MSC Industrial Direct Co., Inc. (MSM) Q1 2013 Earnings Report, Transcript and Summary

We reaffirmed that as we grow, we continue to see long term opportunity for incremental margin expansion in the business. But in the near term, we would expect to see temporary pressure on our margins due to a few growth programs that are near term dilutive to our growth and operating margin percentages as they’re in early stages. Vending and M&A are two examples. Adding to the near-term moderation and operating margin percent would be a couple of infrastructure and productivity investments that are critical to our future such as Davidson and Columbus. We indicated that for FY '13, we expected incremental margins to be lower than historical averages at any given growth rate. At roughly 10% growth rates, we produced read-throughs in the mid-teens and we expected that if revenue growth went up or down, read-throughs would move accordingly and that the pricing environment would influence those read-throughs at any given level of growth. At the same time, we assured you that we would remain good stewards of your capital by carefully watching our spending as changes in the landscape occurred. We also assured you that we have been through occasional step functions like this before, just as every Company has and we came out of them with explosive earnings growth. MSC has compounded topline and bottom line growth of 14% and 15%, respectively since our IPO. As we look to the future, the opportunity is only getting better. As I evaluate our performance a little over one quarter into our fiscal year ’13, I am very pleased with the progress against that strategic backdrop. Our Q1 performance is reflective of our success in executing our strategy. We produced revenue growth of nearly 6% in a significant eroding demand environment due to extreme uncertainty and caution over the pending…

We reaffirmed that as we grow, we continue to see long term opportunity for incremental margin expansion in the business. But in the near term, we would expect to see temporary pressure on our margins due to a few growth programs that are near term dilutive to our growth and operating margin percentages as they’re in early stages. Vending and M&A are two examples. Adding to the near-term moderation and operating margin percent would be a couple of infrastructure and productivity investments that are critical to our future such as Davidson and Columbus. We indicated that for FY '13, we expected incremental margins to be lower than historical averages at any given growth rate. At roughly 10% growth rates, we produced read-throughs in the mid-teens and we expected that if revenue growth went up or down, read-throughs would move accordingly and that the pricing environment would influence those read-throughs at any given level of growth. At the same time, we assured you that we would remain good stewards of your capital by carefully watching our spending as changes in the landscape occurred. We also assured you that we have been through occasional step functions like this before, just as every Company has and we came out of them with explosive earnings growth. MSC has compounded topline and bottom line growth of 14% and 15%, respectively since our IPO. As we look to the future, the opportunity is only getting better. As I evaluate our performance a little over one quarter into our fiscal year ’13, I am very pleased with the progress against that strategic backdrop. Our Q1 performance is reflective of our success in executing our strategy. We produced revenue growth of nearly 6% in a significant eroding demand environment due to extreme uncertainty and caution over the pending…

Hamzah Mazari - Crédit Suisse AG:

Hamzah Mazari - Crédit Suisse AG:

Hamzah Mazari - Crédit Suisse AG:

Hamzah Mazari - Crédit Suisse AG:

David Manthey – Robert W. Baird:

David Manthey – Robert W. Baird:

Ryan Merkel - William Blair & Company:

Ryan Merkel - William Blair & Company:

Ryan Merkel - William Blair & Company:

Sam Darkatsh - Raymond James & Associates:

Sam Darkatsh - Raymond James & Associates:

Sam Darkatsh - Raymond James & Associates:

Sam Darkatsh - Raymond James & Associates:

Derek Jose – Longbow Research:

Derek Jose – Longbow Research:

Derek Jose – Longbow Research:

Derek Jose – Longbow Research:

Derek Jose – Longbow Research:

Derek Jose – Longbow Research:

Holden Lewis - BB&T Capital Markets:

Holden Lewis - BB&T Capital Markets:

Holden Lewis - BB&T Capital Markets:

John Baliotti - Janney Montgomery & Scott:

John, we've said it for a long time. Yes, I think you are absolutely right, just go back to the last downturn and see how we came out of it. And at that time David, (inaudible) called it a land grab. I think you are absolutely right. The share gain opportunity is enormous. John Baliotti - Janney Montgomery & Scott: Yes. So, if you were seeing your customers -- obviously given your size, you've got some more of a cushion than some of the smaller guys that control a large part of the market. And I am just curious, is there anything anecdotal or anything you can share with us that either data wise or anecdotally that, that would indicate that the hand to mouth dynamic you saw from customers just had a greater impact on the small guys. I would imagine that, as you point out, inventory is a lever for you and you have the ability to hang on to that inventory, but like your customer is going after cash flow, protecting their cash flow, I would imagine some of the smaller distributors have no choice but to do the same. And I would imagine that there's got to be some input you're getting from your guys in the field that would support that?

Yeah, it's a good question, John. I mean in terms of the confirmation, we get it a ton. We hear it from field, we see it on our own road trips and meeting with -- we hear it from customers. One of the best sources we really have for – and of good objective data, is our supplier network. because they are seeing point-of-sale performance across their entire channel, absolutely. So, if you go back to the last time there was a downturn in the dynamics that put pressure on the small locals, where the inability to carry products on the shelf, the inability to retain people, and the break in relationships that had been there for so long, all of those dynamics exist and then some. And I think the then some is, technology is playing a bigger role in our business now than it was even three, four, five years ago. And the two examples I give of that are vending and ecommerce, that three, four years ago were there but not as big a presence as they are now, where you think about a local distributor under good times, let alone bad times, the ability to invest in capital, the capital outlay for a vending machine, they get squeezed. They just can't do it. And it’s (inaudible) John Baliotti - Janney Montgomery & Scott: Right. So, given that your relationship with your suppliers, I'm sure a lot of little guys use similar suppliers. But it would seem that your relationship with those suppliers would be better now given that you are more of a potent storm relative to little guys. Is that -- you are hearing that at all?

Yeah. I think, John, that's part of what I would describe in, anecdotally, what we hear from our suppliers. We become a really good alternative in times like this. I think that's absolutely right. John Baliotti - Janney Montgomery & Scott: Just finally, you talked about how ISM ticked up a little bit and that's encouraging. And I'm trying to marry that up with the fall of last year where ISM ticked up even a little bit more but sales didn't necessarily reflect that trend. Do you think that that was being offset by the political landscape that you're talking about, the election, the debt crisis, all that was there? Do you think that was offsetting that tick-up in September and October of ISM?

John, I really do. I think there's been, if you look back over the past few months, so much noise in the system that it's really tough to make heads or tails out of ISM readings versus what we're seeing when we go to accounts and how they're spending money versus what happened on the headlines in the news and the fear of investment. So, I think there's been an incredible amount of noise in the system and that's really reflecting the challenge that we face in forecasting Q2, and why we're kind of reverting back to what we'd actually seen in the business because there is just so much noise. John Baliotti - Janney Montgomery & Scott: Do you feel that even though that we haven't completely resolved the problem and it kind of kicked it out another month, our customers incrementally feel better than they did going into the end of your negotiations?

I think there is more cause for optimism. I think there is a lot of uncertainty still. So, I would say, uncertainty is still pretty high because people are still trying to make heads or tails of what exactly was the tax impact on my business, how do I need to cut investment in order to fund the business. And at the same time, knowing that the spending issue still looms. So, I do think there is a more of a cause for optimism, yeah, but a lot of uncertainty.

And our final question will come from Brent Rakers of Wunderlich Securities. Please go ahead.

Just, I think a couple of clarifications more than anything. Jeff, you talked about $0.07 was the impact from gross margins from not getting the price increase. Just to go back to what David asked earlier, that is a function essentially of you not increasing prices mid-year and your suppliers increasing pricing modestly to you. Is that correct?

The $0.07 is just the equivalent of if we did the similar price increase as we did last year, this year that would have been the impact on margin and our bottom line.

Could you maybe just quickly then walk me through the disconnect though? Why would the gross margins sequentially deteriorate to that degree unless there was some disconnect between what vendors are pricing to you and what you’re charging customers?

Again there is headwinds Q1 to Q2 that include the seasonal product mix change particularly in the month of December and then the natural flow of product cost increase that get reflected in our gross margin as you progress throughout the year from purchases that would have occurred earlier in the year.

Brent, I think very important to realize, make a distinction here between the impact in margin in a given quarter from our pricing actions, versus any impact from what happens on the purchase side. There’s a big difference in timing. So what Jeff described sequentially from Q1 to Q2, any impact from purchase cost is the result of negotiations that happened in a very different environment that are in the P&L now. So that's why there is two separate issues between pricing and purchase cost.

And then maybe just somewhat interrelated, is there are lag effect to when you realize big book pricing to larger national account customers or is it fairly immediate across your customer set?

There is a timeline to the realization. So it happens over a period of time where the bulk of it would be upfront and then there is a somewhat of a gradual flowing of the rest.

Okay. And then last question and I think you've talked around this a little bit, but you talk a lot about incremental and you talked about being back above 20%. If you use the base line revenue growth assumptions you’re talking for next quarter, how would you look at if revenues do come in excess of that, how would you look at the incremental on top of that? Are we talking back 15%? Will you spend that back through? Are you talking back more of this 20%, 25% number now?

Well, I think you can turn historically to what we delivered in this past Q1 and the previous quarter and that would give you a good indication of the range for the various levels of revenue growth. Of course we've tightened down a little more in terms of the discretionary spending and it gave us some positive upside. We're going to continue that in the quarter. So if we’re able to achieve somewhat higher levels of revenue, I would expect it falls through a little more easily.

Brent, just on that point, I agree with Jeff, that you realize that if things changed in the revenue line in a hurry, the read through is pretty high because we couldn't react that quickly on incremental investment spending anyway. So I think it would be fair to say the read through would be pretty good if things turned for January and February.

Including the pricing environment.

Ladies and gentlemen, that will conclude our question and answer session. I would like to turn the conference back over to Mr. Gershwind for any closing remarks.

Thank you very much. We appreciate everybody's interest and Happy New Year to all and we look forward to speaking to you next quarter.

Ladies and gentlemen, the conference has now concluded. We thank you for attending today's presentation. You may now disconnect your lines.