MSC Industrial Direct Co Inc (MSM) 2006 Q2 法說會逐字稿

Good morning.

My name is Wendy and I will be your conference operator today.

At this time, I would like to welcome everyone to the MSC Industrial Direct second quarter results 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 session. (OPERATOR INSTRUCTIONS).

Thank you.

Mr. Eric Boyriven of Financial Dynamics, you may begin your conference.

Thank you in good morning everyone.

This is Eric Boyriven of Financial Dynamics and I would like to welcome you to the MSC Industrial Direct fiscal 2006 second quarter results conference call.

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

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

An on-line 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 on 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 significant risks and uncertainties, including the future operating and financial performance of the Company.

Although the Company believes the expectations reflected in its forward-looking statements are reasonable, they can give no assurance that such expectations or any of its forward-looking statements will prove to be correct.

Important risk factors that can cause actual results to differ materially from those reflected in the Company's forward-looking statements are included in today's earnings release and in the Company's filings with the Securities and Exchange Commission.

In addition, the information contained in this conference call is accurate only on the date discussed.

Investors should not assume 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 President and Chief Executive Officer, David Sandler.

Please go ahead, sir.

Thank you.

Good morning everyone.

Thank you for joining us today.

With me are Chuck Boehlke, Executive Vice President and CFO, and Shelley Boxer, Vice President Finance.

I'll be providing some details on the quarter and the execution of our business model.

Chuck will give some details on the financials and then we'll open it up for Q & A.

I'm very pleased with our second quarter results.

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

We exceeded our targets for sales, gross margin, and incremental margin in the second quarter.

And that enabled us to exceed the top end of the earnings range we initially gave as guidance for the second quarter.

Market conditions continue to the solid.

Our customers are generally confident, are telling us order flows remain steady and that raw materials, supplies and pricing have stabilized.

There is still concern, however, about costs in general in the marketplace.

The ISM index continues to be positive and is staying well north of 50.

Historically, that's been a strong indicator of future growth.

We continue to execute on our West Coast growth plan and we are pleased with the results to date.

We expect to continue to grow our sales force in the West in Q3 to further fuel our sales growth in that region.

As we move forward with the J & L integration plan, we will decide on how best to position the combination of the two sales teams in the market.

We view this as a huge opportunity and we will be growing our sales force by 25% with the addition of the J & L team.

We have already begun the planning process on how best to allocate our combined resources.

Until that process is complete and we implement our decisions post closing, we intend to maintain the MSC sales force at its current levels of 560 or so.

We expect that the increase in our West Coast sales force buildup will be offset by normal attrition in those states were we see potential overlap between the MSC and J & L sales forces.

All of our metrics remain solid and the business continues to execute at a very high level.

The metrics are posted on our website.

Before I give some guidance, I have been asked to remind everyone that any guidance, projections, or forecasts we may give do not include the operations or financial performance of J & L. Now moving to the guidance for the third fiscal quarter, at this point we think that sales will be in the range of $323 to $327 million.

And diluted earnings per share will be in the range of $0.52 to $0.54, including the charge of approximately $0.02 per share for the effect of expensing stock options.

Before concluding, I would like to add that I'm really excited about our future.

Over the long-term, the acquisition of J & L is expected to increase our future growth in revenues and earnings beyond our current strategic plan.

We will be modifying some programs within our strategic plan as we move forward through the integration process to take advantage of the opportunities that the acquisition represents.

Overall, it's another step toward fulfilling our mission to be the best industrial distributor in the world as measured by associates, customers, owners, and suppliers.

In conclusion, I want to thank all of our associates for their dedication and hard work.

The excellent results reported today reflect their efforts.

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

Thanks, David.

MSC had another excellent quarter financially.

We grew sales by 12.7% over the same quarter last year and generated the contribution margin which we call [read through] of 38%, excluding the charges to operating expenses to reflect the compensation costs of stock options and the costs related to the departure of an executive.

The excellent read through in Q2 will likely normalize in the low 30s for the balance of fiscal 2006, excluding a charge for options accounting.

Earnings per diluted share were reduced by $0.03 to reflect the charges noted earlier.

On a comparable basis to last year, which did not have those charges, we would have earned $0.52 per diluted share compared to last year's $0.39 per share in Q2.

The increase in gross margin to 47.5% in Q2 reflects the favorable timing effect of pricing adjustments we made in Q2 to pass on cost increases from our suppliers.

As we turn our inventory, those cost increases will raise the cost basis of our inventory and therefore cost of sales will increase.

Consequently, our gross margin will likely moderate somewhat over the next two quarters, but should be in the 47% range for the balance of fiscal '06.

Income from operations increased to 17.7% of sales from 16.2% in the same quarter last year and would have reached 18.7% excluding the effect of the charges mentioned above.

We continue to see moderation in the rate of growth in the cost of our medical benefits, realized from savings in our variable cost due to process improvements and continue to take advantage of the leverage inherent in our model.

Balance sheet metrics are very good as well.

We had 41 days in DSOs and we maintain our inventory turns at an annualized 2.7 turns in Q2.

Free cash flow, which we define as cash provided by operating activities less CapEx, was $6.8 million in Q2.

This compares favorably with last year's free cash flow of $1.3 million in the same quarter.

Cash, cash equivalents, and investments in marketable securities grew to approximately 122 million at the end of the quarter.

After-tax return on invested capital was an annualized 27% in Q2, reflecting the excellent earnings as well as the program that has returned a significant amount of cash to our stockholders in the form of dividends and repurchases of the Company stock in the open market.

Thank you, and now I would like to open the lines for questions.

(OPERATOR INSTRUCTIONS).

Holden Lewis, BB&T.

Can you give a little bit more color with respect to the impact of the timing in the gross margin?

And I ask largely because it looks like the guidance that you have given doesn't assume much of a sequential step up in margins -- in operating margins for Q3.

That step up is seasonally normal and I was wondering whether you're just being conservative given the J & L piece or whether there some moving pieces in the margin side that would explain that?

Holden, this is Chuck.

First off, our Q3 guidance has -- does not reflect any impact from the J & L acquisition, so that is pure MSC so it certainly is not related to that.

This is really more in the gross margin side; a case of our average costing system, really.

The replacement costs, now we're putting into inventory, which are now -- will be bleeding through to cost of sales in Q3, no longer averaged with some lower-cost volumes.

They are actually in effect replacement costs that are pretty much current pricing in the marketplace today.

So you have a modest mild deterioration in the gross margin in Q3.

And the second aspect of that, you're absorbing a full quarter now of all the sales associates we've hired even throughout the period of the second quarter.

All the OPEX associated with those folks are in for a full quarter in Q3.

And the combination of those two events, albeit with some pretty solid sales growth, makes the margin percentage roughly the same as you saw in the prior quarter.

Okay.

And can you give a sense of what the impact on gross margin was because of the price and timing issues?

Can you give us some ballpark number?

Well, you've seen it.

In Q1, we were at 46.9 in gross margin.

We went up to 47.5.

Certainly a piece of that was the impact of our original big book price increase, but obviously complementing that was the little bit of pricing we took in Q2 as well.

So that would give you a sense of for how the margin changed, the gross margin changed in Q2 over Q1.

And them with the average costing system based on how we purchase and so forth now turning over, as I said, higher cost in Q3, we lose a little bit of that for the rest of the year.

But you think that using 47 as your benchmark, you think essentially all of the increase from the 47 benchmark to 47.5, that's essentially all timing related?

Timing relative to cost increases and so forth you mean?

Yes.

Yes, that, a little bit of mix.

It's not all pricing, but it's timing, little bit of mix in there.

Yes, absolutely are the two drivers of that change in margin.

Okay.

So there is no reason to think that the 47 benchmark, that really is still the good number going forward.

Yes, you're safe using that in your modeling.

Okay.

Thank you.

Dan Leben, Robert W. Baird.

Good morning.

Two quick questions.

The first on the pricing impact with the new prices on the books, what impact did that have on sales growth versus just volume increase?

What was your name again?

Dan Leben, with Robert W. Baird.

Thank you, Dan.

It's David.

Basically, we think that the pricing actions that we've taken contribute to roughly 4% of our sales growth.

Okay.

Great.

And then with the J & L acquisition, could you give us an idea of where their sales resources are located?

I'm interested primarily to the extent that you're going to be able to accelerate your West Coast expansion with sales resources there.

Are they primarily more in Midwest and back East?

Dan, we're not going to lay out specifically where all of the pockets are.

I will tell you that they are largely focused on the central part of the United States.

That is where we see the bulk of our overlap.

Okay.

So basically, no changes in your hiring prospects on the West Coast due to J & L then?

We're going to continue to fuel our West Coast plan and execute as we've been planning.

Okay.

And real quick on the tax rate, a little bit higher this quarter than the guidance.

What should we expect for that going forward?

I think 39.4 is the rate you can use moving forward.

There is -- as we take on some debt, there's a mix in tax-free investments and so forth that all net out in the wash to what we believe to be a rate of about 39.4 going forward.

(OPERATOR INSTRUCTIONS).

Adam Uhlman, Midwest Research.

Good morning.

Chuck, I have question for you on your stock repurchase program.

It doesn't look like you bought back any shares this quarter.

Could you run through what the plan is here for the rest of the year?

Yes, we have authorization, Adam, from our Board to do up to a full 5 million shares.

We haven't done any to your point in the second quarter.

And [why] that's available to us at any point in time, there's no preset strategy of exactly when and how we would go about doing that.

We look at the market and opportunistically utilize that 5 million share buyback option, but there's no preset plan for it.

Okay.

And then are there any working capital targets for the year?

You have this new carbide authorization coming on.

Is that going to require a big step up in inventory?

As we move through the second half of the year, is that beyond in the 2007 yet?

Adam, it's David.

We're not yet prepared to start discussing what the combined plan will look like.

After we close and as our integration team works through that process, we will share more of the relevant details.

Okay.

And the last question I had was -- David, the average calls per associate has been trending down.

Could you just remind us what is driving that phenomenon?

Sure.

Happy to, Adam.

Actually, the calls per associate is a measure of customer service.

And what is driving it right now is that we're -- we've been in the process of fine-tuning our staffing model in the call centers, a combination of training and many of the things that we've do to make sure that we've got optimal service for our customers, so service levels have been at all-time highs.

But what this tweaking and tuning has done has actually generated a productivity improvement opportunity for us, which is actually part of what the call center team is focused on right now and digging in.

So customer service levels are at all-time high levels, but that lower number does indicate a productivity improvement that we're digging into and that will help us over time on the cost side of the business.

Okay, so are you growing your inside sales force?

Is that the implication or --?

Yes.

Okay.

Great thanks.

(OPERATOR INSTRUCTIONS).

Holden Lewis, BB&T.

Great.

Thank you again.

In the supplemental data that you provided, a couple of things that I noticed.

First, the West has really begun to grow faster over the past couple of quarters than the other three regions that you list.

Is that really sort of evidence of success in your efforts out there, or is or something else going on?

And then secondly, I also noticed there's not a single region that grows less than 13% which doesn't seem to dovetail with what you reported on the P&L.

I was curious what the difference was.

Holden, we noticed that as well just a few minutes before we got on the call.

We need to -- we apologize and need to go back and revisit those numbers.

We obviously got a glitch somewhere that is going to require us to revise some of those sales growth metrics by region on the website.

So we apologize.

We'll take a look at it and we will get back to you on that one.

And the same I gather from manufacturing/non-manufacturing?

Exactly.

Exactly.

And then, so I guess it was relevant in Q1 and maybe in Q2, but are the growth rates that you're seeing in the West in Q2 superior to what you are seeing in the other regions?

And is that because of the market that's out there or is it because you're beginning to see some real traction of the sales force?

To what do we attribute the relative growth in the West to that -- past couple of quarters?

It's David.

We certainly want to hold off answering the macro number until we get the new numbers posted on the website at some point today.

I will tell you that irrespective of what that numbers shows we are seeing traction in the West.

Certainly around the branches and the territories that we focus our efforts on, we are seeing significantly higher growth rates in that region around those branch territories.

And that is a result of our expansion plans there.

Okay.

And one last follow-up.

When you -- the fact that you're sort of tapping the brakes on the total number of salespeople, at what rate would you expect those salespeople to be able to climb the learning curve and get to productivity numbers that you have seen in the past?

At what rate will they mature?

We don't lay out the details of how long it actually takes to get to what we'll call optimum levels.

I will tell you that as you know, we talked about for a long time the fact that it takes time to ramp up, is a training and an assimilation process.

Our investments are dilutive in the long-term, certainly accretive over the -- sorry, they're dilutive in the short-term and certainly accretive over the long-term.

And frankly, as we measure the longer -- the maturation process, the more accretive the investment is.

And in part largely due to an OSA's relationship with the customer, deep understanding of their territory and their ability to drive value there.

So we don't break out the absolute ramp up time.

It is something of course internally that we measure significantly; both break even, time to profitability, and look at those classes of individuals.

But it is a long-term process and one that the longer it goes, the more that those out year classes actually fuel growth in revenue and earnings.

Okay.

And as you look at the potential, and I guess this relates to those to your most recent sales force adds, but also to the J & L Group, is there any reason why sort of historical levels of productivity can't be achieved by either the new people or the J & L people coming on?

I think it premature to answer that given that we're still learning and digging in.

Over the top, I can't imagine why we wouldn't be able to achieve significant productivity levels by our combined sales force moving forward.

But I want to be sure there's no anomalies there as we're learning and building our plan.

I think it's a huge, huge opportunity for us in the future though.

I will say that.

Okay.

Great, thank you.

Yvonne Verano, Jefferies & Co.

Thanks.

I just wanted to see if you to give us more detail on the comps associated with the departure of the executives.

It seems like a pretty big impact in the quarter.

This is Chuck.

It was about a penny.

It was for personal reasons.

We booked it all at the time of the departure and there's really not a lot more to say about that.

It's not an ongoing cost.

It's won and done and won't be in our numbers moving forward.

Okay, thanks.

Adam Uhlman, Midwest Research.

I was wondering if you could give us an early look at how the monthly sales growth has been going here so far in March.

Sure.

Happy to, Adam.

Actually through Tuesday our growth rate is at 16%.

We've got another a few days before we closeout this fiscal month.

But let me just caution or I guess remind everyone that we've got easier comps in March due to the switch in the Easter holiday weekend.

Last fiscal year in March is when the Easter weekend occurred.

We actually won't see the comp for that until this April, which means we will see a kind of a leveling out between the two months of March and April given the reverse, the switch in holidays in the Easter weekend between the two months.

Okay.

Great ,thanks.

At this time, there are no further questions.

I will now turn the conference back over to management for closing remarks.

Okay.

Thank you so much for your attention and time today, and we look forward to speaking to you again next quarter.

Thanks a lot folks.

This concludes today's conference call.

You may now disconnect.