MSC Industrial Direct Co Inc (MSM) 2005 Q4 法說會逐字稿

Good morning.

My name is Constance.

And I will be your conference facilitator.

At this time, I would like to welcome everyone to the MSC Industrial Direct Fiscal 2005 fourth quarter and full year results conference call. [Operator Instructions].

Thank you.

Mr. Olecki, you may begin your conference.

Thank you and good morning everyone.

This is Jim Olecki with Financial Dynamics, and I'd like to welcome you to the MSC Industrial Direct Fiscal 2005 fourth quarter and full year results conference call.

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

If you have not yet 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 also 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 Web site under 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 these forward-looking statements are reasonable, they cannot give 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'd like to introduce MSC Industrial Direct's President and COO, David Sandler.

Please go ahead, sir.

Thank you, Jim.

Good morning everyone and thank you for joining us today.

With me are Mitchell Jacobson, our Chairman;

Chuck Boehlke, Executive Vice President and CFO; and Shelley Boxer VP of Finance.

I'll begin with an overview of the fourth quarter and fiscal '05 and our expectations for the first quarter of fiscal '06.

Chuck will provide details on the financials.

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

Fiscal 2005 was a great year for MSC and it was capped by a solid fourth quarter.

For the first time in our history, we reported annual sales in excess of $1 billion.

We delivered on every commitment we made.

We improved our operating margins, grew net income and EPS substantially and executed on all of our strategic initiatives.

Our business mission is based upon our performance for the benefit of the four groups with a stake in our success -- our owners, associates, customers and suppliers.

We feel strongly that our company will win long-term if we continue to drive value for all of our stakeholders.

This was a terrific year for our owners.

We delivered record sales and earnings, which drove growth in our share price and contributed to our ability to return over $230 million to shareholders in the form of common stock, purchases in the open market and our cash dividends.

Our associates will be rewarded for their performance with a terrific bonus payout.

In addition, our growth will provide continued career opportunities.

This, combined with our unique value-driven culture, makes MSC a long-term career choice for our 3,000-plus motivated team members.

Our customers benefited from our innovative strides in procurement cost savings and product breadth and selection.

We continue to deliver on our service promise for a flawless execution.

Finally, our suppliers had a great year as we continued to grow using our balance sheet to process quick payments and investing in new products and an expanded sales force to market their offerings.

It's easy to assess the short-term wins this year.

However, it's important to note that we accomplished all of the above, while continuing to invest in our future.

Strategically, we took our first steps in the western region of the United States, we invested in and grew our field sales force by 15% in FY '05, we used technology to improve the profitability of our "Direct Mail Program," and to improve our search capabilities on mscdirect.com.

As we look toward fiscal year '06, we will continue to invest in the sales force, and by the end of Q2, we intend to grow the field sales team to 550 associates.

My recent trip to the Midwest reinforced the value of our integrated approach to procurement cost reduction.

As you know, we combine product breadth, flawless execution, a solutions-based sales force, and customer-focused technology in order to add value to our customers.

While this occurs day in and day out throughout our company, I experienced it first-hand while I was traveling with one of our sales associates out of the Cleveland branch.

We visited a customer who had been purchasing approximately $60,000 a year in merchandise from us.

They had recently brought another customer of ours.

The company that they acquired was using our VMI system to manage their tool crib.

As our customer proceeded to integrate the two companies, they were so impressed by the efficiencies generated by VMI in the acquired company that they installed it throughout their plant as well.

Our win?

What was $60,000 a year is now $20,000 a month in business and growing.

They did this because our approach to semi-plan (ph) demand works.

It saves our customers time, allows them to optimize their purchasing and to consolidate their supplier base.

Field testing the decisions we make at the senior level is critical to our continued leadership in our industry.

That is why our leadership team visits branches and calls on customers throughout the year.

Sadly the Gulf region experienced the devastating effects of hurricanes Katrina and Rita.

Our branches in the regions were closed for some time but fortunately were not seriously damaged and have reopened to serve our customers relatively quickly.

We did experience a temporary decline in sales in this region.

Subsequently, we experienced an upturn in orders including some large orders from relief agencies.

In sum, we think the net effect was close to zero.

We are very proud of how our entire team responded to the community's needs during this natural disaster.

In general, business conditions remained solid.

The ISM index remained safely above 50, which indicates expansion in our core customer base.

Customers are still concerned about raw material prices and in particular how rising energy costs will effect their businesses.

I'd like to give some guidance for Q1 at this point.

We expect sales in Q1 to be between 292 million and 298 million and EPS to be between $0.44 and $0.46 per diluted share.

Included in the EPS guidance is a charge of approximately $0.03 per share to reflect the effect of implementing the FASB statement on accounting for the cost of stock options.

And as a remainder, all of our operating stats have been updated to Q4 and are posted in the Investor Relations section on MSCdirect.com.

In conclusion, my thanks to all of our associates for their hard work in delivering an outstanding year.

It is their efforts that will continue to reward all of our stakeholders in the future.

Thank you.

And I'll now turn the mic over to Chuck.

Thanks David.

For fiscal year 2005 net income grew 38.3% and fully diluted EPS grew 37.6% on sales growth of 15.1%.

Contribution margin, which we call 'read through' was 32.5% for fiscal 2005.

And our operating margins improved to 16.2% of sales.

We generated free cash flow, which we define as cash provided from operating activities plus capital expenditures of over $113 million, which exceeded our net income for the year.

In Q4 net income grew 26.6% and fully diluted EPS grew 31.3% on 12.2% sales growth.

Gross margin was 46% and operating income grew to 15.5% of sales.

Included in Q4 operating income, is a pretax charge of $800,000 representing a settlement on the claim for patent infringement.

We chose to settle this claim to avoid the expenses and distraction of litigation. 'Read through' in Q4 was 23.2%, and would have been 25% if the settlement had not occurred.

As we noted last quarter, the fourth quarter 'read through' was also reduced due to higher cost of fringe benefits, notably on medical benefits.

In FY 2004, due to favorable experience, we found we had accrued too much leading us to reduce Q4 '04 fringe benefit expense by about $2 million.

This was not the case in 2005 and in fact we've been accruing at a significantly higher rate than originally anticipated during fiscal year '05.

Therefore, Q4 '05 was burdened by about $3 million more in fringe benefits than the comparable quarter in '04.

The balance of the increase in operating expenses in Q4 of '05 versus Q4 of last year is due to the expenses to support higher sales volume, salary inflation and the increase in our field sales force.

In Q4, we reduced our tax accrual to bring our effective rate to 38.2% for all of '05.

During the three previous fiscal quarters, we had underestimated the effect of tax exempt interest income and overestimated our state tax requirements, the effect of which was an over-accrual of our tax provision by approximately $1 million.

When combined with the offsetting after-tax effect of the legal settlement noted earlier, fully diluted EPS was increased by a $0.01 per share in Q4.

MSC generated free cash flow of $33.5 million in Q4 and $113.7 million for the year.

We converted over 100% of net income into free cash flow through solid balance sheet management.

For the year, inventory returns increased to 2.5 from 2.4 in fiscal year '04.

Receivable DSOs were approximately the same at 41 days.

In FY '06 we expect our gross margin to increase to approximately 47% or 120 basis points above FY '05 level.

Our 47% forecast incorporates a Big Book price increase of between 3.5 to 4%, partially offset by product cost increases.

The net effect is an improving gross margin that affords us the opportunity to offset inflationary pressures in energy costs, fringe benefits and salaries while continuing to invest for growth.

Our 'read through' for '06 should be similar to '05 excluding the impact of stock option accounting.

We expect that we will continue to generate substantial free cash flow in FY '06 as well.

At the end of '05, we have invested cash of approximately $85 million and currently have an expense of $120 million in invested cash.

CapEx for '05 was $11.4 million, about $850,000 less than depreciation and amortization.

For FY '06, we expect maintenance CapEx to be about 14 to $15 million.

As discussed in prior years we said the CapEx would be in the range of depreciation and has been for the last few years.

This year we are initiating an exciting additional investment.

Exciting because it will pay back its cost within three years of completion.

We will install a new warehouse management system in one of our distribution centers.

If it performs as expected, it will dramatically reduce the cost of order processing.

And better yet, if successful we will able to leverage the learning across our other distribution centers.

This project will cost roughly $8 million in CapEx and increase our total CapEx spending to the 22 to $23 million range for FY '06.

In FY '06 we'll be required to expend the effective stock options.

We have estimated this will reduce earnings for all of 2006 by $0.09 per share.

Thank you and now I'll turn it over to Mitchell.

Thanks Chuck.

It is with great pleasure that we announce David Sandler's promotion to CEO.

I have complete confidence that David will continue to drive MSC's success for many years to come.

MSC is one of the very few companies to have survived and flourished after passing -- after the passing of the baton from founder to the next generation.

Fewer still begin as family companies and achieve over $1 billion in annual revenues.

Only those that are built to last develop a culture of succession planning, career opportunity and relentless focus on mission.

We're fortunate to have had a wonderful role model for this process.

My dad who founded the company, passed the CEO baton to me early enough in his career.

But he was able to continue as my mentor and sounding board for many years.

That transition dated my success and set the tone for succession planning in our company.

The board, David and I have been working on succession planning for quite some time.

It is our expectation that little will change.

I will remain involved in the strategic process of the company.

Continue to visit branches and customers and to utilize my industry relationships for the benefit of the company and of course be that mentor and sounding board for David and the entire team.

My extended family owns more than 20 million shares of MSC's stock and my immediate family owns in excess of 13 million shares.

I remain very committed to the success of this company.

David and I speak regularly and our offices are next to each other.

Most importantly, we share a common view of our culture and our incredible opportunity.

Our team and our company remain focused on our mission.

To be the best industrial distributor in the world as measured by our associates, customers, owners and suppliers.

We have tiny market share of a giant $140 billion market.

We are fortunate to have achieved momentum in this market and be extremely well positioned with a solid balance sheet, excellent cash flow and significant strategic advantages.

Although, we're 64 years old as a company, we are only in the early innings of what will be an amazing growth story.

I remain excited about our future and committed to our success.

Thanks.

And Constance is it?

Can we open the line for Q&A please?

[Operator instructions].

Your first question comes from Jeff Germanotta of William Blair.

Good morning gentleman and thank you on a great quarter.

Congratulations David also.

Thank you Jeff.

I wanted to talk a little bit about one of the key operating metrics that we've been tracking for a while that being the incremental operating margin or the 'read through.'

Was it mostly the fringe benefit expense that resulted in that being closer to your minimum target or were there other dynamics such as investment growth drivers that influenced that as well?

Because candidly we were -- while your earnings were in line with our expectations we were probably looking for that metric to be slightly higher.

Jeff, hi, it's Chuck.

Let me take that 1 for you.

I think if you recall maybe on the last call we had mentioned about this anomaly in our fringe benefits.

Anomaly, being '04 having a very exceptional year and booking a reduced reserve requirement in FY '04 versus unusually unfortunate history in the medical benefits in '05.

And that factor alone is worth about $3 million in swinging expenses from '04 to '05 in the fourth quarter.

That $3 million is worth tenfold pints on the 'read through.'

So we would have been up in the 32/33% range again versus what we actually reported in the 23 range.

And I believe we did last time give guidance that we thought the 'read through' because of this would be in the low 20s.

So it's really a full 10 points that would be added back in on a comparable basis.

Then how should we think about it on a go-forward basis?

Is -- are we going to be accruing at a much higher rate of the fringe benefit expense and what would be the future implications for the 'read through'?

That's -- Jeff, yes, but that's all baked into the 'read through' guidance that we provided in the script here that we believe '06 will be very comparable to '05 on a full year basis.

And that number was in the 32%, 32/33% range for '05.

So incorporating all that, the growth driver investments, the inflationary pressures that I mentioned in the market from energy and so forth, all that's baked into the guidance that we've given at comparable levels to '05.

Thank you.

You're welcome.

Thanks Jeff.

The next question comes from Ababishek Rathod (ph) of Merrill Lynch.

Congratulations David.

Thank you.

I had a question on options expense.

You guys are guided to $0.03 for 1Q '06 and then $0.09 for the whole year.

Can you give us more color on the timing of the option expense throughout '06?

Yes, I'll give you the exact quarters, if you like, the minutes, it gets into rounding, but then basically you come up with first quarter is in real terms $0.025, $0.022 in Q2 and then $0.021 in Q3 and Q4.

They are the net numbers that impact EPS, that's $0.089, $0.09 worth of EPS impact for the full year.

Sure, now isn't this number little higher than what you guys recorded in fiscal '05 on a pro forma basis?

Yes, on a pro forma basis.

The pro forma number for last year -- let me say this.

On a comparable basis last year had $0.10 and this year has $0.09 in it.

The pro forma number that we reported last year took that $0.10 number and was able to reduce it to $0.05 for some tax benefit we could use in the pro forma statement.

Unfortunately on a go forward basis that tax benefit's no longer valid in the real world of actually expensing the options.

So, comparable to comparable, a reduction from $0.10 to $0.09 and we would expect that number to continue to go down in the future as more expensive grants follow off and replacement grants with fewer shares come in.

But you're absolutely right, on a pro forma basis to last year, because of the tax breaks, it looks like $0.05 last year versus $0.09 this year.

Okay.

And on your guidance for fiscal 1Q '06, you guys guided to 44 to $0.46.

Now does that guidance assume a strongest September month or do you assume better business conditions throughout the rest of the quarter?

The guidance incorporates -- we posted what the September results actually were, which was about 12% sales growth on our Web.

We have actually also been running through Tuesday about 11.5% growth in October -- October month end is this Saturday.

All that's been incorporated into our guidance mid-point of the range sales growth rise is right at 12%.

Okay.

And lastly, what kind of pricing benefit are you guys seeing from the Big Book rollout so far?

Have you seen the 3.5% pricing benefit that you mentioned now -- earlier in this call?

Yes we -- as we said, our Big Book pricing increase was between 3.5 and 4% and we've incorporated that.

Certainly you'll be seeing the effects of that in our guidance.

And in fact, our full year gross margin guidance is going to be in the neighborhood of 47% this year.

Okay.

Thank you guys.

Thank you.

[Operator Instructions].

Your next question comes from Bob Little (ph) of MBSAS Investor Services.

That's MBSAS.

Thank you.

I have just one question.

Has Home Depot been a competitor of yours at all and with the acquisitions they've been making recently, is it becoming more of a competitor perhaps?

Bob, it's David.

Home Depot is certainly one of the competitors that's out in the marketplace.

Between the big bosses and some of the companies they acquired I guess even back as early as maintenance warehouse in the mid '90s.

Certainly they're one of the big elephants that are out in the jungle.

We can see that they're pushing to some degree into the MRO space, but we've got lots of competitors out there.

Frankly, we think we've got a very unique value proposition and model and fortunately we've got less than 1% share of this highly fragmented market.

Okay.

Thank you.

Your next question comes from David Manthey of Robert W. Baird.

Hi.

Thank you.

Congratulations David.

Thank you.

Sales associates were up more than we thought at 520.

That's a pretty healthy number.

Were those folks added pretty evenly throughout the period or were they weighted toward the beginning or the end of the quarter?

The increase was -- it was much -- it was stronger towards the middle latter part, which obviously has impact for the expense as far as the move forward into '06 but in terms of the peer sale tiers (ph), yes, they were weighted probably middle to latter part of the quarter.

I think that's fair.

Okay.

Since you had a goal of -- I think it was 510 and the increase year-to-year is something like 15%.

Going forward, should we expect -- should we expect something more like a 15% year-to-year additions going forward, or will that moderate because you're a little ahead of the goal right now?

Well David we certainly hope to continue to invest at significant levels in explaining our sales force.

You know that it's an important growth driver for us long-term.

We're only comfortable at this point going out two quarters.

And basically, the guidance that we've given is 550 through the end of Q2 and we'll certainly continue to look at that and -- but we'd rather guide a little bit further in than go in for the full year.

But directionally, certainly we hope to continue to expand at significant rates.

Okay.

Thank you.

And in terms of your auto exposure, could you talk about what specifically, in terms of a percentage that you have auto exposure hearing about production schedules being lower and weeks being taken out in November/December, do you have any idea of the percentage there?

I don't have the exact percentage.

I will tell you, as we consistently said, fortunately our auto exposure not only in the primary but with the secondary and tertiary contractors and shops that support auto in general is our exposure to that market is really very small.

We haven't seen a great deal of difference in the auto segment in general.

I would tell you that there has been prolonged weakness there, although as we look at all of our markets we get a little bit of feedback with some plants perhaps based on the vehicles that they are making are actually doing a little bit better with a bit more activity, than what we have been consistently seeing.

Although consistently domestic auto has been -- has been pretty down.

But again, really insignificant to our total business.

Okay.

And then finally in terms of the price increases, if I remember correctly last year, I think the overall increase was much lower.

And you may have used that as a competitive advantage in trying to capture more customers.

Could you talk about the -- you must have looked at a cost benefit analysis and figured out the raising prices would be more advantageous to profitability than trying to just gain share to keep your prices lower.

And then is the 3.5 to 4% -- is that sort of -- I think the example you gave last year was if you brought one of everything in the catalogue that would be the price increase.

Is that what you're talking about or is this weighted for mix?

Well let's see.

First of all on the market share question and on pricing position in general, certainly we hope to do both, meaning continue to capture and gain market share while at the same time using and being able to benefit from the opportunity that we see in the marketplace.

And we think that our pricing position in the catalogue has done exactly that, David.

So, we think we're -- even with this increase, we still think that competitively we're very well positioned.

David, the second part of your question was on the weighting of the increase.

I mean, that range basically, it's not an exact science.

I mean you have to remember that there is several factors that play into the pricing.

Certainly that's approximately the increase that we took in Big Book pricing but there is of course offsetting effects to our margin guidance moving forward.

Things like product mix as you mentioned, the weighting of how our customers mix changes for example, some of our increasing pricing is also there to offset some of the dilution that we see from segments like government and national accounts.

All of that though is factored into our first quarter's guidance as well as our full year guidance on growth margin which should run around 47% plus or minus.

Okay.

Thanks very much.

Thank you, David.

[Operator Instruction].

Your next question comes from Yvonne Varano of Jefferies.

We can't hear you.

Yvonne?

Constance, are you there?

Yes, sir, she has withdrew her question.

Okay.

And there are no further questions at this time.

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

Okay, well thank you all so much for your time and attention and joining us today.

And we look forward to speaking to you in another couple of months.

This concludes today's conference call.

You may now disconnect.