MSC Industrial Direct Company, Inc.

Good morning and welcome to the MSC Industrial Supply 2020 Third Quarter Conference Call. All participants will be in 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 a touch-tone phone. To withdraw your question, please press star then two. Please note today's 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, sir.

Thank you, Rocco, and good morning, everyone. Eric Gershwin, our Chief Executive Officer, as well as Greg Clark, our Interim Chief Financial Officer, are both on the call with me. As we were on our last call, we are all remote, so bear with us if we encounter any technical difficulties. 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 refer to 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 statements about the impact of COVID-19 on our business operations, results of operations and financial condition, expected future results, expected benefits from our investment and strategic plans and other initiatives, and expected future margins. 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 in the MD&A sections of our latest annual report on Form 10-K filed with the SEC, as well as in other SEC filings. These risk factors include our comments on the potential impact of COVID-19. 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. I'll now turn the call over to Eric.

Thank you, John, and good morning everybody. Thanks for joining us today. Most importantly, let me start by saying that I hope everybody on this call is staying safe and healthy. Before I dive into the details of the quarter, I want to begin this morning's call by providing some perspective on our company's performance since the COVID-19 pandemic began. I'm quite pleased with how our company has risen to the occasion in the face of the most severe crisis that most of us have seen in our lifetimes. When we spoke on our last call, it was early April, and we were still in the early stages of crisis management. And we were focused on playing defense, and that meant ensuring the safety of our team and our customers, solidifying business continuity plans for ourselves and partners, adapting to a remote working environment, and ensuring the financial stability for the enterprise. While all of these still remain top of mind, our attention has since turned to playing offense where we saw opportunities, such as providing much needed PPE and janitorial supplies to keep our customers running, capturing new customer relationships as our smaller competitors struggle to effectively serve their customers, and striking new and improved programs with our supplier partners. This dual approach of playing offense and defense has served us well thus far. At the same time, it's also clear that we're not out of the woods yet. As you can see from our June growth rate, with the benefit from the PPE surge subsiding, our base business is showing the realities of a challenging manufacturing environment and a very cautious customer base. More about this later. But it's not surprising to us, given the dynamics in key industries that drive metalworking consumption, such as automotive, aerospace, and oil and gas, along with the obvious uncertainty regarding the trajectory of the virus. With the early days of crisis management now behind us, we resume our journey to reposition MSC from spot-by supplier to mission-critical partner. Over the past four years, we've migrated MSC from a secondary supplier to our customer's primary option. We play a key role on the plant floor through our metalworking technical experts, our inventory management service team, who support vending, along with our VMI program, which is also the centerpiece of our Class C business, and more. This presence deepens the customer relationship which, when executed, yields benefits of higher customer retention rates and hence stronger lifetime values and more resilient gross margins over time. It also allows for the ongoing capture of the legacy spot-by business in these customers. Before the pandemic began, we had completed most elements of the repositioning with just a few remaining. And I'll provide an update on those remaining ones later on in my remarks. Let me now turn to an overview of our fiscal third quarter and I'll then hand the call over to Greg who will review the details of the quarter. I'll then wrap up before we open up the line for questions. First, an update on our business continuity efforts. While our customer fulfillment centers have remained open throughout the crisis as an essential operation, most of our other areas remained in a remote working mode. And given its effectiveness, we'll continue operating remotely until at least September 1st in most of our facilities, at which point we'll determine our go-forward approach. In the meantime, we continue operating our fulfillment centers with enhanced safety procedures. As of mid-March, we eliminated all travel in order to ensure health and safety. Over the last couple of weeks, some limited travel has resumed, primarily for our sales and service associates who need to be onsite with customers in those states that allow it. And rest assured, they're all practicing social distancing and using strict safety protocols. We plan to keep travel quite limited for the foreseeable future, focused only on customer facing needs. Our fiscal third quarter financial results reflected strong execution in a tough environment, and tough is an understatement. Versus the prior year, overall sales were down 3.6% and gross margin was down just 10 basis points. You may recall that we experienced an unusually large gap between bookings, and what was invoiced in fiscal March. This trend continued through fiscal April with bookings increasing at a double-digit pace over prior year due to the continuing surge in large safety and janitorial orders, scarcity of product and longer lead times. During both fiscal March and fiscal April, our non-safety and non-janitorial product lines saw significant declines versus prior year due to the impact of prolonged customer shutdowns and the worldwide efforts to control COVID-19. May sales grew over prior year, and that was driven by the fulfillment of the large safety and janitorial backlog that had built over the prior couple of months. At the same time, we noted that bookings levels for safety and janitorial orders came down in May from the elevated levels of March and April. As a result, Our order backlog decreased from well above $100 million to about $100 million at the end of our fiscal third quarter. The current backlog now stands at roughly $85 million, which is still above historic levels, but certainly below the bulge we saw last quarter. Orders and invoicing in May for non-safety and non-janitorial products continued to see double-digit declines versus the prior year. although we did see average daily sales rates improve at a modest rate through the month. Looking at performance by customer type, national accounts declined high single digits, even with the safety and janitorial surge. In contrast, our core customers declined mid-teens. Remember, this is the portion of our business most heavily levered to metalworking, which saw significant weakness and really extensive shutdowns. DCSG, similar to national accounts, was down high single digits. Government sales, and that includes both federal and state, were up significantly, in large part due to the surge in safety and janitorial orders, and that partially offset declines in other areas of the business. In fact, as a percentage of total sales, government represented 15% of sales in our fiscal third quarter. This is a high watermark for government, and we would expect more normal levels moving forward. As you can see from our June's estimated total sales growth of minus 11.1% or minus 14.8% on an ADS basis, customer reopenings have provided to date only a modest improvement in underlying non-safety, non-janitorial-related sales. We're hearing a few things from our customers and our sales force. First, most manufacturing end markets are quite soft and fundamentals are weak. For example, our job shop and machine shop customers that normally have a new order backlog in the range of six to eight weeks are down to much smaller backlogs right now. Second and related, customers are cautious about spending, and so they're burning off as much inventory as possible. There's also caution about the persistence of the virus and the potential for future surges. So while customers are reopening, they're doing so gradually. And in fact, many have even cut hours after opening up, particularly in late June. Some customers shut down for a longer than normal period around the July 4th holiday. As a side note, you'll see that our fiscal June this year has one extra day compared to last year, and that explains the discrepancy between total sales growth and average daily sales growth. This was due to the timing of July 4th falling on a Thursday last year and our decision hence to close on that Friday. So all of the caution that I described is reflected in the recent sentiment indices such as the MBI. The March reading was 41. April was worse at 34.4. May rebounded to 40.8. and the June reading of 42.9, while a slight improvement continues to point to significant contraction in metalworking end markets. The weakness in industrial demand was pretty much across the board with some isolated pockets of strength in areas such as medical manufacturing and food processing, which are not quite as core to us as some of the others. As I mentioned earlier, we're seeing sustained and acute weakness across certain heavily metalworking centric markets such as automotive, aerospace, and oil and gas. I'll move now to gross margins, and I was quite pleased with our third quarter performance, which built upon the solid results that we've been seeing throughout the fiscal year. There are three levers to our gross margin formula, and each one worked in our favor. The first is price. As I mentioned earlier, We continue to see good realization from our mid-year price increase, supported by some improvements to execution. The second is purchase cost. As anticipated, we're seeing the purchase cost escalation that's been with us for the past year start to wane. This is due to a combination of lower input costs making their way through our average costing system and also due to improved supplier programs that we had recently negotiated. Our third gross margin lever is mix. Right now, mix is more of a wild card than the other two. While it's generally been a gross margin headwind over time, it had less of an effect this quarter due to a combination of product mix and lower production-oriented metalworking sales. June gross margins continued our solid Q3 trending. Looking beyond June, we expect to sustain our recent gross margin performance with a couple of caveats. First, our Q4 generally has a seasonal tick down from Q3 levels, and that would likely be the case again this year. And second, we do anticipate some pressure on our rebates as we talked about over the last few months due to lower purchasing levels with lower sales. In terms of the gross margin levers that I just mentioned, we expect to continue executing well on the price front, albeit in a tougher pricing environment. We also expect to build on the momentum to bring purchase costs down, notwithstanding the rebate factor I just mentioned. Rebates, again, will remain a headwind with purchasing at current levels, although that could change quickly if we were to see a pickup in the coming months in sales. Mix will remain a wild card, especially in these unusual times, and is therefore less predictable. Finally, I'll move to operating expenses, where we managed our spending carefully and took temporary measures to reduce our cost structure. As a result, our OpEx to sales ratio was 60 basis points below the prior year period, and Greg will provide more detail in just a bit on how we did that. All of this resulted in an improvement in operating margin of 40 basis points and earnings per share that were down 4 cents versus the same quarter last year. I'll now turn things over to Greg before coming back with some concluding remarks.