MSC Industrial Direct Company, Inc.

Good morning and welcome to the MSC Industrial Supply 2020 first quarter conference call. All participants will be in a listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your touchtone phone. To withdraw your question, please press star then two. Please note this event is being recorded. I would now like to turn the conference over to John Corona, Vice President of Investor Relations and Treasurer. Please go ahead.

Thank you, Alyssa, and good morning, everyone. I'd like to wish everyone a happy new year and welcome you to our fiscal 2020 first quarter earnings call. With me are Eric Gershwin, our Chief Executive Officer, Rustem Jilla, our Chief Financial Officer, and Greg Clark, our Vice President of Finance and Corporate Controller. As you all know, Greg will become our interim CFO when Rustem leaves the company at the end of the next week. During today's call, we will refer to various financial and management data in the presentation slides that accompany our comments, as well as our operational statistics, both of which can be found on the investor relations section of our website. Let me reference our safe harbor statement under the Private Securities Litigation Reform Act of 1995. Our comments on this call, as well as the supplemental information we are providing on the website, contain forward-looking statements within the meaning of the U.S. securities laws, including guidance about expected future results, expectations regarding our ability to gain market share, and expected benefits from our investment and strategic plans, including expected results from acquisition. These forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from those anticipated by these statements. Information about these risks is noted in our earnings press release and the risk factors and the MD&A sections of our latest annual report on Form 10-K filed with the SEC, as well as in our other SEC filings. These forward-looking statements are based on our current expectations, and the company assumes no obligation to update these statements. Investors are cautioned not to place undue reliance on these forward-looking statements. In addition, during this call, we may refer to certain adjusted financial results which are non-GAAP measures. Please refer to the GAAP versus non-GAAP reconciliations in our presentation which contain the reconciliation of the adjusted financial measures to the most directly comparable GAAP measures. I'll now turn the call over to Eric.

Thank you, John, and good morning, everybody. Thanks for joining us today. I'd also like to reiterate a happy and healthy new year to everybody. As our fiscal 2020 is now in full swing, I'll begin this morning's call with some strategic context before getting into the usual specifics of the quarter. Over the past several years, we've repositioned MSC from our historic role as a spot-by-only supplier to a mission-critical partner on the plant floors of North American manufacturing and industry. We undertook this journey primarily because we saw an opportunity to partner more closely with our customers who've been calling out for help in running their businesses better. And MSC is uniquely positioned to fill that void. We also foresaw increasing pressure coming over time on our legacy spot-buy-only model, mainly from increased pricing transparency in this more transactional side of the business. Over the past several years, We've taken a number of steps to realize our vision. First, we focused on building trust with our customers, the kind of trust that allows us to play a bigger and deeper role in their business. We've done so by developing a new sales model and new tools to facilitate trust building, such as robust cost savings documentation, which we recently patented. While the implementation of our new sales plan has taken time, we're seeing the early results pay off in higher levels of customer satisfaction and loyalty. And this is important because our data shows that higher loyalty leads to higher growth over time. Second, we doubled down on product and service categories that are technical and high touch in nature, bringing us closer to the center of our customers' operation. We've invested in our traditional core of metalworking through a further build-out of technical specialists, through product innovation, and the introduction of additional value-add services. We expanded our footprint with the acquisition of Barnes Distribution, or now CCSG, to build leadership capabilities in the Class C parts category. We also acquired AIS, an OEM fastener business, to build out another platform that's both technical and high-touch. Each of these categories entrenches us at the heart of our customers' operations and provides us a position from which to grow share of wallet through account penetration. And third, we are expanding our supply chain onto our customers' plant floors through inventory management solutions and primarily vending and VMI. Since the start of our fiscal 2013, revenues to customers with those solutions are up 1,800 basis points and approaching half of total company sales, driven by the growth of MSC's vending and VMI initiatives, along with the benefit of the Barnes and AIS acquisitions. Two-thirds of that lift, though, was organic. And looking forward, we expect continued growth in solutions. A noteworthy characteristic of our new strategy is that it yields revenue streams correlated with higher retention rates, and that increases customer lifetime value. This becomes meaningful as we model our growth over time. Less customer churn and higher retention Produce a more effective growth model and higher ROIC by better leveraging our fixed costs. During last quarter's call, I outlined three initiatives that have our near-term attention in order to restore operating margin stability and ultimately expansion. And they are, first, refining the sales effectiveness plan. Second, improving the profitability of our supplier programs. and third, improving productivity by reducing operating expenses. We will remain focused on these three through the course of our fiscal 2020. So I'll now explain how they fit into our journey to reposition the company. First, getting the new sales model right is the cornerstone of our new value proposition. Our journey from a simpler spot-by-value prop to a more technical one required a change in our sales model. With the new leadership team providing a fresh perspective on our plan, we're finding that the design was on target, but its implementation needed refinements. More specifically, certain areas were under-resourced while we were over-allocated to others. These recent refinements are preparing us to accelerate growth. You can see from our operating stats that we took sales headcount down in the first quarter, reflecting the areas in which we were over-allocated. We will increase sales headcount from here with investments into growth areas over the coming few quarters. These growth areas include business development or the hunter roles, CCSG, and a couple of others. Our ultimate measure of success, of course, is our growth gap to market. In the meantime, we're focused on interim measures, such as the business development funnel of new wins, which have us encouraged about progress. Our second initiative is improving the profitability of supplier programs. As we've migrated from spot-by-supplier to mission-critical partner, the value proposition that we offer our suppliers is changing Just as it is for our customers. As a result, we've enhanced many of our supplier programs to receive more support in exchange for more dedicated focus from MSC on market share capture. As I mentioned on the last call, we've negotiated roughly $20 million in annualized profit improvements split about equally between the back half of fiscal 2020 and fiscal 2021. We're now turning our attention to implementing those programs and driving share capture for those suppliers who have invested in us. The third fiscal 2020 initiative is realigning our operating model to reduce operating expenses and improve productivity. And this is critical because as we reposition the company, the new business often comes with lower gross margins. We've now built scale in some of our new revenue streams, such as inventory management, and we're therefore ready to focus on improving the cost structure and efficiency with which we run them. We began this process in our fiscal fourth quarter with several more tactical measures. For example, we offered voluntary early retirement to associates with significant tenure in our distribution centers. We also ratcheted up performance management intensity and selectively eliminated positions where our focus is changing. As I noted on the last call, some of those actions would continue into our fiscal first quarter, and we guided to further headcount reductions and additional severance and separation costs, both of which took place, and Rustem will give the details in just a few minutes. For the balance of the year, We anticipate selective hiring in certain customer-facing roles and will maintain our intense focus on performance management. With some of these initial steps behind us, we're now focused on a more thorough assessment of additional opportunities to align our operating model to the new strategy. We will also focus on becoming leaner. We look forward to sharing the results of this planning with you within the next quarter or two. With all of this as context, I'll now turn to the quarter. I'll start with a brief overview of our fiscal 2020 first quarter results. I'll then provide an update on the environment and our recent performance before turning it over to Rustem to review the details of the quarter and provide guidance. And then I'll wrap things up and we'll open up the line for questions. Our fiscal first quarter results reflect solid execution in a weak demand environment. Sales and gross margin were both better than the midpoint of our guidance range. And operating expenses to sales, both as reported and excluding severance and separation costs, were slightly better than the guidance midpoint. As a result, both our operating margin and earnings per share came in at the top end of our guidance range. And again, Ruskin will provide more details. Turning to the environment, industrial demand remains weak. The softness is evidenced in the data points coming from manufacturing output, distributor growth surveys, and sentiment indices. In September and October, readings for the MBI were 48.6 and 48.3, respectively, and November was 47.0. The December MBI reading ticked back up but remained below 50 at 48.2, which takes the rolling 12-month average to 50.7. and while that rolling average is still positive, it has been steadily declining. We continue to see customers and suppliers eliminate shifts and in some pockets announce layoffs and restructurings. In terms of end markets, the weakness in industrial demand is broad-based with some acute pockets of softness in areas like automotive, heavy truck, oil and gas and agriculture. Aerospace is one of the few end markets that remains relatively strong, although the recent Boeing updates have created some choppiness there as well. With regards to the pricing environment, uncertainty due to tariffs and decelerating global growth continued. Combined with the price scrutiny that comes when customers' businesses slow down, and all of this results in a slightly softer pricing environment than we've seen over the past year. That said, We have seen some continued list price movement from our suppliers and fully expect to pass those increases along. We anticipate taking a mid-year price increase likely towards the end of our fiscal second quarter or the end of February. Turning to our performance, national accounts grew slightly, while core customers declined in the low-to-mid single-digit range, as this is the portion of our business most heavily levered to metalworking. which is particularly soft right now. Government sales growth levels improved from the fourth quarter as anticipated but still declined in the high single digits, weighing down overall growth. CCSG was a bright spot, growing in the mid-single digits. Looking at our most recent data point, the month of December is always difficult to extrapolate from due to holiday timing, shutdown schedules, and end-of-year capital purchasing and inventory burn-off decisions by our customers. This year, December was down 2% on an ADS basis, but that was aided by one fewer selling day. We decided to close on both Christmas Eve and New Year's Eve, largely because UPS was not processing ground shipments on those days. On a total revenue basis, growth was down roughly 7%, which is a significant step down from where we have been running. We attribute much of this weakness to holiday timing. When Christmas and New Year's fall on a Wednesday, we historically experienced the largest drag on sales. We also heard a greater prevalence of extended holiday shutdowns this year, which appeared to be customers anticipating slow conditions around the holidays. It's tough for us to say whether December was strictly about holiday timing or whether the underlying trends eroded as well. Unfortunately, we don't yet have a full week in January to see how activity rebounds. So Rustem will describe the assumptions we make for the revenue guidance forecast. Before I turn it over to Rustem to cover the financials, I want to thank him for his four years of service. We are grateful for his contributions and leadership. and we will certainly miss them. We're conducting a comprehensive search for a permanent CFO. As John mentioned, Greg Clark, our Vice President of Finance and Corporate Controller, will assume the position of Interim CFO. We're privileged to have a deep bench of finance talent here at MSC and Rustem and I feel very confident that Greg and the team will continue to strengthen our financial operations and ensure a smooth transition until a permanent replacement has been made. I'll now turn it over to Rustam.