MSC Industrial Direct Co Inc (MSM) 2012 Q1 法說會逐字稿

Good morning and welcome to the MSC Industrial Direct first quarter 2012 conference call.

All participants will be in listen-only mode.

(Operator Instructions)

After today's presentation there will be an opportunity to ask questions.

Please note this event is being recorded.

I would now like to turn the conference over to Alex Tramont of FTI Consulting, please go ahead.

Thank you and good morning, everyone.

Welcome to the MSC Industrial Direct fiscal 2012 first quarter conference call.

An on-line archive of this broadcast will be available one hour after the conclusion of the call and available for one month on the homepage of company's website at www.mscdirect.com.

During today's presentation Management will refer to financial and management data included under the section operational statistics, which you can find on the investor relations section of the Company's website.

Let me now take a minute to reference the safe harbor statement under the Private Securities Litigation Reform Act of 1995.

This call contains forward-looking statements within the meaning of the US Securities Law, including guidance about expected future results, statements regarding expected revenue growth, and operating margin and earnings growth.

Expectations regarding the Company's ability to capture market share, and expected benefits from the Company's investment and strategic plans.

These forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from those anticipated by these forward-looking statements.

Information about these risks is noted in the earnings press release and the risk factors in the MD&A sections of the Company's latest annual report on Form 10-K, filed with the SEC as well as in the Company's other SEC filings.

These forward-looking statements are based on the Company's 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 would now like to introduce MSC Industrial Direct 's Chief Executive Officer, David Sandler.

David, please go ahead.

Thanks Alex.

Good morning, everyone and thanks for joining us.

With me today is our President and Chief Operating Officer, Erik Gershwind.

Jeff Kaczka our Executive Vice President and Chief Financial Officer.

And Shelley Boxer, Vice President Finance and Accounting.

We'll begin by outlining what we'll cover on the call.

I'll provide perspective on our team's progress, performance and results for our first quarter of fiscal '12, Erik will update you on our growth strategy, what we're hearing from our customers about the current state of the economic landscape, as well as an update on the execution of our model.

Jeff will provide details on our Q1 financial performance, and on Q2's guidance.

Over the last couple of years, we've been communicating our succession plans and how MSC is a company that's been built to last.

I'm gratified to report on our progress.

Jeff has been on board for about nine months, and is proving to be a great addition to our team.

He fits perfectly in MSC culture, and is a great financial partner in managing the business.

Through Erik's leadership our entire management team is doing an exceptional job executing our plan.

We have a stable, deep, and talented team of executives.

As a result, I've been able to devote more of my time and focus to longer term strategy and future growth, knowing that day-to-day operations are in great hands.

I couldn't be more comfortable with how the process that we outlined sometime ago is being executed as it continues to be seamless to all stakeholders exactly as planned.

I remain excited about the future and extremely confident in our team's ability to take MSC to new levels of growth and prosperity over the next several years.

Our performance in Q1 was very solid.

We delivered earnings at the top end of our guidance range, on sales that exceeded the mid point of that guidance.

Incremental and operating margins were excellent.

These results reflect strong growth rates while incorporating the effects of our investment decisions, which as you know, moderate some of our earnings growth in the near term.

Our results also continue to reflect the advantages that our model delivers, capitalizing on current market conditions, and taking share from those regional and small competitors weakened during the downturn and who control a significant portion of the MRO market.

Our share gains are evident as MSC continues to grow at a much faster rate than what the macro readings indicate as growth for the market.

We're very pleased with the effectiveness and returns from our investment program, as we continue to invest significantly in future growth and market share gains, capitalizing on the great land grab opportunity.

The value gap between large and small distributors continues to widen and we continue to press to increase that gap.

Our investments remain primarily focused in areas that we believe will maximize our potential for high future growth.

Those being our sales force build out, expansion of our metalworking capabilities, vending solutions, private brands and eCommerce.

These investments will result in improved capabilities to help our customers further save time and money.

I'd like to now provide guidance for our second quarter.

We expect that sales will be between $548 million and $560 million, and fully diluted EPS to be between $0.92 and $0.96 per share.

Thanks, and I'll now turn the mic over to Erik.

Thanks David.

Jeff, Shelly, and I have spent considerable time with our investor community in recent months.

One of the takeaways from our discussions with many of you is the desire for a clearer understanding of our growth formula.

So I'd like to spend some time outlining it for you.

I'm going to start today by describing our strategy.

To do so we need to go back three decades as its roots are that deep.

That strategy is based on a vision that is enduring and time tested.

The tactics we use to achieve that strategy, what we consider the growth programs or as some have called the growth hooks, have changed and evolved over time.

But the essence of the strategy remains firmly in place.

Let me now take you back in time.

It was the late 1980s, the Company was a regional metalworking catalog supplier, doing less than $100 million selling into machine shops primarily in the northeast.

We may have been a relatively small company, but we had a big appetite.

We saw the opportunity to become a multi billion dollar distributor.

It was not only a goal, but it was a very clear vision.

We would become a national supplier, selling metalworking and broad line MRO supplies.

We would move from relationships with machine shops alone, to penetration across a number of industry verticals.

We would move from strictly spot buys through a catalog, to deeper product line penetration through a sales force and the creation of value added services.

This vision however, was a big leap from where we were.

It meant selling new products into new customers and new geographies while capturing new streams of demand.

To some, that sounded like a risky proposition, so we put a clear road map in place on how to get there.

We saw it as a systematic march of moves that together, added up to something very big and very special.

Today, we call those moves adjacencies, back then we just called them our growth plans.

But the concept was very much the same.

We invested heavily to march along that vision.

And those investments got us to where we are today, $2 billion in sales.

We've taken our unplanned spot buy service model national through the build out of a world class logistics network.

We're now a broad line metalworking and MRO supplier, carrying over 600,000 SKUs, we've added hundreds of thousands of new products to sell to our existing customers.

We've laid the foundation for deeper account penetration through a national sales network that's selling value added services and solutions.

So what's next?

How do we now go from $2 billion to $10 billion over the years to come?

We will follow the same measured approach that we followed in the past.

We see ourselves as teammates in a relay race.

The baton has now been handed to us to take MSC to the next level.

The first step for the current team has been to move into deeper product line penetration.

This means selling not only the unplanned spot buys that have been the Company's bread and butter, but the broader set of needs that our customers have.

And we decided to start in the lowest risk place there was, metalworking.

It was the easy choice to get started.

As the clear market leader, we have share approaching 10%, which is multiples bigger than the next biggest guys in our space.

At the same time, it provides us with a large runway of profitable growth right in our sweet spot.

With the experience in hand for metalworking on how to penetrate a product category, we've begun to move across other lines like safety, fasteners, hand and power tools, material handling and more.

You've heard us refer on recent calls to these product lines as closely related adjacencies.

That's because they're consumed on the plant floor in metalworking environments and oftentimes they're purchased by the same buyers who are buying metalworking supplies.

In addition, we already have experience in these product lines.

They were some of the early MRO editions back in the 1990s.

We have brought product offerings in our book, long standing relationships with key suppliers, and years of experience in learning what products sell and what additional value added services will be required to become a leader.

Executing upon our product penetration strategy, will give us experience in lines consumed outside of metalworking environments.

Making it easier to now sell those products into new customers.

Our next step will therefore be to move into new end markets.

Since our current penetration levels even within durable manufacturing are low, we'll begin this journey by inching out into those durable and non-durable manufacturing environments where we're under penetrated.

This allows our sales force to call on environments that are familiar to them, as they're all within the four walls of the manufacturing plant.

We've begun to lay the foundation in these newer segments through our national accounts program, but we'll get the true penetration in the years to come.

From there, we'll move to non-manufacturing environments where our products are consumed, opening up a whole new set of verticals to us.

We've also laid a foundation here in the form of our government business.

And once again, deeper penetration will happen in the years to come.

Finally, we'll move to geographies outside of the US, most likely starting with North America.

So that's the road map for our journey well into the future.

To move from $2 billion to $10 billion in sales.

From the past, our regional spot buy supplier of metalworking supplies, to the present, a national distributor of metalworking and MRO supplies selling value added solutions through a large sales force, to the future, a $10 billion global distributor, deeply penetrated across many product lines, and many vertical end markets.

The tactics have and will continue to change.

From direct mail to web, from product transactions to technology solutions and so on, but the vision remains the same.

My job in succeeding David, just as David's has been before me, is to serve as a steward for our mission statement, our vision and our culture.

Embedded in our culture is the understanding that the MSC team of today stands on the shoulders of those who came before us.

It's both a tremendous opportunity and responsibility.

One that I don't take lightly.

I'll return on a future call to give you an overview of the current set of tactics or growth programs that we're using to execute on our strategy.

In the meantime, you can visit our website and find our approach to growth laid out in our most recent investor presentation.

Turning now to the quarter, the execution of our model continues to be at historical highs.

We're realizing the benefits of our investments in the form of accelerated share gains as our sales growth demonstrates.

Q1 growth of 15.4% includes growth in our manufacturing segment of 19.8%, bringing the overall portion of our sales to manufacturing customers to 74% of sales.

Sales to the non-manufacturing segment grew 4.1%, and reflect the continued softness in the Government sector.

As expected, Government sales were down versus prior quarter, and prior year.

The continuation of the Government sales trend is reflective of heavy troop deployments overseas last year that weren't repeated this year, along with a continued clamp down on spending across most government entities.

Our Q2 forecast include the assumption of continued softness in Government sales and continued strength in sales to manufacturing customers.

As we disclosed last quarter, we anticipated taking a mid year price increase, which went into effect about two weeks ago, to mitigate the effect of purchase cost increases.

So far, realization on this increase is strong and reflects the continued strength of our value proposition.

We completed the integration of American Tool per plan in our first quarter.

As a result, synergies have begun to kick in.

ATS was break even in Q1, and we're on track to achieve roughly $0.02 to $0.03 of accretion during the balance of our fiscal year.

Our M&A funnel remains full and we're pleased with progress to date.

I'll now turn to the business environment.

During the quarter we visited extensively with our customers to take the pulse of business conditions.

The short answer is that customers are generally more optimistic as current activity levels remain strong.

While we continue to hear similar concerns about the lack of visibility into future demands, we are encouraged by a more positive tone.

We view the recent uptick in the last two ISM readings of 52.7 and 53.9 as consistent with what we're hearing in our direct customer interactions.

At the present time we'd characterize the environment as one of moderate growth.

This trend bodes well for future growth if it continues.

Finally, our sales force grew to 1,056 associates in Q1 and we expect it to grow to approximately 1,065 associates by the end of Q2.

Thanks and I'll now turn things over to Jeff.

Thanks, Erik.

Overall we had a strong quarter and we're very pleased with the way we've begun our fiscal year.

To the first quarter, compared to the same period last year sales grew 15.4% of which ATS contributed 2.5 points of growth.

Gross margin is up 20 basis points and earnings per share grew 27%.

Our EPS was $0.95 for the quarter and this came in at the top end of our guidance range.

The primary factor contributing to this top end EPS was our higher sales.

Our sales came in above the midpoint of the guidance range, thanks again to even stronger than expected growth from our core customer base.

We continue to realize success from our growth initiatives.

Our gross margin in Q1 was positively impacted by the price increase incorporated at the end of fiscal 2011, and was partially offset by ATS, which diluted our gross margin by 55 basis points and also by the fully anticipated impact of product cost increases.

Our operating expenses came in as expected for the quarter, and we're also pleased with the 17.7% operating margin we achieved in Q1, which included 40 basis points of dilution from the ATS acquisition.

I'd also like to point out that our incremental margin in Q1 was 27%, including about 500 basis points in dilution from ATS.

The tax provision for Q1 came in at 38.2%, close to expectations.

Q1 balance sheet metrics remain strong.

DSOs were 46 days, up slightly from Q4, reflecting normal seasonal patterns and are right where we expected them to be.

Inventory turns were 3.42.

Down slightly from Q4 levels and were as expected.

Inventories increased about 5% from fiscal Q4 levels as we continued to take advantage of our liquidity and financial strengths to ensure our ability to meet customer demand and enhance our service levels as well as protecting our gross margins in this inflationary period.

We have been taking advantage of rebate and opportunity buys that continue to produce strong ROIs.

The increase in inventory is expected to continue into Q2 for similar reasons.

Turning to cash flow.

We converted 77% of our net income into cash flow from operations in Q1, and we had approximately $128 million in cash at the end of Q1.

Cash flow conversion is historically a bit weaker in Q2, due to the fact that we make two tax payments in the quarter.

Over the last couple of years, we've seen total year cash conversion well over 90%.

This year I would expect conversion to remain strong, but a bit below those levels due to the inventory strategy that we've been utilizing.

Our current cash position stands at approximately $120 million.

Turning now to our guidance for Q2.

Our anticipated sales growth at the midpoint is 14.5%.

This reflects solid growth on top of a 22% growth quarter a year ago.

We currently expect gross margins for Q2 to be in the range of 46.5% plus or minus 20 basis points.

This is consistent with our expectations taking into consideration all the factors including ATS dilution and the product cost catch up, which is now flowing through cost of sales.

In Q2, we expect operating expenses will increase at the midpoint of guidance by $5.6 million.

An increase that is consistent with our historical trends in growth years.

The drivers of this expected increase are, $2 million related to the normal beginning of the calendar year increases in payroll taxes and salaries, $1 million in variable expense to support the increased volume in Q2, $1 million for other fringe benefit costs including workers' comp and medical and the remaining $1.6 million for growth investments and other items offset partially by productivity.

We expect our incremental margin in Q2 to be about 23% at the middle of the guidance range, including the dilution from ATS.

As you already know, our incremental margins are a function of several variables, including revenue trajectory, pricing and cost environment, and investment spend.

Our FY '12 incremental margins are quite healthy, but are moderating relative to the FY '11 levels.

This of course, is due primarily to the fact that in FY '11, we were in the early stage of the inflation cycle where price was ahead of cost increases.

In FY '12, it is more mid cycle, with purchase cost catch up moderating the gains as compared with the prior year.

All quite normal.

And all in line with our expectations.

Looking around the corner past Q2 into Q3, with what we see today, if we had similar growth rates in Q3 as in Q2, we would expect similar incremental margin.

Of course, should we see higher revenue trajectory or increased pricing and inflation levels, we would expect to see higher incremental margins, just as we saw in FY '11.

And a final data point that I'd like to give on guidance is that we expect the Q2 tax rate to be about 38.2%.

So again, we're pleased with our results and we're off to a good start in 2012.

Thanks, and now I'll turn it back to David for the wrap up.

Thanks, Jeff.

In summary, we are delighted with our continued strong financial performance and progress against the opportunity we foresaw more than three years ago.

As Erik described in detail, our plan follows the course of a longer term strategy against which we continue to successfully execute.

Our investments are beginning to deliver the results we expected, as we take advantage of the incredible land grab opportunity that we continue to see before us.

Team MSC's hard work and dedication is seen once again, in this quarter's results.

This unique and talented group associates inspire my confidence in the future and I want to thank them for all of their efforts.

Thanks, and I'll now open up the line for questions.

We will now begin the question-and-answer session.

(Operator Instructions) At the same time we will pause momentarily to assemble our roster.

Robert Barry, UBS.

Hi guys, good morning.

Good morning Rob.

I was wondering if you could give a little more color how much the Government sales were down?

Is this like a low single digit decline, mid single digit?

Any additional color there?

Sure.

Rob, it's Erik.

I'll talk a minute more, put more color on Government.

The government trend that we described, the softness is certainly nothing new, we've talked about it over the past few quarters.

What we saw in Q1, in our Q1, was we saw average daily sales slightly down from the prior quarter.

Which is fairly typical given the fiscal year that the Government works on, which is August through September, there tends to be a build leading up to and through September in spend at year end and then it drops off.

No surprise there.

But down relative to prior year.

We don't break out specifically -- I won't give you a specific number in terms of how much it was down versus prior year.

But I think, just while we're on Government, Rob, just to pull back for a second, and looking at the bigger picture, one of the things hopefully you got from the prepared remarks is we are very committed to our vision and the long-term strategy that we've laid out.

And we don't really get fazed by short-term blips in any given segment and economic fluctuations, so recently if you go back two or three years and look at our approach to the metalworking manufacturing environment in '08 and '09 there were many asking us why we weren't diversifying away from metalworking.

We struck with our strategic vision; we serviced the heck out of our customers there even though they were down and I think the story played out pretty well in terms of the share gains and growth that we're now seeing.

And we're taking very much the same approach with Government.

We're very confident long-term about our share position and the way we're delighting customers.

So you still think that in Government your net gaining share, it's kind of the base is down for everyone.

You're picking up some share.

The weakness in the base is larger than the share gain, but do you think you're still gaining share?

Yes, we do, Rob, yes.

The other question I had was, looking at the organic growth, it looks to me like if you strip out ATS and Rutland as well, because I think that just annualizes in the first month of 2Q.

It looks like the organic growth you're expecting is accelerating in your forecast from 1Q to 2Q.

My question is if I'm thinking about that the right way, and then second, is what's driving that acceleration?

It seems consistent with some of the good ISM and durables data, but just wanted to get your view on that.

Yes, Rob, overall what I'd say with respect to organic growth, we're really pleased.

We're really pleased and I think you heard David touch on it and me touch on it.

Yes, is there a piece of this that may be related to the ISM?

Possibly, but we feel really good about the way our investment programs and all the things that we've been doing over the last couple of years are translating into share gains and I think, primarily, that's what you're seeing.

Certainly, your point is right that we actually -- January becomes the anniversary of the Rutland acquisition, so as an aside, you're right there.

In general I think you're right and we would characterize it as share gains due to our investment programs.

And maybe just finally, and maybe this is what you meant by saying you'd come back with more detail on a future call about the growth strategies.

I'm just wondering if you could dimension for us how much you're spending on growth investments?

So would it compare it to like what you might have been spending a year ago, or a few years ago, so we can kind of tie this pursuit of this great land grab to something more tangible?

Yes, Rob.

Does that make sense>?

It does.

I think what you're getting at.

So first of all, as I mentioned, we wanted today to provide some more clarity around our growth strategy and the direction and the fact that it's been in place.

The tactics, the programs change over time, and we will come back to put more color and give you more clarity around the specific programs.

In terms of spend, we don't break out, for competitive reasons, we don't break out a specific number.

So I won't give you a number.

Directionally, I certainly can tell you that over the past few years, we have ramped up investment, and we've done that by design.

You heard David talk about, in his entire career this being the greatest opportunity he's seen.

The land grab that we've described.

We're very confident that those investments are paying off.

We've got a ton of metrics internally that we use to gauge, and we're also seeing it in the organic revenue growth that you described.

But directionally we are spending more on investment and we're seeing that translate into accelerated share gain.

Okay.

Thank you.

Thanks, Rob.

Matt Duncan, Stephens Company.

I guess, Erik, maybe the first question I've got is for you.

I appreciate all the detail you gave us on the growth strategy and was wondering if maybe you can layout a little bit more about where you think you are in sort of timeline of that strategy specifically with moving into manufacturing environments outside of metalworking?

How much of that opportunity have you tapped?

And then what type of customer are you focusing on there in size?

I guess the most available market share right now is probably that small customer that historically has been served by the smaller distributor.

Is that the initial focus as you move into new markets?

Just a little more detail would be great.

Sure, Matt.

I think your first question in particular gets at the heart of what's so exciting about the growth story here and why we're so confident in the $10 billion vision.

So the answer to your question is, we're very early on.

Particularly as it relates to, if you're getting at the new end markets, we're very, very early on in that lifecycle, so where we described where we're at today is we took what was a regional spot buy catalog supplier; we've now become a broad based national metalworking and MRO supplier.

But still, largely, the current state is we're largely focused on product penetration and even within product penetration, it's still largely focused within metalworking, so in terms of runway, we see plenty of runway left in our metalworking penetration strategy, point one.

Point two would be, we see lots of opportunity and runway in other product lines that I talked about on the call, and as far as the end markets go, very early stages.

So a tremendous amount of runway there, which gets us really excited, and again, that much more committed to this $10 billion vision that I described.

Okay.

You had asked another question, I'm sorry.

Yes.

As you look at those new markets you're getting into, what type of customer are you going after?

Is it that small customer that's been your bread and butter in the past and is probably the most available market share right now?

So one of the nice things about our model is we, and particularly how it's evolved in that vision that I laid out, Matt, is the ability to service different points of the market, in terms of customer size, effectively and efficiently.

So we have a really vibrant direct mail program that's been supplemented with the heavy web based marketing, our logistics and all the improvements to mscdirect.com that are a great fit for the smaller end of the market.

We also have a great fit for the larger end of the market which, by the way, is where most of the potential is, not surprisingly, between our sales force, our value added solutions, our national accounts program.

So what I tell you is, we have a good fit for both ends of the spectrum there, and I think that's what you're seeing us pursue is both ends of spectrum.

Okay.

And then last thing for me.

Talk about how M&A fits into that strategy, is it still focused on the metalworking side or are you looking at maybe buying in new end markets?

So M&A, Matt, the first thing I would say is I think you characterized it right is that M&A fits into that strategy.

We view M&A as an enabler, and as one of tools that we use to execute.

It's not an end to itself, but it's a means of achieving that vision that I talked about earlier.

It definitely fits into the strategy.

On one of the prior calls, we talked about really two types of acquisitions that we look at that fuel the strategy and the vision.

One would be what we'd refer to as a fold-in acquisition, which is primarily focused on the metalworking market, as a means of continuing our metalworking penetration.

And I'd refer you back to the two, from the past year, and American Tool and Rutland would both fit that category.

And I'll tell you that our funnel looking ahead remains very robust with respect to metalworking businesses.

The second type of acquisition is what we would refer to as a platform acquisition that we would see as a means of fueling a move into one of those adjacent product lines that we talked about.

Or potentially a move into an adjacent vertical end market that we refer to.

All right.

So when do you think we might see you make that type of acquisition?

I guess that's what I'm getting at, is sort of where does that fit in the strategy from a timing perspective?

Matt, very tough to predict timing.

All I can tell you is that our funnel remains robust and full and the funnel is inclusive of both types of acquisitions.

Okay.

Thanks for the color.

Hamzah Mazari, Credit Suisse.

Good morning.

Thank you.

The first question is just if you could provide a little more color as to how you think about your vending initiative.

What's your go to market strategy there and your install base?

Is this something you have your salespeople push your customer base on?

Or is this more of a customer, customers asking you for vending solutions?

Any color you can provide on how investors should think about your strategy with that particular sales channel.

Hamzah, sure, it's Erik.

You're hitting on, certainly in mentioning vending, one the fastest growing growth initiatives we have right now.

So I'll start out by saying vending has been a big part of our growth and we foresee it continuing as a big part of our growth.

We're seeing where we install vending big deltas in the growth rates for the customers that have a vending machine.

We're seeing very strong retention rates, and I think more importantly, high levels of customer satisfaction.

I think to get to your question, one of the reasons, one of the ingredients here as part of our secret sauce with how we bring vending to market really tracks back to the culture of the Company.

We're very much a customer-centric culture, which means that when we go out with any solution, and certainly in this case, vending.

Vending is a great tool, but it's just a tool.

And it has to be applied to the right type of customer, and to the right type of products within that customer.

So our approach is to really target the right fit for vending, and that really starts with the customer's needs and doing a profile of what their needs are.

When we do that, that's really what's driving the great performance, is beginning with the customer, and selecting the right fit.

Great.

And then my last question is just on inventory and pricing.

Is it fair to say that you're going to continue to build inventory given that you want to get ahead of cost inflation; you're seeing modest growth from your customer base?

And then on pricing, is it fair to say that -- not to expect any further price adjustments given that cost inflation is catching up this year; is that fair?

Hamzah, it's Jeff, I'll take the inventory piece and Erik will take the pricing piece.

Yes you've seen, you've seen the modest build in inventory, about 5% from the Q4 levels.

Again for, really for two reasons.

One is the growth in sales to support the volume and the anticipated volume.

The second is the fact that we're in an inflationary environment.

We've got a strong balance sheet, we have the opportunity to protect the margins and ensure our service levels so we did see an increase in Q1.

We expect another modest increase going into Q2 for those very same reasons.

Hamzah, I'll take your pricing question.

Certainly, you pointed to one factor that lead to the mid year price increase that I referenced in the prepared remarks, that being inflation, and certainly we had anticipated that.

I think the other thing I would point to with respect to pricing is the reason why with the September increase, and so far the early returns with the mid year, our pricing realization has been quite strong and I think it really speaks to the strength of the MSC value proposition right now.

So when we speak to customers, when we speak to salespeople, what comes out is that a matter of a few points in pricing in the bigger picture, really doesn't mean that much with the kind of value we're bringing to customers right now in saving them time and saving them money.

Whether that's the new and improved version of mscdirect.com, or private brands that we're bringing to market that are giving customers price value choices that they haven't seen before, or our metalworking specialists that we've referred to in the past who are on the plant floor saving customers tangible productivity savings, price becomes less of an issue.

So I think it really speak to the strength of the value proposition.

To your last point about a future increase, I wouldn't rule anything out.

I think a lot of it would be a function of what happens over the course of the next several months on the commodities inflation side so I wouldn't rule anything out.

I appreciate that.

Thank you.

And Happy New Year to you guys.

Ryan Merkel, William Blair.

Thanks, a couple questions from me.

First, can you talk about sales trends in December?

And were there plant shutdowns or were they less than expected?

How did the month finish and then maybe where the strength was by end market?

Sure.

Ryan, it's Erik.

December, I'm looking for December.

Overall, I would tell you the December average daily sales growth which we posted on the site was 15.4%.

We're pleased, we're very pleased with what we're seeing.

We referred earlier to the continued strength of our organic growth, so we think it's reflective of the share gains that are being driven from our investment program.

In terms of color on the growth, pretty much consistent with what we already described.

That it's durable manufacturing that's been driving it.

Anything else, oh, you asked about plant shut downs as well.

Right.

I would say, so if we look back over the past few years, we told you that during the downturn there were excessive shut downs, and then on the rebound there were minimal shut downs.

We think it's pretty much returned to a normal steady state.

Okay.

Then as I look at the components of growth, the core business is far outgrowing large accounts.

What explains this and should we expect this to continue?

Ryan, the biggest thing that we would point to there, if you're looking at the decomposition is Government is included in large accounts, so that's the biggest drag on that sector of business.

I'd refer back to the comments that I made earlier, I think it was to Rob, about our commitment to Government to staying the course and knowing that there will be a payoff there.

But that's really what's driving it.

Okay.

That makes sense.

Then last question, on the gross margin guidance I think 46.5% is a bit better than you were thinking heading into the quarter.

I'm wondering was it the mid year price increase that drove some of the upside or is there something else going on?

Yes.

Ryan, this is Jeff, you know, again, gross margin is influenced by a series of the headwinds and tail winds.

Certainly, the mid-year pricing increases is one of the favorable factors associated with that.

But the strategic programs that we continue to push like private brand, global sourcing, pricing optimization, all play a role into it.

So versus where we guided you to last quarter, I guess we're 10 basis points above the top end of that range.

Great.

Well thank you for the color.

Adam Uhlman, Cleveland Research.

Erik, I guess I have to ask -- as the Company grows to $10 billion in revenues, what kind of infrastructure investment would be necessary, because for some time we've talked about just the four DCs will do.

And somewhat related to that, how do you think about the margin profile of the Company when it's so much bigger?

Adam, those are great questions.

Let me go, maybe, in reverse order and start with the margin profile.

I think what I would do there is evidence here, you see, so the first thing I'd say is the strategy that we laid out here hopefully one of the things that you took away is there's nothing new.

It's been ingrained in this company for a long time.

So you've seen us marching along the path here executing this strategy while expanding operating margins.

I think if we look to the future on the margin profile, we don't see a natural ceiling on margins and we don't see a reason why over long periods of time those couldn't be expanded.

And again, I'd say the proof is in the pudding there.

So even as we penetrate a product line, we're doing it today in metalworking, and you're seeing we're doing that while expanding operating margins.

So we feel very good about the strategic plan, and about our ability to expand margins.

Your other question was around infrastructure.

And I'd start out by saying, one of the exciting things about being part of this ride and part of this vision is that with the kind of growth rates we've experienced, every couple of years we need to continually, and have been taking a look and a pressure test at all sorts of things from infrastructure to our operating process because every few years the Company is growing by leaps and bounds.

So with respect to infrastructure, certainly it's going to be an area that we're going to have to look at.

I'll give you one as a for instance, and you had mentioned it.

Our logistics network our four CFCs have been -- we view our logistics network as a real source of competitive advantage for the Company.

That's both in terms of the customer service that we're able to bring to bear with the next day delivery in APM and the accuracy.

It's also been a source of competitive advantage in terms of productivity.

We really like our centralized model.

We think it gives us a lot of leverage and scale and going back to that margin discussion, it's one of the reason why we feel so good about our ability to expand margins over time.

The four centers we have remain expandable and scalable as we've always described.

That said, the kind of continued high growth that we're seeing now and we anticipate that's going to come will put a strain on our network that's large enough that will lead to the need for a fifth CFC.

We are, right now, in the early stages of planning that's really -- we join this up and marry it with our strategic planning cycle.

So as we build out a more robust plan and timelines and so forth, we would return to you with more color.

So did I answer your question?

Yes.

Yes you did.

That's helpful.

Thanks and then, the bad debt expense went up a bit.

It was maybe twice as high as it normally is.

Is that a good run rate going forward or something unusual there?

Yes, Adam, the provision for, for bad debt was a bit higher than we anticipated for, for the quarter.

I think about $800,000 over the prior year, but I assure you this is really isolated primarily to two accounts.

Really not indicative of any trend we're seeing with the entire portfolio.

Both accounts are adequately reserved.

It's something we pay a lot of attention to and take seriously but we truly believe it was two isolated incidents.

Okay.

Good.

And then just one clarification, Erik you had mentioned the new website launch.

Is that out there yet or is that still in the works?

So Adam, overall what I characterized, yes when I talked about the web, let me take a step back.

We're really pleased with progress on the web and we've characterized our investments there as a big means -- part of our value proposition is we want to save customers time.

We want to help them streamline their transaction and their procurement process.

Mscdirect.com is doing that.

Our investments in the web are across a number of areas, some of which customers have already seen benefit from; some of which are in the works.

So for instance, what customers have already seen is a new search engine, an ongoing process to improve our product information and make it more searchable and more robust; much of that is out there.

Then there's other components like the fundamental underlying transactional engine that's in the process now of being rolled out.

That, specifically, is not yet out to the broad market.

It's being rolled out in beta form and will be coming.

Think of it as an iterative series of steps to improve the experience.

Great.

Thank you.

David Manthey, Robert W.

Baird.

Hi, guys.

Happy New Year.

Could you tell us what percentage of your revenues are from customers that have one or more of your inventory solutions; VMI, CMI, vending, et cetera?

David, we don't break out the percentage.

The color there that I would tell you in terms of our solutions is that it's growing rapidly.

I mean, it's still, in the scheme of things, relatively small, but it's growing rapidly.

Okay.

And then second, the non-OEM ADS on a quarterly basis seemed to have troughed and when I looked back it was the first quarter of fiscal '11.

It was the first quarter you mentioned the government seeing some significant softness.

Can you at least talk about the non-OEM business on a monthly basis as we got towards year-end 2011?

Did it continue to flatten out?

Did it improve slightly against easier comps?

Can you just give us an idea of roughly what the trend was in non-OEM at the end of the year?

David, the first thing I'll say is that, you hit on the right point, which is Government.

So if you're looking at that non-manufacturing portion of our business, the biggest thing that's pulling down the growth rate is Government.

So with respect to Government, you're right, we actually, during -- so we're forecasting in our Q2, we're forecasting softness in Government sales, but we actually do begin to start to lap up against weaker comps.

So for Q2, our forecast of weaker Government sales implies roughly flat growth with prior year because we are seeing weaker comps.

Did I answer your question?

Yes.

So would it be safe to assume then that as that flattens out -- I think you said this quarter it was down, I think you mentioned double digits -- so as that flattens out, that would lead to an uptick, a continued uptick in non-OEM overall, sort of on a month to month sequential basis.

Yes.

All else being equal, that's the case.

Okay.

But David, this is Shelley, we need to correct you, we didn't say down double digits.

Okay.

But down?

But down.

Down.

Okay.

Fair enough.

Thanks Shelly.

Thanks a lot.

Sam Darkatsh, Raymond James.

Good morning.

David, Erik, Jeff, Shelly, how are you?

Good morning.

Most of my questions have been asked and answered.

Just a few follow-ups here.

I noticed your active customer count was up on a year-on-year basis.

That's got to be the first time in years; I think back in '08 or '07 might have been the last time that happened.

Is that a function of the ATS acquisition or is that now a point where that's going to level out and start to grow?

If so, could you talk about the effects of that, either on customer acquisition costs, on mix, on ticket, any of that stuff?

Sure.

Sam, it's Erik.

Active customer count.

Yes you're right, I think if you look back over the past few quarters, it's pretty much been stable, and I think what you're seeing is a function of, in part, economy.

In part certainly some actions we're taking in the marketing team.

We're focused heavily on retention.

Overall, I tell you that, and have said this on the last few calls, we're not particularly -- we weren't that concerned when we saw the active customer count going down as we've said to you, and we're not that elated seeing it up slightly.

It really tracks back to the stage we're at in the strategy, so when we talked about our growth plans now, the heavy emphasis with where we're at along that time-tested vision is heavy penetration, product line penetration focused on existing accounts.

So certainly we're bringing in new accounts.

Does it matter somewhat, but it's not as big an issue, a metric as it was years back, and quite frankly, it will be a big metric once again, in years to come as we move towards new customer end market expansion.

But for now it's not a hugely important metric.

To answer your question, I would not really, would not attribute much at all to American Tool.

The American Tool acquisition was great in terms of fueling our metalworking strategy, brought us great people.

Very small in terms of new accounts.

The real opportunity there is account penetration and leveraging the great technical expertise we got.

Thank you for that.

And then the next question would be a follow-up, Erik, on your answer with respect to the website.

The growth from -- the growth gap differential between your growth from your website sales and your overall Company growth has been about 4 or 5 percentage points for the past four, five, six quarters in a row.

Do you anticipate that gap now accelerating based on the investments that you're making?

Or are the investments you're making more to keep that gap pretty static where it's at now?

Sam, you know, what I tell you internally we have -- we're putting a lot of focus on the web.

We think it's a very important part of our value proposition, and internally, we have some -- I won't yet share publicly -- but some aggressive stretch goals that will require us to do an awful lot on the web.

So our philosophy and -- behind the investments is not to stay where we're at, it's to accelerate our web performance.

Last question.

Last quarter you bought back a lot of stock and this quarter you did not.

I noticed that your share repurchase, with few exceptions, tend to be overweighted in the fourth quarter, fourth fiscal quarter.

Is that coincidental or that strategic?

I was wondering whether we should read into anything with respect to the lack of share repurchase this quarter.

No.

I don't think you should, Sam, read anything into that.

You know, over the years, we've had sort of a balanced approach to creating value for the shareholders.

We've done the periodic stock buybacks.

We've done occasional special dividends, and there hasn't been anything related to the calendar year timing associated with any of those.

Of course, we also look for the right acquisitions and the best use of our cash to increase the shareholder value.

Okay.

Thank you much.

Thanks Sam.

John Inch, BoA.

Thanks.

Good morning, everyone.

Can you just remind us where we stand with respect to the impact of rebates in the quarter and maybe sort of (inaudible - technical difficulty) for the year versus last year and how this typically plays out?

Just a little more color on that front?

Sure.

You know, last year, this is Jeff.

Last year, obviously, was a very strong year for us in terms of the rebate levels associated with the calendar year purchases in the prior year.

I would say this year we're back up to -- we're back down to normalized rebate levels, all of which has been baked into our guidance and our forecasts going out.

Okay.

So on a incremental basis, last year was more of an incremental cost opportunity right?

And this year is just steady as she goes type of thing, is that the way to think of it.

I think that's fair, yes.

You called out, Jeff, the $1.6 million of sequential expected year-over-year costs associated with growth and other investments.

I don't think you called that out for the prior quarter.

What are you thinking this incremental number is going to be versus last year for fiscal '12 roughly?

Is it like the 1.6 times 4 or what?

No.

As Erik explained before, we are in a high investment spending mode and we've been increasing year-over-year, but that's one of the categories that we haven't disclosed separately.

Jeff, is there any way to put it into a context?

I mean, 1.6, I mean, you called out the number, but the 1.6 doesn't -- I just don't know what you -- what are you supposed to do with that?

Is that up a lot more in percentage terms versus last year or up half the rate or what does that mean?

What I will say, you know, the 1.6, as I described, was sort of in all other category, it was increased in investment spending and other areas offset by productivity, so essentially an all other category.

I don't think it's -- I don't think there's anything you should read into it in terms of the levels of investment spending other than the fact that we've been repetitively saying that this -- last year we increased our investment spending.

This year we're increasing our investment spending.

There's great opportunity in the marketplace, and we're doing it very wisely.

Say, John, Shelley.

The reason we gave you a bunch of numbers there was simply to reconcile the OpEx and guidance for Q2 versus Q1 actual spending.

And that's why we had all the various pieces in there.

No, I think that makes sense.

Let me just flip gears to one more subject.

It's a matter of much debate that somehow this bonus depreciation has pulled forward, if you will, on the part of manufacturing in the United States spending levels or however you want to characterize it.

I realize you guys -- it's maybe very premature.

But maybe, Erik, you've called out the fact that you've been in touch with a lot of customers, you guys clearly have -- you're kind of a bent manufacturing coincident bellwether.

What are your customers saying on that front?

I realize it's very early in January.

Obviously one of the big concerns here, and it's not an MSC concern, it's just simply that bonus depreciation really has pulled forward, activity levels and that January and February are going to be sort of more of an air pocket than perhaps people realize.

What are your thoughts on that front because you have given forward guidance, what are you thinking?

John, interesting point.

To be honest with you, we've not heard and I personally have not heard much of anything about it from customers, so I, at this point you might be right, but we don't see that there was some major pull forward into December if that's where you're going.

We don't see it.

I'm not hearing about it, so I think in general we're hearing pretty solid things in terms of true demand and activity levels and orders, incoming orders from our customers.

Right.

So based on everything you've seen, I realize again very early in January, there's no real reason to believe that maybe December, November/December were somewhat unusual in terms of their performance?

From everything we see, no.

No reason to believe that.

I could be proven wrong but from everything with our radar system, that's not what we're seeing.

Hi, John, it's David.

Yes, David.

How you doing?

I guess what we're seeing in the macro that's helpful from our customers is an underlying air of strength.

Certainly some caution as we've discussed about visibility for the future, but in particular, the continued focus on basically doing more with less.

Keeping inventories very lean, and that coupled with what we see in some of the underlying ISM metrics.

One other thing that's really encouraging about the ISM -- the latest reading -- is that, not only do you have the total ISM reading, but the underlying metrics within the indicators on things like customers' inventory would indicate that customers' inventory is too low.

I think all of that bodes well for what you're saying about questioning was December an anomaly, and might it return to lower levels?

We're not seeing any of that right now and any of the forward indicators that we're seeing give us reason for being encouraged.

Yes.

Because you would have otherwise seen customer inventories spike, which [I don't think you can sustain].

That's right.

We think so and anything we see on the manufacturing side feels like manufacturers are building a bit more for future demand as -- and being cautious in that regard, as opposed to building something that people could get burned by as was the case in '08.

So from everything that we can tell right now, ex some unusual event coming out of Europe which could be a fly in all of our ointment, it's feeling pretty solid.

Yes.

Thanks, David.

Thanks, guys.

Brent Rakers, Morgan Keegan.

Good morning.

Good afternoon.

I think first you've talked a lot about the mid-year price increase and you were gracious enough to give us the big book increase this year.

Would you maybe help us frame the mid-year price increase level?

Yes.

Brent, this is Erik.

As you know, we don't break out for competitive reasons, we don't break out our mid year separately.

The color that I'll give, as I said earlier, early signs are very good in terms of the realization that we're getting from the increase and, again, I think it really does track back to the strength of our value proposition particularly at this point in the economic cycle.

Okay.

And then maybe a follow-up to that in the terms of the gross margin implications from that.

You have been, you've been behind or you've been ahead of vendor price increases at various times.

It felt like the mid-year one to me was catching up for some, some, maybe some summer, August, kind of September price increases; is that correct?

And does that imply that the gross margins can maybe be sustained at this Q2 guidance level going forward?

So I'll start, and then, and then turn it to Jeff in terms of the margin guidance.

In terms of the environment, Brent, what I would say is between the September increase and the mid-year increase, those are really reflective of what we've been seeing building over the course of the past year on the cost side, so the costs have been building for quite a while.

And I would say the last two increases are both reflective of what we've been seeing, and again, we feel very confident in being able to get out ahead of it given the strength of how our model is delivering.

And Brent, as far as the gross margin going out, we provided the guidance for this quarter.

Gave you some indication of what we thought the read-throughs would be.

Gross margin is always a series of the headwinds and the tail winds.

Of course, we're facing the purchase cost catch up challenges this year.

We've got the strategic programs, the pricing, and so forth offsetting that.

I think the normal trend you would see is that gross margins tend to decline a bit throughout the year after the initial price increases.

I would say we'd anticipate Q3, based on what I told you before, to be in a similar range to Q2, but then would expect somewhat of a decline in Q4 following our typical pattern.

And I guess one last question on the gross margin.

It seems like that during the last cyclical recovery when you went through this kind of pro-product inflation environment, that your gross margin percentage actually was able to receive some sort of permanent benefit from this throughout that time.

It doesn't necessarily -- it seems more like a timing issue this time more than anything.

Is that a correct analysis or could you have thoughts maybe why this would be different than maybe the last cyclical recovery?

Yes.

Brent, it's Erik.

I don't think there's much different at all.

I think one thing you've got to remember that Jeff talked about in the opening remarks is the American Tool dilution of roughly 55 basis points.

If you were to back that out, I think you do see some pretty significant expansion and you see that the benefits of -- between pricing and our strategic programs outweighing what's happening on the headwinds front with cost.

Okay.

Great.

Thank you very much.

(Operator Instructions) Bhupender Bohra, Jefferies.

Hi, good morning, I'm sitting in for Scott Graham at Jefferies.

Most of my questions have been answered.

Just one question on your long-term strategy.

When you say your sales target of $10 billion over the long-term.

I just wanted to make sure like, and you guys mentioned M&A being an enabler.

Do we see the balance sheet -- debt-to-leverage ratios and all these ratios to remain as what we see today on the balance sheet or anything will change as we approach that $10 billion range?

You know what, it's David.

Let me jump in and just -- we talked a lot about our growth strategy and how we see our future.

Where, given the landscape and what we see for where the industry is headed, what's happening with the customers and what their demands are et cetera.

Erik mentioned it earlier, we've threaded it as kind of a theme throughout about really seeing this as the greatest opportunity that I've seen in my career, that's almost 36, 37 years long, or young, as I'd like to think.

We've never, in all the opportunities that I've seen throughout my career, and the opportunities that our Company's taken advantage of, we've never been better positioned than we are now.

And that, coupled with my tremendous confidence in our leadership team, our incredible team of associates and our model and how we're positioned to capitalize.

I think, being more specific, certainly you'll see things change in the Company over time.

Erik had talked about just how robust our platform is and how strong our balance sheet, and what we expect to produce for long-term results.

We're confident in our ability to continue to maintain delivering those kind of results, and given the strength of our balance sheet, certainly you will see, as you've seen historically, periods where we'll lever up the business more.

Where we will take on more debt.

We're in a fortunate position right now of really having an under-leveraged and completely clean balance sheet, but as we see opportunities, and as we move along this march towards $10 billion, there will be times where we lever up to capitalize on those opportunities to help fuel our growth.

Historically, what you've seen is that the tremendous cash generation ability that we have in our model pays down that debt.

Pays it down to some degree and then we continue to repeat that cycle.

We'll continue to do that over time, and you'll continue to see us lever in a way that we're comfortable, but certainly capitalizing on the tremendous strength of our model, and in particular, the flexibility that our balance sheet gives us to fuel our growth story.

Okay.

Just a follow-on on that, do you guys have internally a comfortable level of leverage ratio where you would like to be?

We don't.

We do internally, certainly.

We're obviously well, well below that and have been in the past.

We've got a lot of free board to lever to higher levels than anything you've seen us do in the past.

But it's not something that we share.

Okay.

Thanks a lot.

Holden Lewis, BB&T.

Thank you.

Good afternoon.

I think last quarter you had made mention of having sort of deferred some spending into Q1.

I just wanted to get a sense of, did all that play out kind of like you expected; if you continued to defer some of your spending at this point?

Where do we sit with that event?

Yes.

Holden, it's Jeff.

Yes, we made mention of the fact that there was some deferred spending from Q4 that would leak over into Q1 and that, in fact, happened.

I would say some of that is spilling over into Q2 as well, but for the most part we're caught up to the appropriate levels now.

Or will be through Q2.

Okay.

So you've seen whatever caused you to sort of tap the brakes on that, those risks, threats or issues have sort of passed and you're back fully on path to sort of -- on your growth initiatives.

That's right, Holden.

Okay.

Thank you.

Derek Jose, Longbow Research.

Hi, guys.

I just had a quick question on your field associate hiring.

I know this is a key part of your growth strategy.

I'm just wondering; year-over-year you've grown about 7% in terms of field associates.

I was wondering if you had -- what you had been seeing out in terms of hiring, who you're able to hire and if you've had to make any changes to compensation or benefits in this case.

Good morning, it's Erik.

Overall, I'll start by saying you're hitting on one of the, we talked about earlier, the key growth enablers for the Company and one of the key things that where we're at in this vision is building out our sales force.

We're going to continue to build out our sales force.

I would tell you that we see a very long runway in terms of hiring, and in terms of adjustments, not really.

I think if what you're talking about is if you look over the last quarter or so the net increase in hiring has been slightly lower.

Tough to read too much into any one quarter.

We're very particular in making sure that not only are we adding to the sales force, but that we're bringing in the right kind of person.

Somebody who fits our model; fits our culture.

We put a lot of emphasis on culture so we're getting the right people and the runway for those type of people is quite long.

So overall, we're highly confident that our expansion plan will continue and that the plan to date is working.

Okay.

What I meant was, are you able to hire -- are you able to get better people right now versus previously, or are you able to get more experienced people who, say, would be able to ramp up their sales faster?

Yes.

One of the things that we've talked about since, really since the start of the downturn is that we've seen the -- and David described this as part of the land grab of the smaller regional distributors who employ some of the really strong salespeople in our industry historically had a tight attachment to those businesses.

And we saw that the downturn really broke a lot of the bonds that were there, and as a result, we've been, since the downturn, and this continues, hiring really top notch industry talent that in years past we would not have been able to recruit.

And we see that runway as long, and it's continuing.

Okay.

And lastly, are you winning the battle against some of your larger peers in terms of this hiring?

Interesting.

I think the battle is -- what we've talked about -- the battle ground is really between us and the local distributors, so we don't necessarily see it as a battle between the large guys when it comes to recruiting, when it comes to share gains, due to the fragmented nature of our market.

Our primary competition is the local distributor and the same would go for recruiting.

Okay.

Thank you.

This concludes our question-and-answer session.

I would now like to turn the conference back over to management for any closing remarks.

Okay.

Thank you everyone.

We appreciate your attention and interest today.

We look forward to speaking to you again on the next quarter.

Thank you.

The conference is now concluded.

Thank you for attending today's presentation.

You may now disconnect.