MSC Industrial Direct Co Inc (MSM) 2007 Q1 法說會逐字稿

Good morning, my name is Ashley and I will be your conference operator today. At this time I would like to welcome everyone to the MSC Industrial Direct 2007 first quarter conference call. (OPERATOR INSTRUCTIONS). Now I would like to introduce Bob Joyce of Financial Dynamics. Sir, you may begin your conference.

Thank you and good morning everyone. This is Bob Joyce of Financial Dynamics. I would like to welcome you to the MSC Industrial Direct fiscal 2007 first quarter results conference call. You should have received a copy of this morning's earning 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 online archive of this broadcast will be available within one hour of the conclusion of the call. It will be available for one week at www.mscdirect.com.

Certain information pertaining to non-GAAP financial measures that may arise during this broadcast can also be found 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. Though the Company believes that the expectations reflected in its forward-looking statements are reasonable, they can give no assurances that such expectations or any of the 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 to the date discussed. Investors should not assume that the statements made in this conference call remain operative in a later time. The Company undertakes no obligation to update any information discussed in this call.

That said, I would like to introduce MSC Industrial Direct President and Chief Executive Officer, David Sandler. Please go ahead, sir.

Good morning everyone and thanks for joining us today. With me are Chuck Boehlke, Executive Vice President and CFO; and Shelley Boxer, Vice President of Finance. I will be providing some details on the quarter, market conditions and the status of the integration of J&L. Chuck will provide details of the financial results, and then we will open the phones for questions.

And by the way, I apologize if my phone sounds a bit funny today, I have been battling with a nasty cold.

First quarter results were solid. We continued to execute our business strategy, take share and grow. We exceeded our guidance for earnings as operating margins were better than expected. I am very pleased with MSC's performance in the first quarter.

What we're hearing from our customers is largely unchanged from our last call. Market conditions continued to be good. While there are some regions where we have seen slower growth, our customers are generally telling us that order flows remain solid and that they are growing, but at a slower pace.

While our customers continued to hire, we believe that it is at a more moderate pace. Some of have expressed concern over what 2007 will bring, and just how good business will be.

We're mindful of the ISM Index's declining trend and its historical relation to our growth rate. While we believe that a number of marketing and sales initiatives accomplished over the prior 18 months will moderate its impact, it is apparent that the prior three to six months of ISM weakness has modestly affected our revenue growth, and will probably continue to do so in the next couple of quarters, if past experience proves out.

Yesterday's ISM Index of 51.4 is a potential positive indicator for the future. We are confident that we are taking share and enhancing our competitive position and will continue to do so. As you have heard on past calls, we don't forecast a long-term direction or strength of the economy. Our business plan is a balanced plan that reflects near-term economic trends as well as longer-term positioning.

Given the revenue trends, I think that it is important to spend a few minutes talking in some detail as to how we will execute that balance in a period of slowing revenue growth. First of all, we don't sacrifice execution. As always, we are concentrating on executing our model in a flawless manner and on taking share.

Secondly, we always prioritize growth opportunities, but are more selective in this type of environment. While we will be more cautious on the hires that we might make in better ISM environments, we are aggressively investing in areas which we believe have the greatest potential for growth.

Thirdly, while some growth initiatives that are dilutive to earnings in the short-term might not be prioritized, we will also step up our ongoing focus on reducing the cost that we pay for the products that we carry. We negotiate aggressively with our suppliers, take advantage of opportunity buys, and we are increasing our focus on imported products that generate better margins than their branded counterparts.

Many of our suppliers cross segments and manufacture for both the industrial and construction segments. As home-building has slowed, we are finding opportunities to purchase products more effectively, and believe that these opportunities will be more available in the months to come.

Fourth, we are well-positioned to continue to reduce our operating costs as much as possible. Driving down cost means more dollars to invest in growth and to generate higher levels of profitability. Process improvements like the Harrisburg Optimization Project begun just 18 months ago are important to achieving that result. Early indications from our recent successful implementation are that our productivity goals from this project will be met or exceeded. That means a more efficient fulfillment operation and lower costs for the long-term. Once we feel comfortable about the process and the savings, there are potential follow-on investments in our other fulfillment centers.

Over the past several years we have made significant progress in managing the business and improving our operating margins. We have also learned how to balance our investing activities. One very important thing to understand is that we can actively prioritize how we spend our investment dollars between profitability and growth objectives as the economy changes. We could also scale back some elements of our overall spending to maintain strong margins.

I recently saw another example of the strength of our value-added model and the value that the salesforce brings to our customer relationships during my recent visit to a customer in the mid Atlantic region. This customer is a defense contractor who has done business with us for several years. The field sales associate has been assigned to this account for about one year, and we have seen some substantial growth in our business with that customer during that period.

The customer's senior storeroom manager told me why we're now getting more of his business. He said that our sales associates have brought many of MSC's value-added tools into the account, and to paraphrase, we speak the same language and when MSC says it will be do something, it always does it.

MSC's electronic tools, such as inventory management and the ability to plug MSCdirect.com directly into our electronic ordering system, combined with MSC's incredible inventory and delivery system, and the quality of the MSC team has made MSC the one company that I can bank on. Customer experiences such as this one continue to demonstrate the power of our model and our ability to take share and grow.

The combined MSC sales team was 739 at the end of Q1, above our previously stated goal of 725. We expect that the salesforce will grow to about 750 associates by the end of Q2.

We are extremely pleased with how our integration of J&L is progressing. We are on track to convert the computer system, as well as integrate their DCs into ours in the late spring of 2007. Based on our solid progress to date, we remain confident in our ability to generate the previously forecasted $20 million in margin improvements and cost savings that we had originally anticipated. Overall, J&L continues to meet or exceed the expectations that we had when we bought this business.

Our core execution metrics remain solid. The MSC team has continued to deliver rock solid execution. And I would like to thank all of our associates and express my appreciation for all their hard work in generating these excellent results.

I would like to provide some guidance for Q2. At this point we think that sales will be in the range of $402 million to $408 million, and diluted earnings per share will be in the range of $0.58 to $0.60, including a charge of $0.02 per share for J&L integration costs.

Thanks, and I will now turn the mike over to Chuck.

Financial results for the first quarter of fiscal 2007 were excellent, even in a slower growth environment. We grew sales by 36% over the same quarter last year. J&L contributed approximately two-thirds of that growth.

Consolidated gross margins came in at 46.2%, in line with our expectations. We expect consolidated gross margins to improve by about 20 basis points in Q2, and to increase over the balance of the fiscal year by about another 20 basis points. These improvements reflect gross margin improvements from the harmonization of the pricing from suppliers common to MSC and J&L and from other margin enhancing initiatives.

MSC's consolidated operating margin in Q1 was 17.3% of sales, including the J&L integration cost and amortization of intangibles. Operating margin was somewhat higher than expected due to the timing of hiring, which resulted in lower payroll costs, lower fringe benefits, and lower recruiting costs than we projected for the quarter. As David noted, in Q2 we are increasing our spending in higher growth areas. All of this has been included in our guidance for Q2, as is a moderating sales growth rate reflecting the ISM trends.

Q1 earnings per share includes a pretax charge of approximately $1.1 million for J&L integration costs. This charge did not affect reported earnings per share as the results would still around to $0.60 per share if those costs had not been incurred.

Balance sheet metrics remain solid. Annualized inventory turns were 2.9, and accounts receivable DSOs were 42 days. Consolidated free cash flow, which we define as cash provided from operations, less capital expenditures, was $50.5 million in Q1, an increase of $17.5 million over Q1 of last year.

Capital expenditures increased to $6.3 million in Q1, about in line with our forecast. During fiscal 2007 to date we have purchased 1.1 million shares of the Company's stock, of which 1 million shares have been purchased since our last conference call for approximately $39 million.

As a reminder, we are no longer reporting J&L results separately. And when you review the metrics pages on our website, you will see that J&L is excluded from any metrics. Once J&L is integrated completely, our metrics will include J&L.

Thank you. And now let's open up the mike for questions.

(OPERATOR INSTRUCTIONS). Dan Whang, Lehman Bros.

My first question is regarding your plans for higher growth spending going into the second quarter. I was wondering if you could provide some details as to what areas you expect to target that spending?

It is David. Well what we have talked about is continuing to invest in our salesforce expansion. We have said that in our script today providing some guidance. We are also continuing to invest in the West as one of our growth initiatives.

And in general we have got many, many different growth drivers that we take a balanced approach on how we view our investments, but in particular try and focus on those where we feel are going to be able to provide us the highest growth potential.

Of course, for competitive reasons that isn't something that I would like to share, but we are continuing to certainly invest in our salesforce. We're continuing to invest in our marketing activities, product development, our Asian sourcing opportunities, continuing to buildout our value-added services and focusing on increased penetration and new customer segments as well. So we've got a lot of different growth avenues that we are pursuing. The one that we do talk about front and center is our investment in our outstanding field salesforce again.

I think your comments around the number of salesforce that you had come to 739 versus the previous expectation of 725. Could you comment on where that additional salesforce pad was? With that in the West Coast? Any details on that would be great.

We, for competitive reasons, really don't like to broadcast those details. I will tell you that we are focusing on hiring on where we feel we're going to get the greatest potential and return. There are several different areas that we see highest potential for growth, and that is really where we are focusing our sales team at this point in time.

Jumping over to the J&L integration effort, it seems like that is moving along well. In the first quarter you had $0.01 related to the integration cost. That is picking up a little bit in the second quarter; it is $0.02. Could you comment on where that additional spending is, and how we should look at the spend rate going into the second half of the year?

It is Chuck Boehlke. Yes, the reason it is picking up a little bit as we get closer to frankly the integration of the warehouses there is some additional expenses as we go out Q2 that are related to preparation of being prepared -- being able to be prepared to handle that J&L volume in our centers. So it is the same type of cost we incurred in Q1 for things like stay bonuses and so forth are being booked on kind a flatline basis, but we do ramp up costs as we get closer to the warehouse integration.

Finally, you did talk about the 1 million shares that you purchased since the last call. Could you talk a little bit more about potential ongoing purchase programs?

We've got pretty strong positive cash flow. We've got a fair amount of debt. We got an ongoing dividend program. And as you have seen, we have stepped up the repurchase of stock. Any and all of those avenues would be available for our free cash flow. There's no specific strategy that says we will do X or Y, but that available cash flow will definitely go into one of those areas. And as you have seen the last couple quarters we stepped it up pretty largely on the repurchase of shares.

Again, I guess the only thing I would add to that is we've got just north of 3 million shares that are still authorized for repurchase by the Board. Is that right, Chuck?

Yes.

Adam Uhlman, Cleveland Research.

My first question for you guys here is on the lower than expected operating expense for the quarter. Could you give us a little bit more color on that why that was lower than expected? Because it looks like your new hires came in higher than expected. Is there anything else -- SG&A line, that is more of a onetime nature?

This is Chuck. Really it was a matter of the timing of those hires. We were over what our expectations originally was, but they were more back end loaded than front end loaded based on the guidance we have been out there.

So what is happening in Q2 of course as you move forward you have got the full three quarters of -- three months of expense -- and for the rest of the year the full three quarters of the hires that took place towards the end of the quarter. But have been a bit more front end loaded in our guidance than obviously the salary payroll, the recruiting costs to some extent, and certainly the fringe benefit costs is what drove that operating expense to be lower than our forecast. But it was more about timing than it was about the absolute numbers at the end of the quarter.

David, earlier you were suggesting that you might be able to offset some of these higher growth investments in the salesforce and the like with some gross margin initiatives. Is that how we should read that or should we be looking for some operating margins deterioration as sales growth continues to slow down?

I think that what we have provided for our guidance certainly is that when you look at the blend of our growth investment spending, which actually is increasing for Q2, coupled with our margin guidance, I think you'll find that our operating margin is pretty similar at the midpoint of the range in Q2, as it is what we have reported. So feel very, very strong in that area. And as you know, we continue to manage the business with an ongoing balance between short-term earnings and ensuring our results, coupled with investment for the long-term health of our business.

This is helpful. Thanks. Then my last question here for Chuck. Could you talk about what price realization was in the quarter? And then have you see any price increases coming from your suppliers so far here in calendar 2007?

It is David again. I guess I will talk a little bit about what we are seeing in the pricing environment. Basically we are still continuing to see some increases coming through, but I would generally characterize the environment as still increasing but stabilized.

I will tell you though that we continue to see some pockets that still have some real volatility. I think on the last call I talked about one of those pockets being in copper. Interestingly enough in the last quarter so that settled down quite dramatically. But in fact aluminum, nickel products and stainless steel products have increased significantly, so those and anything associated with those raw materials have increased.

I guess at the same time to talk about the environment, we are also seeing more and more instances presented to us than what we have seen in the recent past on that I will call opportunity buys, especially from those suppliers that have been selling into a segment like home-building where their business has been dramatically affected. And we are now seeing opportunities presented to us by those suppliers to try and make up for some of that volume that is being displaced.

Okay. What was the benefit from pricing -- the revenue for the quarter?

Actually the benefit of pricing, the amount of growth in the quarter coming from pricing was roughly 14%.

14?

14%. That is right. 14% of our growth came from pricing.

I got you. Thanks.

(OPERATOR INSTRUCTIONS). John Inch, Merrill Lynch.

On the cost impact of this hiring deferral, what was that in an aggregated number?

You're talking about the first expense variance to our guidance that we gave?

Yes. Basically you hired more people at the end of the quarter versus earlier in the quarter. What did that invariably save you do you think, just based on your original expectation?

Our guidance is about -- from where we were and what we achieved in the quarter, we are about $0.02 over the midpoint of that guidance. And the bulk of that really was reflected in that expense savings by not incurring those expenses for the entire quarter, and incurring virtually very little of it by hiring near the end of the quarter.

That is helpful. Presuming though that those expenses then flow through to the second quarter, right, just being based on --.

Correct. Correct.

Yet you are describing a margin which I think is pretty positive -- this margin environment that is going to hold than roughly at present levels. What is making up for those extra costs? Where are you saying the cost improvement, if you will?

We gave you guidance on that. The gross margin is picking up 20 basis points in the next quarter, and then subsequent quarters we expect that to improve a little bit as well. What you have going on here is plus or minus, as David pointed out on the previous question, the operating margins that are similar to the first quarter, but with a pickup in gross margin and an increase in investment spending in Q2, inclusive of the hires at the end of the quarter, which will be onboard for the entire three months in Q2. So the two of those kind of get you back to the approximate operating margin we had in Q1.

Right. Is the gross margin benefit of that sort of a function of mix or volume leverage, or what is accounting per that?

There are less moving parts but the piece -- a significant piece of it is the harmonization of the J&L MSC purchasing deals. That stuff which is purchased is in inventory and turns and is now starting to hit the P&L more so in Q2 than we had in Q1. We've got several margin initiatives in play, as well as the J&L MSC harmonization of the deals, and they are contributing to that 20 basis point improvement we expect in gross margin for Q2.

That makes sense. Just as a clarification point, I guess I didn't really understand the pricing comment. You said pricing in the collective -- you did up 36% with J&L -- pricing is 14 of that? Is there a -- I'm just trying to understand, is pricing accelerating, is that sort of holding? How would you compare pricing and the trend in what you're seeing in '07 versus '06?

Maybe I can lay it out a little bit differently. We said that the growth in the quarter, roughly two thirds of that growth came from J&L. The balance of the growth came from MSC. Of that balance of roughly one-third of that growth, when you break that down, roughly 40% of that growth came from pricing -- the cumulative effect of pricing in Q1 based on year-over-year, and the balance of that growth was from organic growth.

That's very helpful. Maybe a last question. You referenced o taking share a few times. It is there a -- I know you don't know on to talk specific companies or whatever, but is there some obvious areas where you feel really good that your initiatives are perhaps reaping some benefits, either they be industry clusters or regions? Maybe a little bit more Caller around the comment vis-a-vis taking share.

Sure. I guess one region to look at that I guess speaks to share growth, but also speaks to the effectiveness of our investment program would be the West where we are getting significant growth in the area. And anecdotally we stay very close to what we are hearing from our field associates to what we're hearing from our customers. That all goes into the share growth comment.

And I guess the other is of course we look at not only our peer group but certainly the bigger group that we will also stay very close to is the bulk of the market, which is that small distributor. And all of that is the basis for our confidence in us continuing to take market share.

Holden Lewis, BB&T Capital Markets.

In terms of the growth spending, you sort of commented about maybe being more cognitive of balancing growth spending and margin -- really focusing on where you're going to spend your resources now on the growth side. And you talked about some areas where you are targeting this type of environment. Flipping that around, can you talk about areas that you might have otherwise been spending where demand is still holding up that you haven't said dropped off the wish list for the time being?

It is David. We're always prioritizing where we think we are going to get the biggest bang for the buck. And we have got many different growth vehicles. And then within those growth vehicles, for example, the salesforce you've got where the salesforce happens to be directed. You've got not only specific customer types, but you've also got regional, geographic issues going on. So all of that goes into the blend of how we actually prioritize. And I guess maybe the way to talk about it is we're constantly turning the dial and reevaluating our investment spending in the business and how best to -- in a particular environment how best to deploy that investment.

Presumably you've tightened the list of potential investment. I was just sort of curious what might get less attention than would have otherwise been the case.

I would rather -- in terms of tightening it, the good news is our list is long, in fact, longer than we can afford to invest in, which I think just bodes well for our runrate for the future. But we would rather not talk about where we're accelerating or decelerating, other than certainly the one driver that we have publicly talked about, and that is the expansion of our field salesforce.

But you have tighten the list. There differently is some of that stuff dropping off. You are just not talking where?

Again, I'm not sure that it is necessarily dropping off as much as it is that if $1 was being spent in a particular area, perhaps $0.75 is being spent in that area, and $0.25 is now being redeployed to a different area. That is what I mean about more tightening the dial. Maybe what you're asking is has been any sea change in terms of where we're investing the growth drivers that we see for the business. And I would said absolutely not.

Got it. Now on J&L, obviously you don't want to talk in terms of specific numbers, but just to give us a sense directionally, I think last quarter it was essentially neutral to the bottom line or the operating line. Is that still the case, or have we begun to see some of the accretion building in? Can you give some perhaps qualitative guidance on whether or not we have begun to see some contribution or if we are still at sort of neutral?

It is Chuck. In the quarter for the results we just released it is still plus or minus neutral to our prior earnings per share. There are some of the benefits are starting to accrue, although most of them will be post integration, certainly on the expense side. But as you heard, we're starting to talk a little bit more about gross margin improvements as the deals are harmonized, and coming out of inventory and go into cost of goods sold. That will continue for the future quarters, but for the first quarter it is plus or minus, it was pretty much neutral.

Even though the margin is going to improve and some of the benefits start to accrue slowly in the second quarter, remember the integration costs are going up as well as we get closer to the warehouse consolidation here. Our expectation still is going to be plus or minus a push until we get through post integration late spring.

Then lastly, what you have done with the hiring and how the operating expenses fell in, if memory serves, I think that your guidance for Q1 assumes that you were going to add about 10 employees, which means that I can see how if you added a bunch more than 10, which you clearly did at the end of the quarter, how that is going to drag on Q2. But I guess I'm sort of confused because you're saying the reason that we did better than we expected is because of the timing of our hiring. But it seems to me that the guidance you gave for the quarter was based on 10 employees, and unless you hired every single one of the people that you hired at the very end, it seems like probably 10 employees were built in largely as expected, and then the balance was sort of added at the end and that will impact Q2.

But I'm trying to get a feel for how much of the Q1 is maybe unsustained, one-time and nature, if you will, or whether it was just a strong execution quarter that Q2 is going to give a little bit back on.

It is Chuck again. Again, I said both hiring, as well as the fringe benefits associated with the hiring, and other pieces of fringe benefits contributed as well. We had -- we're self-insured on the medical side. We had a very favorable quarter on the medical. That is in the fringe benefit line. Not necessarily 100% related to the hiring, but favorable condition that existed Q1. That is virtually impossible to predict quarter by quarter whether you're going to have that same level of experience, given that we are self-insured. So certainly that was a piece of some of the favorability moving forward.

Short of that, that is really where the favorability came to our guidance. The full $0.02 was in both salaries and fringe benefits, and that accounted for virtually all the improvement from the midpoint of our guidance.

(OPERATOR INSTRUCTIONS). Now I would like to turn the call over to management.

Okay. Thanks, Ashley. Thank you everyone for joining us today. And we look forward to speaking to you all again next quarter.

This concludes today's conference call. You may now disconnect.