for Q4 as well as into '06.

And just to give out your various regions and the growth in the Western region -- if that is an area where you are really putting more infrastructure in?

I am assuming it's operating at a lower margin than your other businesses?

Is that fair, to think about as that continues to build, your profitability could be even higher, all things being equal?

Well, you have made an assumption that it's operating at lower margins.

I would not make that assumption, although we don't break out our margins for any region.

That is not something that we share.

And all of that is factored into what our guidance is for this year and into '06.

So as we grow out the West, that will certainly contribute to the margin results that we have said we expect for '06 going forward.

(OPERATOR INSTRUCTIONS).

Chris Xeon (ph), Atlantic Capital Management.

Just a couple of quick ones for me.

First, I just wanted to get what the share count was at quarter end, the absolute share count, as well as sort of what is the date that you are allowed to continue to buy back?

I know you guys have some restrictions on when you are allowed to buy.

The share count, Chris, is 66.7 in terms of shares outstanding.

Now, some of the repurchase took place in the early parts of Q4.

So if you want to know as we sit today, there is 66 million shares outstanding.

It was actually 66.7 at the end of the quarter.

That's without any dilution for options; that's the raw share count (multiple speakers).

So at the end of the quarter diluted is fairly close to where you reported?

That's right.

And in terms of when you can continue to buy back, when the restriction date goes off?

We generally do not buy back during the period when associates here may be transacting business in the window, which starts on Tuesday.

But there is no official prohibition, again.

And just one more thing.

Can you just talk about the rationale regarding the special dividend of $1.50 and sort of why $1.50 and why not just sort up the regular dividend?

The way the process works, it started really with us completing another cycle of our five-year strategic plan.

With that in mind, we're able to look at what our CapEx needs, our working capital needs may have been, as well as establishing a comfortable warchest, if you will, of cash for opportunistic things.

The Board reached out after being provided that information and sought some outside expertise.

And the recommendation that came back was actually adopted, that the return of value to shareholders on some sort of balanced approach to share repurchase and a one-time dividend seemed to make a lot of sense.

And that position was adopted, and as I said in some of my earlier reading here, with all that in place, we still had a cash balance by year end at $60 to $70 million, which is something we were comfortable with.

And that, most likely, is the low point of where the cash balance will be at any point in time, moving forward.

Thanks, guys.

Great quarter.

At this time, there are no further questions.

I would now like to turn the conference call back over to management for closing remarks.

Okay.

Well, thank you all for dialing in and participating today.

We look forward to speaking to you again in the next few months.

Thank you.

This concludes today's conference call.

You may now disconnect.