MSC Industrial Direct Co., Inc. (MSM) Earnings Call Transcript & Summary

Good afternoon. I'm Sam Darkatsh. On behalf of Raymond James, I'd like to welcome you to the MSC Industrial Supply company presentation, used to be Industrial Direct, John. They put you to work on this and changed the name of the whole company. With us today from MSC, Steve Baruch, Executive Vice President, Chief Strategy and Marketing Officer; and John Chironna, Treasurer and Vice President of Investor Relations. Steve, I think your prepared remarks, maybe 10 or 15 minutes, which should leave plenty of time for Q&A. And at that point, we'll then move to the breakout. But without any further ado, welcome, gentlemen. Thank you.

Great. Thanks, Sam. Am I on? Yes, I'm on now. There you go. Okay. Good. Good afternoon, everybody, and thanks, Sam. And as I go through this, I'll make sure we reserve time for Q&A. That will be the important part here, but interesting that Sam started off with the name, MSC Industrial Supply Co., no longer MSC Direct, but it does still act as a harbinger back to where our roots were. So the company started in 1941. I'll give you the quick flyby. It is that American success story, literally started out of the trunk of the car of the founder on the Lower East Side of Manhattan, selling military spares to machine shops. And now these nearly 80 years later and you see where we've become. But that Direct in the name talks to where we started as a direct marketing company. Still iconic in our space is a book that we produce, we actually call it the Big Book, not terribly creative for a marketing guy, but it is a 5,500-page collection of some 500,000 items that makes up the -- about 1/3 of the nearly 1.5 million items that we market more broadly. We've now become -- instead of a direct marketing company, we've become truly an omnichannel distribution model that's got a sales organization, telesales, still maintains some of the direct, both analog and digital, approaches to that marketing. A full suite of solutions and services that we offer our over 300,000 customers from some 3,000 suppliers. And our team of about 6,600, 6,700 people are doing that all day, every day. And what makes us special is where we really bring value to our durable goods manufacturing customers, and I'll talk a little bit more about that. So some of the highlights we talked about. So this market, to truly understand it, is one that has continued to be highly fragmented. We get the question all the time about the competitive landscape, and how are we compared to some of our other publicly traded national competitors. And we're constantly reminding people that while they are always in the competitive set, it's still a market that's largely dominated by the local and regional suppliers. And I'll talk a little bit more about that on the next slide. It's also become a more complicated business. There is a time when just adding more SKUs and more sellers and more branches was enough and you could drive your sales. Increasingly, and I'll say with '08, '09 being the inflection point, our customers began to expect and require more of us than just what you have today to help manufacturing plant run. And this notion of value-added solutions has become a core part of what we do, and how we deploy them, which I'll talk a bit about later on too, is an important differentiator. The customer satisfaction in this world. So we talked about the hundreds of thousands of customers, that's great, and we'll talk more about the potential customers we could serve, but keeping those customers is paramount. And we're very proud of our legacy of very high Net Promoter and CSAT scores with our existing customers. Ultimately, it's a profitable model. It's a model that has stood the test of time, and we'll talk a bit more here this afternoon about the next chapter. So I talked about fragmented. And if you take a look at this slide, the top 50 distributors representing less than 30% of the market. And this is in what we qualify as a $200 billion market. So stop and think about that for a minute in terms of just sheer fragmentation. It changes the game. It's not necessarily us against our publicly traded national competitors. Instead, it's us taking share from the locals and growing our share from them at a faster rate than our national competitors are growing share from those locals. As we think about customer expectations growing, they're expecting more services. They're expecting more consultation. Ultimately, they're expecting more support to drive their own productivity. And that can come in the form of our inventory on their site, our solutions on their site, even our people on their site. And as those needs grow, so too do the challenges for those locals and regionals to satisfy those needs, giving us a distinct advantage. You can see the inverted triangles to the right that talks a bit about the segmentation of the market. So lots of small customers, still the case. And relatively less share, relatively fewer, bigger customers still commanding a big -- lion's share of the market. So let's break down, and I think this is where the story gets really interesting particularly for us. Let's break down that $200 billion. And from a marketing guy's perspective, this is what makes for a pretty exciting story. So $200 billion is when we look at everything that we offer, that's the 1.5 million or so SKUs. And we think about any potential buyer of those SKUs in North America. And that comes to about 19 million customers, which you could look at as either a blessing or a curse. And candidly, when you look at a customer base that big and try to draw focus around 19 million customers, I see it as being more a curse than a blessing. But here's where the blessing is. Our core value prop is bringing real differentiation to the durable goods manufacturing floor. It's where our roots are. It's where we've got expertise, where we've got a Line Card unlike anybody else's. And when you break down the $200 billion and look at those that are in manufacturing, and you can see that 750,000 in manufacturing locations. So truly, a vast minority of locations, but then look at where the spend still lies. $100 billion of that spend is in that few manufacturing locations that I'm describing, where we happen to have a distinct advantage over our competition. So I don't have to necessarily make myself attractive to 19 million customers, but I'm going to make myself super attractive to the core of the 750,000. And we'll talk a little bit more about how we do that. So as we look at those manufacturing customers and think about what's top of mind for them. Historically, in our space, it's been what I like to call a front of the supply chain value prop, and that is search, find and buy or a buy-sell relationship. I need stuff, you've got stuff, and I'll buy it from you. Increasingly, and particularly for us in the manufacturing space, we've shifted our focus to more of the other side of the supply chain, the output side of the supply chain, saying, what are you producing? How effectively are you producing it? How efficiently can you produce it? If we can reduce your cycle times and increase your throughput, make you more competitive through our expertise and our solutions, then aren't we a better partner to you than not and should we deserve more share of wallet from you? And we do see this playing out and earning that opportunity for more share of wallet. In that durable goods manufacturing space, we're the only distributor that can walk into a customer and say that we have absolutely the best choice for you based on offering without any bias because of our Line Card and the fact that we have every major metalworking supplier on our Line Card and can offer a customer the best solution without any bias. And that's what we do and that's how we drive customer value. We then translate that into supply chain value. Now that you've got the right stuff and you're using it the right way, is it at the right point of use so that you're adding efficiency? And are you managing your inventory in the most efficient way possible? And that's where things like vending and VMI and consignment and on-sites will come into play. So we take a customer and we look to apply a variety of the things that I've talked to, and I'll show you a little bit more of how that cycle works. But we do think it's the combination of really high-touch customer care, expertise, that consultative solution deployment, but also always delivering it through the mechanism that the customer finds most efficient. More than 60% of our transactions are electronic. We've got an award-winning website that we continue to use. We'll continue to invest into digital. But there's an expression that we like to use, and it goes something like this, that the more and more the world becomes digital, the more important people are becoming. And sifting through the sea of digital noise and having the expertise that we do to help curate and navigate our customers the right solutions has become a huge differentiator. So it's not instead of digital or being more sophisticated from a transactional perspective, but it's in addition to, but that combination of technology and people we see as a big differentiator. I talked about customer service before. I think everybody will come up here and say our customers love us, and we have great loyalty and what have you. That's not good enough for us, just the platitudes. We do measure it very actively through numerous listening posts, one of them being ForeSee. It's a regular survey that is ongoing on our website, in our customer care centers and in our branches. We're collecting feedback every single day. And it's now a feedback that we can look at more objectively compared to others in our class and best of class. And you can see that our customer satisfaction scores are in the high range and above class and leaning towards world-class, which we're very proud of. So here's how the system kind of works for us. And then I'll just give you a few proof points, and I'll move on to Q&A. But when we engage a customer, it starts with, first of all, identifying a customer who we think would really be a good candidate for our value prop, namely those durable goods manufacturers. But within them, there are those that have greater respect and appreciation for the work that we do and those, as John points out, that have less. So we do look to identify the customers that have that great, I'll say, appreciation for that output-type work that we do. So we'll come in and apply technical expertise in a consultative way to that customer and identify areas across your manufacturing plant where they can be more productive. We'll then install solutions, make changes, make recommendations to their machining itself and start to aggressively measure what the before and after state was, quantifying and capturing all of the cost savings along the way. We'll have that cost savings validated by the customer to say, "Hey, let's not make this our cost savings estimate. Let's make sure somebody with the P&L on your side validates these as cost savings that you would take to the bottom line." From there, let's go and have a regular cadence of identifying what we've done, what we could do next and what it's worth, and then let's continue to kind of go around this logical loop here of adding value, quantifying that value, articulating what that value is, identifying new ways to create more value and that virtuous circle goes and goes and goes. In the last couple of years, we've talked publicly about generating more than $400 million in cost savings that has been signed by our customers as being valid cost savings in the work. So that kind of work, that kind of result in a market where finding machinists and finding good manufacturing talent is becoming scarcer and scarcer and helping customers become more competitive in their space is a story that we're telling. It's one that's getting rewarded in the marketplace and one that we are encouraged to continue telling based on what's going on in manufacturing here in North America. I've got some proof points here on the next slide. I won't read through all of them. Suffice it to say, when you do this for a customer and you save them that kind of money, they like to keep you close and like to keep you working for them versus their competitors. So I'll just, I'll say, leave that up there and turn it over to Q&A. Thank you. I'll move here with John, makes me look younger.

Okay, questions. I'll ask a few and then we'll open it up for the room. You may have heard there's a virus going around. Talk about your exposure. Specifically, are you hearing from vendors or lead times extending? Do you have enough safety stock inventory? Where do you think things might be tight? And then on the other side, what are you hearing from customers in terms of not only how they're preparing, but what their buying patterns have looked like of late?

Yes. So good question, one we've gotten a few times today, usually preceded by, do you have any masks? And the answer is no. So that's the marquee item, right? That's the one, from a supply chain perspective, that has gotten all the attention and the focus, your N95 respirators, and you've all read the stories there. There are a few others that fall into that category from an inventory shock perspective where it's sanitizers or other personal protective equipment that's gotten a lot of attention. By and large right now and for us, first of all, at MSC, our exposure to China, if we start there, and we're fortunate enough to have done -- I'd say now fortunate, to have done all this work during the tariff phases of supply chain disruption to know very clearly where the pipelines were. It's -- for us, it's under 10% exposure to China and haven't seen disruption from a supply chain perspective to this point, direct disruption, I'll say, with the exception of those few marquee items. Our customers right now are asking, right? They're asking us as they plan their, I'll say, disaster prevention or crisis management work to understand the supply chain and our part of that supply chain and understanding what kind of impact or exposure they may have. And the same thing is happening up the supply chain. Right now, our inventory position, we feel very good about. Our inventory strategy historically is one of a good, better, best mechanism where we've got multiple entry-level items, multiple standard items and multiple premium items for everything that we sell. It will give us the ability to jockey our inventory around should the need be, if there are other disruptions or the disruption is more protracted. But right now, our stance frankly is still day-to-day. We're watching very closely. We've got a team assembled, who meets daily and is taking, again, soundbites from our customers, our suppliers and our associates as to current state.

The U.S. metalworking industry has been under pressure for a little over a year now, I suppose, and trying to get a sense of signs of life. The last couple of metalworking business index readings have been over 50. It's a similar reading as the PMI, so it's a diffusion index. Anything over 50 at least implies growth. That's the first time we've seen a number over 50, certainly on a couple of months in a row now for a while. What sorts of things would need to happen for U.S. metalworking to really improve? And is the MBI readings -- do the MBI readings signal what you're seeing on the ground?

So it's a little soon to say, right? So we have historically tracked pretty closely or correlated pretty closely to the MBI, the metalworking business index, on a rolling 12, right? Rather than the monthly reading, we look at the rolling 12. And with a 4-month lag, it's a pretty decent correlation. So while we've seen the last 2 data points, Sam, to your point, they've ticked up, the rolling 12 is still under 50, so -- and declining based on the overall 12-month trend. So there's nothing to say that we're off into the races right now. Now would I rather see it above 50 than below 50? Yes. Are there any specific areas of industry or business where I can say it's that that's creating the sentiment lift or driving the change? Not specifically. There's still an overhang with MAX 8 that we're seeing, cascading. There's still an overhang with oil and gas, while not directly. Secondary, we noted some exposure there. We're not really tremendously impacted by auto, some of the changes going on there. So short answer to your question, there's nothing specific that we're pointing to. But we'd like to see broadly that 50 expansion continue, of course.

We've noted this in our research over the past few years or so, your stock tends to correlate pretty strongly with either EBITDA margins or gross margins. Now there are some mix pressures that you're not only experiencing now but will probably continue for the foreseeable future on the gross margin side. But you've also identified a fair amount of cost savings -- I don't know if I would have called it initiative or just an observation of opportunity certainly with back office. So how do we look at, not only where you start to leverage margins from an organic growth standpoint but what incremental margins might look like on a normalized basis? And perhaps what kind of savings could you attract as you rightsize your overhead structure?

Sure. Why don't I talk a little bit about gross margin headwinds, tailwinds, and then you can talk about EBITDA?

Okay.

Yes. So I think part of the narrative and I think inaccurate narrative that's happened historically is this notion that gross margins are being pressured by other disruptive forces in this space that are marketplace disruptors, price transparency is creating that margin pressure. And I'm not saying that there isn't some of that involved. But by and large, we've got a product mix, customer mix issue that's a bigger margin headwind. When we over-indexed to our larger accounts, our national accounts, their gross margins are lower. We can talk a little bit about their profitability. But as we over-index to our CCSG business, which is our fastener business, and we mentioned recently some strength there, those gross margins are higher. So customer mix, sales versus -- or national versus core product mix, some volume metalworking versus some maintenance fasteners, you can see some mix changes. Those are some kind of headwind, tailwinds. We'll also continue to look at our product mix from an industry brand, private brand perspective. So we have good exposure across many categories for our private label work, which serves as a tailwind as well and, ultimately, with the balanced mix, customer mix, product mix and the industry versus private label mix as well.

I guess I would add, from the incremental margin standpoint, you probably remember a few years back, we used to talk about a 20% to 30% incremental margin range opportunity for us depending upon gross margin or pricing environment as well as the organic growth. And it's been a few years since we were at those levels, obviously. We have seen continued gross margin contraction. I think what's good right now is that, as a leadership team, we've identified the fact that costs can come out of the business and to take -- and we didn't go too far. Obviously, we may say more on the April 8 call earnings call. But we are working with a third-party partner to identify opportunities to take out costs. That as well as, of course, the whole sales force transformation/sales force refinement to get organic growth back, at least to get a gap to market, those 2 things should, at a minimum, stabilize our operating margin and actually should expand it, quite frankly.

And so Sam…

Timing is going to be tough.

Timing is the -- I was going to say near term.

Hard to say but…

We have a midyear price increase. We talked about that. We've also talked publicly about some of the supplier actions that we've taken as well. So it's bringing all those pieces together, the cost downside and then some of the margin mix upside.

Where is your leverage point now in terms of where you'd begin to leverage margins on an organic sales growth basis? And where should it be ultimately?

Well, it really -- it depends on how gross margins are doing, right? But I would say, in general, it's somewhere in the mid-single-digit growth range, more or less, depending on, of course, by how much they're contracting or not.

And the idea is to get that down to low single digits...

I would think so, yes.

Short to intermediate term?

That's right.

Over the last couple of years or so, you went through a pretty significant sales reorganization or sales structure reorganization plan. Take us through the history of that, if you could. What was the derivation? Why did you feel the need? What were the action steps? Where are you now? And how do you hope to -- that it provides an increased ability to delight your customers where you didn't have it before?

Yes, I'll take first cut at it and then turn it to John. So in broad strokes, and as I spoke in the presentation, kind of -- with the great recession '08-'09 being the inflection point, there is how this world acted before that and there's how this world acted after. Prior to '08-'09, this was -- you could just do things quantitatively, more parts, more sellers, more calls, more touches, just more and more. You could get more sales, more profit out of it. As things started to get tighter and tighter in the space, customers expecting more, then the things that we have done historically that I described in terms of output value became much more valuable, much more important and much more differentiated than just the parts per dollars piece of the business. So it became clear that's shifting their sort of 2 purposes, more sophisticated sell, it was a stickier model, it created more value for the customer, but it was also more sophisticated from a sales motion perspective. So the same person that could do some of that sales per dollars work in the past may not be able to perform what I described here as that consultative sales approach. So in short, there is that piece of starting to shift from a less sophisticated to a more sophisticated seller who could perform that well. And in that model, having a hunter-farmer modality with our sales team, some -- again the competency model to go get that new customer and the vastly different behaviors that are required to keep and nurture and retain that customer for time. So we moved both to more sophisticated and to this bifurcated model of hunter-farmer. And in real candor, we got some things wrong in the first cut of that, that we've talked about realigning here more recently, and we feel good about the direction there. It doesn't mean we have it perfect, but we feel pretty good about having that right model in place to continue to make good strides there.

So where are we in stage now in terms of optimizing the sales structure?

Yes. That heavy lifting is done. That's behind us. So now, it becomes a matter of let's work that muscle, grow that muscle, rinse, repeat, rinse, repeat. Yes.

And the learning curve of the salesperson in your view or in your experience now that he or she is being asked to do different.

Yes. I'd say the hunters are ahead of the farmers, right? And it tends -- that tends to be the case naturally in sales, and they're making great strides. Many of the new heads that we added, sales folks we added, were hunters. And so we could screen for, onboard, train and deploy all against that new modality. Some of the farmers that we're moving into more of that solution-based seller mentality are going through the training as well. And I'll say they're a little bit behind the hunters but making good progress.

Sam, I'd add to -- last quarter, we were down about 65 heads in the sales. And obviously, there's a mathematical impact of that. We indicated that we would expect to add heads the rest of this year, right, in the sales function. I would say that if we get to Q4 -- fiscal Q4, and we haven't seen some impact from the sales force refinement such that we're starting to see a growth to market gap, then we're going to have to ask some tough questions again. But we fully expect to see that happening. Today, we would say to you we're growing roughly in line with market, and that's a far cry from our historical trends of 300 to 400 basis points of share gain.

Which is where you'd like to return to, 300 to 400...

At least that, yes.

And we -- I didn't talk to the proof points, but I put them up there. This is a good time to talk to it. When we do that, good things happen. And so we feel like, yes, to John's point, we need to do it more often, more consistently across a broader base. But the proof is in the pudding for sure or the proof of the pudding is in the eating. How does that go?

It's like you say.

Exactly. But it does -- the value that we're bringing really resonates with customers.

Any questions from the field here? Timing is perfect anyway. So we'll continue this in the breakout session. Thank you, gentlemen.

Thanks, Sam.

Thank you, Sam.