MSC Industrial Direct Co. Earnings Call Nuggets: Fourth Quarter Guidance and Sequential Outlook

MSC Industrial Direct Co. (NYSE:MSM) recently reported its third quarter earnings and discussed the following topics in its earnings conference call.

Fourth Quarter Guidance

Ryan Merkel – William Blair & Company: Let me just start then with the guidance. I think your (indiscernible) for Barnes to be neutral to EPS in the fourth quarter but I think it was $0.02 accretive in the third quarter so can you kind of walk us through that?

Erik Gershwind – President and CEO: We were pleasantly surprised that we were actually $0.02 accretive in that stub period which included the results from April 22 on there is a little bit of an interest phenomenon there which benefitted us Ryan and that is that the sales at the tail end of the months in Barnes are traditionally very strong, so we had the benefit of the higher sales week in the last week of April without the proportionately higher expenses, and so that was the primary reason we were actually accretive in April. We’ll have more of a normal quarter in the fourth quarter with the exception that we have, and this is associated with normal acquisition accounting, a step-up in the inventory which suppresses the gross margins as I said in my prepared comment, and that will run through our gross margin through the end of the year. We haven’t spiked that out separately as a transaction or integration cost, it runs through the operations, so therefore we expect to be roughly breakeven in Q4. And then, as we head into next year, we don’t have that impact and we start realizing the benefits of the synergies.

Ryan Merkel – William Blair & Company: Then, I guess, it was nice to see that you reiterated the accretion for the next couple of years on Barnes. I guess as it relates to next year, the $0.15 to $0.20 of EPS accretion, how much of that is operational versus synergies kicking in? Just trying to get a sense of how quickly those kick in…

Erik Gershwind – President and CEO: Ryan, it’s Erik. I would say on the synergy front, as you heard in the prepared remarks, we feel very good about the range that we provided. You can hear, we wanted to give you the sort of the bread crumps of how we are going to go about achieving those. But what you could also imagine is that, most of those take time to realize. So, from a synergy standpoint, most of that number will take some time before it kicks into the P&L.

Ryan Merkel – William Blair & Company: Okay. That’s what I figured. And then just last one real quick. You probably won’t want to answer this question, but you mentioned in prepared remarks that spending on growth initiatives will continue into fiscal year ’14. Can you just give us a sense — is it stepping down? Is it half? Just give us a little bit of a sense there because I think a lot of us were assuming that some of that will start to fall off in ’14 and then the margins will start to improve quite a bit.

Erik Gershwind – President and CEO: Yeah. Ryan, it’s Erik. So I know what you’re grasping at there, which is kind of a framework for thinking about ’14. And as I said, we are in the middle of doing our work right now and we’re going to come back to you with more of what we typically give you as a perspective for the year. Let me say this, I’m going to start by stepping back to what we talked about at the start of fiscal year ’13, and we gave a framework and that framework basically outlined that we were entering a period of accelerated investment and that was growth investment and that was infrastructure investment. And then, as a result of that, at any given level of revenue that you pick, incremental margins were going to be lower than historical. So what we talked about was at that time, it was a little bit of a frothier environment and we were looking at around 10% top line growth, and what we said was that around 10% growth, you could expect mid-teens incrementals from us, and it wouldn’t be until what we called healthy double-digits, which to us was 12 or higher before you’d see op margin expansion. And that then as revenue growth, if it were to step down from the 10, incrementals would get proportionately lower until we’d reach a point somewhere in the low to single mid-single-digits where we wouldn’t be able to grow earnings due to the step-up in investments. And then we overlaid that by saying, look the wildcard on top of all of this is pricing. So that was our outlook on ’13. And I’ll tell you, I think what’s played out in ’13 is entirely consistent with that framework. Of course, what we have liked to have seen a stronger demand environment, which would have led to higher revenue growth of course, but I think what you’ve seen is consistent what I would tell us is for now that frame work still holds and you are seeing it in our Q4 guidance and I think not much changes in our perspective of course we still, there’s a lot of work going on right now on ’14 and we’ll be back with more detail.

Sequential Outlook

John Inch – Deutsche Bank: Wanted to ask you about the fourth quarter guide in the context of the sequential. I appreciate the walk, and by the way I do think these slides are very helpful. So I would continue them. I understand your year-over-year walk in (locking) the week. But if I look at sort of the third quarter to the fourth quarter each has 64 days and if you I think Jeff you said that BDNA was neutral to EPS. So you are kind of going from a walk of a $1.03 down to $0.89. I am not quite sure why that’s actually happening if you’ve got the same number of days and if you look historically, right your third quarter to fourth quarter walk it doesn’t go down that much. So is there anything else going on here it’s just not clear it’s certainly down 12%. It doesn’t seem to jive with flat environment and the cost cutting that you’ve been successfully invoking?

Jeff Kaczka – EVP and CFO: In regard to the sequential walk I think you will normally see John the decline and primarily associated with the drop in the organic gross margin in the fourth quarter due to the lower margin mix of product we generally sell in our fiscal fourth quarter.

John Inch – Deutsche Bank: What’s the magnitude of…

Jeff Kaczka – EVP and CFO: The magnitude over the last several years John has been in the range of 50 basis points to 125 basis points. A lot will depend on whether or not there’s fourth quarter actions in pricing, as you recall last year, we did accelerate some of our pricing actions, so in that range of gross margin decline.

John Inch – Deutsche Bank: So I am assuming that’s probably coming in at the high-end, just to be conservative. Is there anything else on the sequential that you would call out other than pricing and flat environment that’s maybe tweaking some of those? I see what your tax rate is, but is there anything else?

Jeff Kaczka – EVP and CFO: You see the tax rate and then you see also the fact that sequentially, our operating expenses, as I mentioned, are going up $5 million excluding the impact of BDNA, and those are some strategic investments that we are choosing to make, that will benefit us going forward…

John Inch – Deutsche Bank: Then, Erik, you called out the price increase that you are expecting in the catalog. I’m curious, because obviously, you traditionally put through a price increase. Are you expecting that sort of the impact of this price increase to be the same order of magnitude as a year ago or perhaps a little bit higher or lower, because obviously that will have in turn kind of a run rate in terms of the impact of pricing as you get past this quarter into kind of future quarters?

Erik Gershwind – President and CEO: Yeah, John, we’ll come back. I mean, our practice is – as you know, our practice is we wait until after we release the catalog. So on next quarter, we’ll give you the specifics, not trying to be coy, but just for competitive reasons, we’re going to wait till I’ve to give you the increase. Yeah, I used the words, normal, and basically what I mean by that is if you go back and you’ve tracked us for a while, if you took the low-end of what we’ve done in catalog increases and the high-end of what we’ve done, it’s going to fall somewhere in the middle.

John Inch – Deutsche Bank: Just lastly, I think you said you’ve got about $20 million left of integration transaction cost for BDNA, based on the math you’ve done thus far in the $25 million to $30 million guide. Does that all conclude in ’14 and how does that, Jeff, kind of delineate over the coming quarters? Is it relatively linear?

Jeff Kaczka – EVP and CFO: Yeah. John, what we said was that the majority of that would be complete by the end of FY ’14, but it will continue to some extent into ’15 and linear is not a bad look at it, probably a little bit more heavier-weighted in the first half of the year.

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