Jan 10, 2013
Executives
Erik Gershwind - CEO Jeffrey Kaczka - EVP and CFO John Chironna - VP of IR and Treasurer
Analysts
Matt Duncan - Stephens Inc. Robert Barry - UBS Adam Uhlman - Cleveland Research Company Ryan Merkel - William Blair & Company Sam Darkatsh - Raymond James & Associates Holden Lewis - BB&T Capital Markets Brent Rakers - Wunderlich Securities Hamzah Mazari - Crédit Suisse AG David Manthey - Robert W.
Baird John Baliotti - Janney Montgomery & Scott Derek Jose - Longbow Research
Operator
John Chironna
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 fiscal cliff. Our share gain initiatives continue to fuel above market growth.
We produced the gross margin at our guidance of 45.9%, thanks to the strong price realization that demonstrates the power of our model in good times or bad.And finally, we demonstrated exceptional cost control resulting in adjusted re-throughs over 20% with only mid-single digit revenue growth. I will now turn to some specifics for the quarter.Growth in the manufacturing business was 6.2% on an average daily sales basis and continues to demonstrate our share gains.
Growth did however progressively slow during the quarter consistent with the macro trends that I just mentioned. Growth in the non-manufacturing business was approximately 4.9% on an average daily sales basis compared to last quarter’s 7.9%.
Our government business was a bright spot. We saw a significant lift in ADS through September due to the government’s fiscal year-end spend, and growth over prior year continued in October and November.Let me say a few words regarding our growth initiatives.
While we have clamped down on discretionary spending, we continue to forge ahead on select strategic investments. Customers with vending continue to contribute significantly to our growth and delivered approximately 3 points of sales growth in the first quarter.
The slowdown in total growth contribution from the prior quarter’s 4 points, is reflective of the general softening everywhere and is simply a matter of the water levels coming down on customer spend.In fact if anything, demand for our vending solution is growing as our Q1 signings exceeded our own internal targets. This is encouraging to us because it should translate into revenue growth and share gain when the economy improves.
Ecommerce is another key growth initiative. As we have described on past calls, we continue to invest.
Including a new search function, improvements to our product information, and a new transactional platform. Regarding the new site customer feedback has been very positive as we undertake the rollout process.
Customers tell us that they find the new sit easier to use, faster and more intuitive. They are also impressed with the enhanced functionality, and we continue to see ecommerce increase as a percentage of sales as Q1 reached 42.8% up 50 basis points from last quarter.
We see plenty of runway to take this number higher as the new site reaches full adoption in the coming months.With respect to our headquarters co-location in Davidson, North Carolina, we continued to make progress during the quarter and remain on-track to complete construction in 2013. And with our new customer fulfillment center in Columbus, Ohio, we also remain on track to break ground on the facility in the spring of 2013, keeping pace for a late 2014 opening.Turning to the environment.
Conditions and activity levels have continued to soften since we last reported. After a slight uptick in the September and October ISM readings, November returned to a level of contraction and is more consistent with what we heard from customers.
Last quarter on our call, we described the environment as a holding pattern due to the uncertainty surrounding the election and the fiscal cliff resolution. And since then, despite getting the election behind us, the holding pattern continued to escalate.
In fact, it built to a near paralysis in December as our customers like everyone else waited to see the outcome of the fiscal cliff resolution.They went hand to mouth when it came to MRO supplies, ordering only what they absolutely needed and avoiding any investment for the future. That dynamic along with a holiday season that was particularly weak due to the timing of Christmas and New Year’s on a Tuesday, produced a very soft December.
In addition to a softening demand environment, we have seen the same dynamics on the pricing front. Very limited in the way of opportunities.
Price increases from our suppliers have been and are projected to be very selective, and in general, customers are watching their own spend and prices very carefully.I would note that when looking ahead, there is some cause for optimism. For one thing, the fiscal cliff has passed and life has gone on.
The recent [lease tax] deal in place, and while much work remains to be done on federal spending, at least some uncertainty has diminished. Additionally, December’s ISM reading of 50.7 and its positive tone regarding the pricing environment are encouraging signs.
Should they continue or better yet build momentum, it would bode well for our business.
Erik Gershwind
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 fiscal cliff. Our share gain initiatives continue to fuel above market growth.
We produced the gross margin at our guidance of 45.9%, thanks to the strong price realization that demonstrates the power of our model in good times or bad.And finally, we demonstrated exceptional cost control resulting in adjusted re-throughs over 20% with only mid-single digit revenue growth. I will now turn to some specifics for the quarter.Growth in the manufacturing business was 6.2% on an average daily sales basis and continues to demonstrate our share gains.
Growth did however progressively slow during the quarter consistent with the macro trends that I just mentioned. Growth in the non-manufacturing business was approximately 4.9% on an average daily sales basis compared to last quarter’s 7.9%.
Our government business was a bright spot. We saw a significant lift in ADS through September due to the government’s fiscal year-end spend, and growth over prior year continued in October and November.Let me say a few words regarding our growth initiatives.
While we have clamped down on discretionary spending, we continue to forge ahead on select strategic investments. Customers with vending continue to contribute significantly to our growth and delivered approximately 3 points of sales growth in the first quarter.
The slowdown in total growth contribution from the prior quarter’s 4 points, is reflective of the general softening everywhere and is simply a matter of the water levels coming down on customer spend.In fact if anything, demand for our vending solution is growing as our Q1 signings exceeded our own internal targets. This is encouraging to us because it should translate into revenue growth and share gain when the economy improves.
Ecommerce is another key growth initiative. As we have described on past calls, we continue to invest.
Including a new search function, improvements to our product information, and a new transactional platform. Regarding the new site customer feedback has been very positive as we undertake the rollout process.
Customers tell us that they find the new sit easier to use, faster and more intuitive. They are also impressed with the enhanced functionality, and we continue to see ecommerce increase as a percentage of sales as Q1 reached 42.8% up 50 basis points from last quarter.
We see plenty of runway to take this number higher as the new site reaches full adoption in the coming months.With respect to our headquarters co-location in Davidson, North Carolina, we continued to make progress during the quarter and remain on-track to complete construction in 2013. And with our new customer fulfillment center in Columbus, Ohio, we also remain on track to break ground on the facility in the spring of 2013, keeping pace for a late 2014 opening.Turning to the environment.
Conditions and activity levels have continued to soften since we last reported. After a slight uptick in the September and October ISM readings, November returned to a level of contraction and is more consistent with what we heard from customers.
Last quarter on our call, we described the environment as a holding pattern due to the uncertainty surrounding the election and the fiscal cliff resolution. And since then, despite getting the election behind us, the holding pattern continued to escalate.
In fact, it built to a near paralysis in December as our customers like everyone else waited to see the outcome of the fiscal cliff resolution.They went hand to mouth when it came to MRO supplies, ordering only what they absolutely needed and avoiding any investment for the future. That dynamic along with a holiday season that was particularly weak due to the timing of Christmas and New Year’s on a Tuesday, produced a very soft December.
In addition to a softening demand environment, we have seen the same dynamics on the pricing front. Very limited in the way of opportunities.
Price increases from our suppliers have been and are projected to be very selective, and in general, customers are watching their own spend and prices very carefully.I would note that when looking ahead, there is some cause for optimism. For one thing, the fiscal cliff has passed and life has gone on.
The recent [lease tax] deal in place, and while much work remains to be done on federal spending, at least some uncertainty has diminished. Additionally, December’s ISM reading of 50.7 and its positive tone regarding the pricing environment are encouraging signs.
Should they continue or better yet build momentum, it would bode well for our business.
Jeffrey Kaczka
Erik Gershwind
Operator
Matt Duncan - Stephens Inc.
Erik Gershwind
Matt Duncan - Stephens Inc.
Erik Gershwind
Matt Duncan - Stephens Inc.
Erik Gershwind
Matt Duncan - Stephens Inc.
Erik Gershwind
Operator
Robert Barry - UBS
Erik Gershwind
Robert Barry - UBS
Erik Gershwind
Robert Barry - UBS
Jeffrey Kaczka
Robert Barry - UBS
Jeffrey Kaczka
Robert Barry - UBS
Operator
Hamzah Mazari - Crédit Suisse AG
Erik Gershwind
Hamzah Mazari - Crédit Suisse AG
Erik Gershwind
Hamzah Mazari - Crédit Suisse AG
Jeffrey Kaczka
Erik Gershwind
Hamzah Mazari - Crédit Suisse AG
Erik Gershwind
Operator
Adam Uhlman - Cleveland Research Company
Erik Gershwind
Adam Uhlman - Cleveland Research Company
Erik Gershwind
Adam Uhlman - Cleveland Research Company
Operator
David Manthey - Robert W. Baird
Erik Gershwind
David Manthey – Robert W. Baird
Erik Gershwind
David Manthey – Robert W. Baird
Erik Gershwind
Operator
Ryan Merkel - William Blair & Company
Erik Gershwind
Ryan Merkel - William Blair & Company
Erik Gershwind
Ryan Merkel - William Blair & Company
Erik Gershwind
Operator
Sam Darkatsh - Raymond James & Associates
Jeffrey Kaczka
Sam Darkatsh - Raymond James & Associates
Jeffrey Kaczka
Sam Darkatsh - Raymond James & Associates
Erik Gershwind
Sam Darkatsh - Raymond James & Associates
Operator
Derek Jose – Longbow Research
Erik Gershwind
Derek Jose – Longbow Research
Erik Gershwind
Derek Jose – Longbow Research
Erik Gershwind
Derek Jose – Longbow Research
Erik Gershwind
Derek Jose – Longbow Research
Erik Gershwind
Derek Jose – Longbow Research
Erik Gershwind
Operator
Holden Lewis - BB&T Capital Markets
Jeffrey Kaczka
Erik Gershwind
Holden Lewis - BB&T Capital Markets
Jeffrey Kaczka
Holden Lewis - BB&T Capital Markets
Erik Gershwind
Operator
John Baliotti - Janney Montgomery & Scott
Erik Gershwind
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?
Erik Gershwind
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?
Erik Gershwind
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?
Erik Gershwind
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?
Erik Gershwind
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.
Operator
And our final question will come from Brent Rakers of Wunderlich Securities. Please go ahead.
Brent Rakers - Wunderlich Securities
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?
Jeffrey Kaczka
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.
Brent Rakers - Wunderlich Securities
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?
Jeffrey Kaczka
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.
Erik Gershwind
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.
Brent Rakers - Wunderlich Securities
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?
Erik Gershwind
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.
Brent Rakers - Wunderlich Securities
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?
Jeffrey Kaczka
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.
Erik Gershwind
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.
Jeffrey Kaczka
Including the pricing environment.
Operator
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.
Erik Gershwind
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.
Operator
Ladies and gentlemen, the conference has now concluded. We thank you for attending today's presentation.
You may now disconnect your lines.