MSC Industrial Direct Co Inc (MSM) 2012 Q3 法說會逐字稿

Good morning, everyone, and welcome to the MSC Industrial Direct 3Q 2012 conference call.

All participants will be in a listen-only mode.

(Operator Instructions).

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

(Operator Instructions).

Please note today's event is being recorded.

At this time, I would like to turn the conference call over to Ms. Alex Tramont.

Ms. Tramont, please go ahead.

Thank you and good morning everyone.

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

An online archive of this broadcast will be available one hour after the conclusion of the call and available for one month on the home page of the 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 laws, including guidance about expected future results, expectations regarding the Company's ability to gain market share, and expected benefits of 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 and 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 like now to introduce MSC Industrial Direct's Chief Executive Officer, David Sandler.

Thanks, Alex.

Good morning, and thanks for joining us today.

With me are 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.

I'll provide some perspective on our strategy.

Erik will add details about our investments in the current landscape environment, and Jeff will provide details on Q3 financial performance and Q4 guidance.

Let me take you back a bit in time.

When we experienced a downturn in '09, I talked about it as the biggest land-grab opportunity in my many years in distribution.

At that time, I saw that we had a long runway to take share from weakened, small regional competitors due to their inability to fund investment spending and lack of a balance sheet to support working capital on the rebound.

As it proved out, we were correct and did capitalize on that opportunity.

Unlike slowdowns and rebounds where share was gained and that the market returned to normalcy, we believe this time is different.

I've had so many conversations with you over the years about the reason for the slow but inexorable shift of market share to larger, well-capitalized distributors from the locals.

We've talked about the stickiness of relationships and the quality of the technical abilities of these companies.

The top 50 companies in 1995 represented about 14% of the MRO market.

The top 50 now control 30% of the MRO market.

Rapid share gains usually occur during a slowdown in recovery and then is moderated through the in-between years.

We believe that this is no longer the case.

We think that the land-grab continues and is actually increasing in speed.

The difference is technology and value-added solutions.

The combination of digital information, eCommerce, vending in support of technology is finally tilting the value equation towards those with the ability to invest.

This period is one during which winners will widen the gap and lock in barriers of entry and competitive advantage and take major market share.

To capitalize on this quickly changing environment and be one of the winners, it requires us to make significant investments in the business.

Our enhanced investment program was initiated during the Great Recession of a few years ago and has grown due to our need for new infrastructure build such as our new CSC in North Carolina, our fifth CSC, and to fund the increasing demand for vending and world-class eCommerce solutions.

We now face the challenge caused by the conflict between a slowing growth environment with our investment needs.

We could cut back significantly and make adjustments in the business that could endanger our future success.

As CEO, I have chosen a more balanced position.

While we will moderate spending in many areas of the business in response to moderating growth, we will nonetheless push ahead with several of our investment programs that are so critical to our future.

So what does that mean?

It means that, if we are right and the results set this foundation for tremendously accretive growth over the long term, then the short-term moderation in earnings growth rates will be well worth it.

At reduced sales growth rates similar to Q4, we can expect earnings growth rates will be slower than historical levels and incremental margins, while still producing earnings growth, will also decrease from previous levels.

From our analysis of projected spending in FY '13, based on our expected spending on growth and infrastructure investments, then the lower earnings and incremental margin growth rates could persist through the year.

Of course, should sales growth return to the mid teens, then earnings growth and incremental margin will grow and improve quickly.

Erik will speak in more detail about the impact of the fee change in the landscape.

At this point, I'd like to provide guidance for fiscal Q4.

Taking into account current market conditions, we expect revenues to be between $630 million and $642 million, and fully diluted earnings per share to be between $1.05 and $1.09.

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

Thank you, David.

As you heard from David, despite a moderating growth environment, we firmly believe that the land grab continues as industry consolidation is still in its early stages.

Against this backdrop, we are investing in our future in order to achieve the long-term targets that we've laid out on the last few calls -- our ultimate vision of $10 billion and our intermediate growth goal of $4 billion by the year 2016, implying a 15% compound annual growth rate.

We have a convergence of initiatives that drive and support our long-term growth strategy.

They are highly accretive to earnings over a period of years but put some temporary pressure on contribution margins, particularly in a moderating revenue growth environment like the one we are now seeing.

Vending and eCommerce are two examples of how we're using technology to provide value-add to our customers, to firmly entrench MSC within our key accounts, and to capitalize on the consolidation trends that David just described.

On the last call, I talked about vending and how it's contributing significantly to our growth, adding nearly 4 points to our recent growth rates.

While our vending program overall is contributing to earnings growth, it's dilutive to our growth in operating margin percentages.

This is because account level profitability varies significantly based on how long the solution has been in place.

Vending affects margins early on in the lifecycle of an installation as we incur startup, selling, and implementation expenses, along with a capital outlay for the machine itself that results in depreciation expense.

Over time, the more mature classes of vending customers become highly profitable as we see a large growth delta over Company average, we leverage the early startup expenses across the larger revenue base, and we reap the benefits of extremely high account retention rates.

Given that we are still in the early stages of the vending program, we are driving to accelerate the program further.

As a result, our ratio of new account implementations to total implementations is high.

That pulls down total program profitability in the short-term.

In fact, the faster the program accelerates, the more pressure we see on operating margins in the near term as that ratio increases.

eCommerce is another large growth initiative that we are undertaking.

As we've described on past calls, we've made significant investments across a number of areas, including a new search function, improvements to our product information, and a new transactional platform, which will launch this fall in its entirety.

We are seeing eCommerce as a percentage of sales increasing and we're thrilled with early results.

We'll be continuing to invest and we're confident that we'll continue to see strong returns.

In addition to our organic growth initiatives, we are making some infrastructure investments that should show high returns over a period of years, but are dilutive to earnings in the near term.

The recently announced co-location of our CSC in North Carolina is a good example.

And CSC, by the way, is short for customer support center, which is typically called headquarters by most companies.

We are excited about the opportunities that our co-location strategy will provide.

As part of our planning, we determined the physical space is fast approaching capacity at our Melville headquarters.

To address this, we evaluated a number of options to expand capacity with a focus on flexibility to cost-effectively grow our business, to attract the industry's best talent, and achieve a high return on investment.

Our recently announced co-location plan allows us to achieve these goals.

Over the long-term, it's expected that the cost of the further expanding the company in Davidson, North Carolina, will be substantially less than doing so in New York.

Our investment is further supported by other incentives provided by the state of North Carolina, the city of Davidson, and Mecklenburg county.

At the same time, we are able to retain our strong and talent-rich foundation right here on Long Island.

Additionally, as I mentioned on the last call, our growth plan will require us to add a new customer fulfillment center in order to support our world-class service model while we grow.

We remain in the planning stage and will report back once our plan is fully developed.

Our fifth CFC, or distribution center, is yet another investment that yields a high ROI in the long run as we can more efficiently manage and service our volume, but will have a dilutive effect when it first opens.

Turning now to the quarter, I will begin with the current environment.

We're generally experiencing solid business conditions within our core customer base.

Customers have, though, voiced concern about the overhang of the upcoming election and the impact of the turmoil in Europe.

All of that is translating into solid activity levels, but we have seen a leveling off for moderation in our customers' order backlogs and, hence, their purchases from us, resulting in lower growth rates as we move into Q4.

The ISM readings throughout the third quarter demonstrated what we are experiencing and other manufacturing reports have indicated a slowdown in growth after the rapid acceleration we experienced earlier this year.

That said, we continue to take share as the May sales numbers indicate.

Q3 revenues came in at 15% growth, driven by manufacturing which grew at about 18%.

Growth in the Non-Manufacturing segment was approximately 7%, impacted by softness in government, as we expected, due, once again, to the tight spending environment across both federal and state entities.

Q3 government average daily sales were, again, about as expected, up from Q2 and slightly down relative to prior year.

Looking ahead to Q4, we see growth continuing, but at more moderate levels.

The midpoint of our guidance implies a 10.5% growth in average daily sales.

Our forecast assumes continued but moderating growth in manufacturing and roughly flat government revenues and, as a point of reference, year-to-date government business represents approximately 9% of overall sales.

Finally, our Q3 sales force headcount came in at 1101 associates and we anticipate the Q4 number to be roughly flat with Q3.

This is one of several areas in which we are moderating our spending in response to the slowdown in growth rates, allowing us to press ahead on the investment programs that David and I described earlier, while still producing earnings growth.

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

Thanks, Erik.

Overall, we are pleased with our financial performance for the third quarter.

Compared with the same period last year, sales grew 15% and earnings per share grew 13%.

Our sales were within the guidance range.

However, in the early part of the third quarter, we began to see our sales growth trend slightly lower, and this trend continued throughout the quarter and into June.

Nonetheless, we continued to experience growth from our investment programs during this land-grab environment.

Of the 15% quarterly sales growth year-over-year.

About 4 points came from customers within our vending program and approximately 4 points came from our recent acquisitions.

The remaining growth came from other volume and pricing.

As I've mentioned on previous earnings calls, the growth related to our vending program is measured by the total revenue growth in accounts with vending.

It is an important component of our investment strategy and is expected to continue to fuel growth in the future.

Our gross margin for the quarter was 45.7%, down approximately 160 basis points in Q3 versus the same period in the prior year but in line with our expectations.

As you know, there are a series of headwinds and tailwinds affecting gross margin, but the 160 basis point decline from last year was driven primarily by about 70 basis points of dilution from the two ATS acquisitions and about 30 points of dilution related to vending program gross margin.

I should also point out that gross margin for Q3 of last year was somewhat of an anomaly due to the favorability of price increases taken ahead of product cost catch up, as well as increased rebate income.

Our operating margin was 18.1% in Q3, and incremental margin was 16%.

Our incremental margin was affected by the outstanding gross margins of Q3 of last year, making for difficult comps, but we are entering a period of time where we are expecting to see lower incremental margins.

The tax provision for Q3 came in at 36.7%, slightly lower than expectations because of favorable state audit results.

Our EPS was $1.10 for the quarter, and this came in right in line with our expectations.

We were able to achieve this while continuing to invest in growth during this moderate sales growth environment.

Q3 balance sheet metrics remain strong.

DSOs were 45 days, approximately the same as the prior quarter, and inventory turns were 3.37, down very slightly from Q2 levels.

Turning now to cash flow, cash flow conversion was strong.

We converted approximately 100% of our net income into cash flow from operations in Q3, and we had approximately $111 million in cash and cash equivalents at quarter end.

Our current cash position stands at $142 million and we ended the quarter with virtually no long-term debt.

We also used approximately $44 million of our cash to purchase 616,000 shares of our stock in the open market during Q3.

In regard to capital expenditures, through the first three quarters of FY '12, our CapEx was $28.8 million.

It's expected to accelerate in Q4, primarily driven by our CSC co-location and the continuing investments in the vending program.

As Erik mentioned, for many reasons, we are excited about our CSC co-location.

We provided a good deal of information regarding the financial impact and benefits in our press release last week.

In addition to the capital outlay, we do anticipate incurring one-time relocation costs that will run through the P&L primarily in fiscal years 2013 and 2014.

The amount and timing of these expenses will depend upon how many associates choose to relocate and when.

We currently estimate the impact to be approximately $7 million to $10 million pretax over the course of two years.

We will be capturing these expenses separately and plan to provide the impact of these one-time costs on a quarterly basis.

Before I get to guidance for Q4, I'd like to remind you that FY '12 is a 53-week year for MSC and our fiscal fourth quarter has an additional week.

Our year-end date is September 1, 2012.

So now turning to our guidance for Q4, our anticipated sales growth, based on average daily sales, is expected to be approximately 10.5%, reflecting the moderate growth environment that Erik described and the fact that we will anniversary the ATS East acquisition in the middle of July.

The overall sales level in this guidance at the midpoint indicates growth of 19.3% and reflects the 53rd week and the typical seasonal pattern that occurs in our business.

Sales are generally lower due to temporary shutdowns in our manufacturing customer base and we experience product mix changes.

We are expecting the normal decline in gross margin in Q4 to hold true again this year, due to the typical seasonal factors, primarily driven by product mix.

As a result, we currently expect gross margin for Q4 to be in the range of 45.1%, plus or minus 20 basis points.

This also takes into consideration the dilution from recent acquisitions as well as sales mix, purchase cost catch-up, and the impact from vending program growth.

It also assumes the benefit from moderate pricing actions taken in the quarter.

In Q4, OpEx is projected to be 28.3% of sales, down 10 basis points from Q4 of last year.

As compared to Q3 on an absolute basis, we expect Q4 operating expenses will increase at the midpoint of guidance by approximately $11 million.

The vast majority of the increase is driven by the impact of the 53rd week.

As Erik mentioned, we are taking some actions to slow down the growth in operating expense, but we will continue to invest in important land-grab initiatives such as vending.

Our read-through or incremental margin for the fourth quarter is expected to be about 13%.

As we've always said, read-throughs are a function of revenue trajectory, gross margin, and OpEx and investment spend.

In Q4, we see revenue growth moderating and gross margin pressured a bit for the reasons I mentioned.

And on the OpEx side, we continued to invest in the programs David and Erik described that are critical to our future.

Also in Q4, we need to ensure that we have volume-sensitive positions filled and in place for the normal seasonal uptick in our fiscal first quarter.

We are also taking responsible actions that will moderate our expense growth in a way that will not impact delivering on our strategy.

This Q4 incremental margin is lower than we've seen in the recent past, but is more typical of what we currently expect to see over the next several quarters.

This means that we expect to see earnings grow, but if revenue growth continues to moderate, earnings growth will not be at historical rates and not in excess of revenue growth.

With our current plan, we feel we would need revenue growth into the mid teens to expand operating margins.

Our longer-term plan to eventually expand operating margins, however, has not changed.

The final data point I'd like to provide a guidance is that we expect the Q4 tax rate to be about 36.8%, based upon anticipated total year effective tax rate of 37.3%.

Thanks.

Now, I'll turn it back to David for the wrap-up.

Thanks, Jeff.

In conclusion, we believe that the consolidation of the industrial distribution marketplace is gaining momentum.

Certainly, the time when the small and regional distributors were able to hold on to customers purely through long-term relationships, lower prices, and technical savvy is beginning to come to an end.

The long-term winners will be those distributors who can also invest in the technology, eCommerce solutions, infrastructure, and all the other value-added programs that customers are demanding.

We intend to be one of those winners and have chosen to moderate but continue our investment program in the face of slowing revenue growth.

Although this means somewhat slower earnings growth for a time, we will return to historic earnings growth rates as revenue growth returns to higher levels.

We remain very excited about our future.

I'll take this opportunity to thank our outstanding team of associates whose efforts, dedication and focus underpin my high level of confidence in our long-term success.

Thanks, all, and I'll now open it up for Q&A.

(Operator Instructions).

Robert Barry, UBS.

Hi, guys.

Good morning.

Wanted to first touch on pricing.

It sounds like you took a small price increase in the quarter.

Can you tell us how much pricing contributed in 3Q and what your assumption is for it in 4Q?

Sure, Rob.

It's Erik.

Yes, as Jeff mentioned, we took what we would consider moderate pricing action in this quarter; that's in Q4.

For competitive reasons, we're not going to go into any detail.

You could expect, as Jeff described, in conjunction with our big book along the lines of our usual increase upcoming, that would account for the uptick in gross margin we would plan to see in Q1.

We'll give you more color, as we usually do, on our big book increase next quarter.

Okay.

Was it about 3% in this third quarter?

I think that's about where it was tracking the last couple of quarters.

Yes, we're not -- sorry, but we don't break out the mid-years.

Okay.

Then I guess I wanted to see if you could unpack a little bit more your outlook for the contribution margins staying, I think you said, at around this 13% level that you expect in Q4.

It sounds like it's a combination of getting more aggressive with some of the investment spending, but also contemplating some slowdown in the top line.

I was wondering if you could just maybe dimension that and also put it in perspective of what we might expect on the gross margin line.

I'll take that, Robert.

It's Jeff.

As we head into FY '13, it's difficult to predict the economy, the impact on the revenues and so forth.

What we tried to give you was a sense of the read-through and the read-throughs as always is driven by the revenue trajectory, the operating expenses, investment levels and the gross margins.

In Q4, we explained the environment and the ADS growth at around 10.5%.

The gross margin in Q4 is typically lower than what you see in Q1 because of the impact of price increases and so forth.

We do intend to continue to invest, although balance that with moderate OpEx actions and so forth in a responsible way.

But what all this adds up for in Q3, or Q4, is the 13%.

As we look ahead to FY '13, there are indications of the moderating revenue growth.

There is the intent for us to continue the investments in the growth programs in a responsible way.

Given this scenario, what we've said is the read-through that we are experiencing in Q4 is somewhat indicative of what we would expect going forward.

Now, depending on the varying revenue levels, this could change.

If we see revenue growth in the mid teens, we certainly would expect to see read-throughs return to the level where we would again see expanding operating margins.

Okay.

Maybe just finally, it sounds like you purchased some shares in the quarter.

Just any thoughts on how you're thinking about that going forward, especially with the stock down here where it is?

Jeff again.

As always, we take a balanced approach.

We've got a very strong balance sheet, as you know.

We've got cash on the balance sheet.

We are certainly willing and able to use that to fund the right acquisitions that fit strategically and culturally.

We pay our regular dividends.

We've periodically paid special dividends and we periodically do stock buybacks.

So there's no current plans, but we'll evaluate that as we go forward.

Okay.

Thank you.

Adam Uhlman, Cleveland Research.

Hi.

Good morning.

Just a clarification on the gross margin first.

The acquisition impact and the vending impact this quarter was slightly more of a drag that it was last quarter, but the contribution of revenue seems to be about the same.

Can you remind me why that's becoming more dilutive?

Well, it would also be a function of, I guess, the revenue growth, but I think the acquisition impact was actually similar to the previous quarter.

As we look forward to Q4, there will be an overlapping of the first ATS acquisition, so there's only one quarter overlap associated with that.

The vending impact we mentioned was about 30 basis points.

In the previous quarter, I believe, it was 20 basis points and that's due to the growth in the vending program.

Okay.

Then when you talk about the value equation that's shifting in the marketplace right now, as we look out over the longer term, I am wondering how much of that -- the value-added that the Company is providing to customers, if you guys think you can actually keep -- or how much of that you have to give away as price transparency becomes even greater as more of the model in the industry shifts to online purchasing.

Yes, Adam, it's Erik.

It's a good question and I would say that taking our vending program as an example, what we see strategically is, if anything, where most of our volume is coming from -- these deep relationships we are building with our customers -- it's becoming less about price and more about adding value into the customer supply chain.

We're doing that in a number of ways.

So we are streamlining inventory and we're freeing up cash flow.

We're bringing in our technical experts and we're taking out costs on the plant floor.

All of those are taking the conversation really away from price and towards what we can bring to help them streamline their cost structure.

So I wouldn't draw a conclusion between the increased online percentage of sales going through the Web translating into more focus on price.

Most of our customers that are doing business with us on the website, it's a multichannel relationship.

In most cases, or in many cases, there's technical experts coming in and helping our customers on the plant floor.

There's other value-added services going in, so it's really, what we're describing here is a move towards a deeper relationship with our key accounts.

How much greater share of wallet do you think you get with those tighter accounts, with the vending relationship or anything else?

Can you give us any kind of data points on that directionally?

Yes, the short answer is a lot.

We see a significant difference in share gain and in how deeply we embed ourselves in our account.

So the reference points there would be, number one, we've started to break out for you the growth contribution of vending as roughly 4 points of -- accounting for 4 points of recent growth.

The reason that happened is because when we put our vending system in, it's very well received by our customers and along with our technical specialists and our full program are producing growth rates well in excess of what we see in the rest of the Company.

So certainly that's one metric.

The other one I would point to that I referred to in the prepared remarks is our retention rates, which we're not going to break out, but are very high.

So what that indicates to us is we really are embedding ourselves in these accounts.

Okay.

Great.

Thanks.

Sam Darkatsh, Raymond James.

Good morning, folks.

This is Josh filling in for Sam.

I want to drill down a little bit into the moderation that you're seeing.

Could you maybe give us some color on some particular end-markets or industries where you're seeing the most moderation?

Yes, Josh, it's Erik.

So overall, what we would characterize, it's still a very solid environment.

We are hearing some caution from customers, certainly on the world events, on Europe, on election and so forth.

But it's still solid.

Activity levels are solid and our customers, their order flow and backlogs are solid.

The change that we've seen is it's been a leveling off.

So the leveling off of the moderation is producing lower growth rates for the Company and for our customers.

In terms of pockets, we'd point to durable manufacturing, generally, and no surprise.

So given that manufacturing overall is roughly 75% of our business, that that's accounting for a good portion of the moderation that we're seeing.

Are there any areas you are seeing accelerate?

Yes.

For competitive reasons, I'm not going to break it out.

Within the durable arena, there are certainly a couple of out-performers and a couple of underperformers, but I'm not going to break those out on the call.

Okay.

And then just to make sure I understand your sales growth guidance for the next quarter, what's the contribution from acquisitions?

Is it -- I think you've maybe said in the past 1.7%?

For Q4.

For Q3 it was 4 points of the growth associated with the acquisitions and then in Q4 we dropped off halfway because of the overlap of the first ATS acquisition.

So that would drop off.

We'd go down about 2.5 points of growth, closer to 3.

Okay.

Thank you very much.

Luke Junk, Robert W. Baird.

Thanks for taking the questions.

Good morning, guys.

Sure.

First, I just wanted to touch on the pricing environment again really I guess as we look out from here and see whether you guys have any change in your thought as to your ability to get price in the 2013 big book?

I would think that the recent moderate price increase that you got here even as growth has leveled off would seem to be encouraging, but any thoughts there would be appreciated.

Yes, Luke, it's Erik again.

So in general, we see a pretty solid environment and we feel good about our ability to pass through pricing to the customers.

Again, I would take you back to the earlier question about our value proposition and the fact that where we are doing most of our volume and where we're are spending most of our time, the relationships have moved away from a price-transactional sort of relationship to one that's about much deeper value-add into our customers.

As a result, we feel good about being able to take pricing, given how much we're saving our accounts in total supply chain cost.

Okay.

That's helpful.

I guess second question, since no one else has asked, I guess I'll go ahead and ask.

Just if you guys have some general thoughts on the Amazon supply launch that of course came out a few months ago here.

Sure.

So Amazon.

Overall, Luke, what I would tell you is it wasn't particularly surprising to us, in general not surprising to see a new entrant into the space.

It feels like every few years and there is somebody else we are talking about.

It's a huge market.

It's fragmented and the top four players are highly profitable, so certainly no surprise.

We have a ton of respect for Amazon, as everybody does.

So of course we take them -- take it very seriously.

We pay attention.

That said, what I would tell you we feel very good about our positioning and the strategic direction that we are taking the Company and that you heard David described in his opening remarks.

Yes, a couple of points on Amazon in specific.

One is, from what we see, it's much more complicated to take what they do in a B2C environment and apply it to B2B.

In the second thing is, even if they're successful doing so, again, go back to the point that I just made with you about pricing, that the price and transaction are really a relatively small percentage of the total equation with our key accounts and where we are bringing value, so supply chain savings, productivity on the plant floor, that's really where we believe the game is won and lost.

And just as a proof point here, for years and years, we've been competing against local distributors in this business and, if you look at most published reports, the average gross margin of a local distributor is around 22%, 23%.

Clearly, for years and years, we've been competing against folks who were good competitors but price lower than we do.

So if price were the game, we wouldn't be able to continue taking share from the locals the way we have.

Perfect.

Thanks a lot, Erik.

Ryan Merkel, William Blair.

Good morning, everyone.

So the first question I've got is on the fourth-quarter revenue guidance.

It looks like you expect July and August average daily sales to decelerate a bit from June.

I know you mentioned moderating manufacturing environment.

But does this also assume just normal seasonal slowdown in July and then a little bit of pickup into August?

Is that right?

Yes, Ryan, it's Erik.

So you are correct that implied in our forecast, based on what you see from June, is some slowdown.

So there's a small piece of it, as Jeff just mentioned, that's the anniversarying of the first ATS acquisition.

The majority, though, is what we are seeing in moderation.

The way I would describe it is, again, going back to activity levels are still solid, so it's more about a moderation and a leveling off.

When compared to last year in more of a recovery mode, the growth rates are compressing.

So, that's how I would describe what we are seeing.

Got it.

Okay.

And then, if I hear you right, it sounds like 2013 is going to be a year of investment and potentially below-average EPS growth.

But then as I look to fiscal 2014, will some of these investments be kicking in at the same time that spending is falling off and then we get a re-acceleration of growth rate of?

Is that kind of the planning?

Yes, so Ryan, let me start.

I'll just start.

I think you have it right with 2013.

I mean, I think the theme we're trying to get across here is moderation.

So, we are seeing moderating of the revenue growth -- growth rates as of now.

We're certainly not a condiment, so who knows what's going to happen, but for now that's what we are seeing.

What you're hearing from us is balancing short-term and long-term.

So, like we always do, you can expect us to moderate in spending, in areas of the Company as we see moderating growth rates.

The change is, what David described is some select investments where we say they are so important to the future, so strategic that, despite the fact that they have a near-term dilutive effect, we're going to press ahead because, long-term, they are just so creative.

Vending, I tried to put some color on the call.

Vending is a great example where, just to put some color on that, in the near term with vending, the issue is you have -- it's a long selling process, so longer than typically going in and just selling on a transactional basis.

Start-up, you have significant start-up expenses, implementation expenses in putting the machine in place.

But over the long run, what happens is we see a large growth delta, so all of a sudden we start leveraging all the fixed upfront investments across a larger sales base and we see incredibly high retention rates.

So all of that produces this great long-term picture.

So what you heard from David is, for those select areas, vending being one of them, we're not going to back off, although we will moderate in other areas.

So again, even in 2013, if revenue growth picks up, then it will certainly be a different story.

In terms of 2014, for now, Ryan, we are really going out one year.

Typical with our normal process where we'll give you a perspective on the year, there's so many moving parts.

It's going to be hard to predict.

For instance, vending, if it keeps -- what's happened is that every quarter that's gone by, the number of new installations have outpaced our plan.

If that were to continue, who knows for 2014.

So there's many moving parts.

We're going to stick with one year for now, as we normally do.

Got it.

Okay.

Then just last one for me.

If I calculated this right, growth from national accounts this quarter was about 4%.

If that number is right, I'm just wondering what explains the softness there and aren't those primarily the vending customers?

Ryan, so we don't actually break out.

I'm not going to disclose the growth in the large account segment.

Okay?

Okay.

Remember one thing is when you look at that large accounts, it's a combination of national accounts and government.

As we mentioned, government does pull the number down.

Got you.

I would not assume that vending is definitely not limited to our denomination of large accounts.

There are many accounts that would be in our core segment that are right in the sweet spot of our plan where we also have vending.

Right.

Thanks for taking the questions.

Hamzah Mazari, Credit Suisse.

Good morning.

This is Chris Parkinson on behalf of Hamzah Mazari.

Most of my questions have been answered, but just two very quick ones.

The first, out of your 9% government sales, can you just parse out what is more MRO facilities maintenance versus more project activity, generally?

Then any differences in growth rates there?

Chris, it's Erik.

We actually sell beyond the 9% government.

Within government, as you said, we've got many pockets.

We don't break them out publicly.

Okay.

Fair enough.

Just a general question of the acquisition landscape.

What are you seeing from a multiple perspective and do you have any updates on what adjacencies in the future you're going to try to target?

Yes, Chris, it's Erik again.

So I mean, M&A landscape in general, we would describe our funnel is pretty full and pretty robust.

There's lots of discussions happening.

From what we're seeing from a multiple perspective, still pretty solid.

Then in terms of your second question was around our strategy.

And, yes, we've identified a number of adjacencies and what we've told you is, while we look at a couple, the most likely one and the one that is first and foremost on our minds in terms of the growth strategy is the product line adjacencies.

So, these are the MRO categories that we've referred to over the past several calls that we carry in our catalog, that we've got existing relationships and existing business where they are sold into manufacturing plants, in many cases by the same buyers who are buying metal working.

That would be the most likely place you'd see us do something on an adjacency move.

Perfect.

Thank you very much.

Holden Lewis, BB&T Capital Markets.

Great.

Thank you.

Are you able to hear me?

Yes, Holden.

Okay.

Good morning.

A couple of things.

First, when you talked about revenues, the positive there would be revenues back to 15%.

Is that a statement about if the macro environment re-accelerates or could you get to that 15% because of the traction your investments are getting and then also seeing margins grow during that scenario?

Yes, Holden, it's Erik.

I think the short answer is both; we could get there either way.

Let me start with what we are currently seeing.

So you look at our Q3 performance and we think, relative to what's going on in the world with comps, with peers, that the share gains are pretty good.

We think they continue to be pretty good.

So the difference between Q3 and Q4 is really just moderation in the environment.

To your question going forward, it certainly could happen either way if share gains were to widen even further, but I do think it would be helpful to have a little juice in the economy as well.

Right, but if the share gains widened further, would that come along with increasing pressure?

So in other words, you're willing to accelerate the growth through growth drivers, but that will also mean burdening yourself with more costs so that's really not the path there?

Yes, Holden, that's a fair point.

I mean part of what we're describing here is take a program like vending.

As we said, it is exploding and it's outpacing our plan.

The more we do, the more, because of the dynamics I described, the more near-term dilution there is.

So yes, that's fair.

Okay.

Then the second question I would ask, you've sort of given us the end game where it relates to incremental margins and things like that.

But I'd be kind of interested -- you've laid out the pieces where you're investing in incurring costs.

You haven't really suggested to us where you are taking some of the savings.

So I wondered if you might give it a little bit of granularity there.

Then if you could also -- maybe when you look at the entire package of costs from investments and savings from those cuts, over the next 12 months, what's the relative size of those things?

Are the costs that you spend going to be X times greater than the savings that you incur?

Can you give some color on that?

Yes, sure.

Holden, it's Erik.

I'll start with -- and Jeff had described in the prepared remarks that we are moderating spending.

So the savings area that we are doing moderating as part of balancing, given the moderating growth rates.

You see one place is our Q4 sales force headcount guidance.

I'd tell you that, overall, we -- beyond just the sales force headcount, we are moderating the rate of hiring and we've also looked at select areas.

Take a line item like professional fees that are tied to certain projects where we slowed down the pace of those.

In terms of quantifying it for you, very difficult to break out and compare relative to the dilution from the investments because, again, it's hard to predict just how fast an area like vending will grow.

So what we've tried to do for you is give you a perspective and a framework on read-throughs given certain revenue assumptions for 2013.

Okay.

What I'm kind of curious about is if you don't see a reacceleration in revenues, but in fact you see a moderation, a further moderation, you're not going to slow down the investments.

Can you incrementally go after the costs stronger and stronger, or with the spending investment that you have, every 100 basis point downtick in revenue is going to have a real negative impact on your results?

Yes, Holden, look, there are other areas and you've seen us take out different playbooks off the shelf, depending upon the environment.

Right now, with what we see, we still consider it moderate growth.

We don't think we need to pull a different playbook off the shelf.

But even with the playbook that is off-the-shelf, we've got several areas where we are moderating spend.

Depending upon what we see in the revenue environment, if it were to get worse, we would moderate further.

Okay.

Great.

Thanks, guys.

Thank you.

Brent Rakers, Wunderlich.

Yes, good morning.

I think maybe first, to follow a little bit on Holden's question about pulling levers, could you maybe talk a little bit about the natural levers you have in place on the cost side?

More specifically, if you're growing a mid-single digit, maybe even high single-digit level next year, what kind of movement happens there in terms of both hiring, but also in terms of the variable portion of compensation?

Brent, yes, I mean, I think, look, the biggest lever we have in terms of it's a percentage of our costs is people.

The lever that we have to use is the rate at which we would hire and slow that down.

So, I think certainly you mentioned another one.

Yes, there is a portion of compensation for our sales force in particular.

It's variable.

But, yes, the biggest lever would be the rate at which we add people and it would be other professional type fees related to key projects that we would either slow down or stop, depending upon the environment.

So what we described this morning are the ones that we don't want to scale back on and would not plan to, despite near-term dilution.

There's plenty of others where we would.

Erik, in the past, at least on a quarter-to-quarter basis, you have maybe got a little bit more specific about dollars attached to some of the investment spending on a sequential growth rate number.

Care to elaborate a little bit more in terms of the OpEx impact to some of the investment spending dollars you're talking about for fiscal 2013?

No, Brent, we've typically not shared -- you know, tied a dollar number to the investment program.

We're not going to do it now.

Again, the way we try to let you plan and understand it is through giving you some read-through perspective at various growth rates for 2013, but I'd rather not break out the dollar amount tied to the investment program.

So, Erik, maybe as another way of at least somewhat addressing that, if you were growing a mid to high single digit number and yet you pulled off some of these growth spending initiatives, do we think that you could manage a normal or traditional kind of a high 20s kind of percent read-through with a mid-single, high single-digit growth rate or would that still be lower than that even without the investment spending?

Yes, Brent, so what you are hearing from us and what you heard from Jeff today, the answer would be no.

So that at a high single-digit growth rate, we would have -- we would expect to grow earnings, but at lower rates than -- at least for the year -- lower rates than historical, and at read-throughs lower than the 20s%.

Even excluding the investment spending, correct?

Tough to break it out.

I mean, no, we're giving you kind of an all-in number.

Okay.

Great.

Then just last question I think Erik, specifically.

You've talked a lot about activity levels being solid in the marketplace.

I guess I just wanted a little more reconciliation on that because when you look at the guidance number for the fourth quarter, adjusting for price and the share gain tied to some of the vending programs and M&A, it spits out kind of a 0% year-over-year growth from core activity.

I guess first is, is that calibration right and then I guess what distinction would you make between activity being solid and that kind of level of market growth?

Yes, not sure how you're getting to the math.

Tough to comment on the breakout of organic without exactly understanding how you're doing the math.

But what I would tell you is what we're hearing from our customers, Brent, is that things are still solid.

Realize, we are coming off of a year last year where activity levels through Q4, kind of over the last couple of years in recovery mode, broke -- bucked the normal feasible trend where things get slow in the summer because it was a recovery period, things kept escalating.

So they are still at solid levels.

It's, again, relative to comps compared to last year.

Certainly, though, that said, there's no question that you are reading it right, that we do think things have moderated.

There is a little more caution being expressed by customers than in the past, so hopefully that came across as well.

Okay.

No, great, Erik.

That's very helpful.

Thanks a lot.

Derek Jose, Longbow Research.

Hi.

I was wondering if you could break out the new hirings.

You recently just mentioned that you stopped -- it's one of the areas that you can stop increasing hiring.

I was kind of wondering if you could talk about the breakout between new, like really new people hirings or experienced hirings market share gains that you're taking some from some smaller competitors?

Yes, the only thing we -- Derek, it's Erik again.

We do provide on the website total headcount by quarter so you can see total headcount for Q3.

The only other piece that we'll breakout is the field sales, which is what I shared, that we'd expect Q4 to be about at Q3 levels.

Okay.

Then I'll touch on this.

Derek, I'm sorry.

One other point to make, which is you'll see -- so if you look at the Q3 headcount, you won't have seen the effect of moderating the rate of hiring growth yet.

Given that we made the adjustments, it takes a little bit of time before you would see that in the number.

Okay.

I guess I'm just trying to reconcile your gaining share because part of the way to gain share is to pick up good salespeople from smaller competitors.

If you're looting that amount, won't that further curtail your market share gains?

So a couple of things, Derek, one is that, to date, you have seen us expand our field sales force.

The second thing is -- so what you're referring to is Q4?

Yes.

Or even over 2013, you said one of the variable costs you can limit is salesforce.

So I'm just kind of curious about that.

Yes, so two things I'd say.

Even with a flat sales force likely we would project for Q4, we absolutely expect to take share gains.

There's a couple of ways we do it.

So one is all the programs we're describing, when we take them to our key accounts, there is huge share of wallet opportunities.

The second thing that you don't see in an absolute number of sales associates is we are constantly upgrading the quality of our sales team.

So there is a churn, a natural churn and attrition through our sales force.

When that happens, we have the ability to bring in somebody that's even more talented, more connected in the industry, and with more contacts.

Okay.

Last one.

When you're kind of connecting these new salespeople, say, some more experienced sales people from the industry, all the offerings that you have right now, how much is that adding to what -- versus they previously had at their former employer?

Yes, Derek, when I get a chance to ride with some of our newer sales associates or meet with them in focus groups, particularly those that come from the industry are typically coming from a local or regional competitor.

Honestly, they are blown away.

They've had to -- great salespeople.

They typically have a lot of technical expertise, great credibility with suppliers, but for years and years they've had to sell around service, they've had to sell around the solutions that, at MSC, the size of the product offering that we could bring to bear, it's just like they are a kid in a candy store.

Okay.

Part of this is showing up in the increase in online sales, I imagine?

Yes, it's certainly a piece of it.

But again, for our new associates, I would say Web is just a piece of it.

It takes somebody that even comes out of the metalworking industry to get a chance to sell the entire MRO offering from MSC and then, within our metalworking offering, to be able to sell a full suite of brands that they've never had before, it comes out in a whole bunch of ways and really gives them the ability to sell with confidence.

Okay.

Thanks, guys.

[Pinder Bora], Jeffries.

Hey, guys.

Most of my questions have been answered, so thanks a lot.

[Steven Raggart], Stephens.

Hi, guys.

Steven in for Matt this morning.

Most of my questions have also been answered.

Just real quick, do you guys break out how much of SG&A was growth investments this quarter?

No, that's not one of the things that we report out separately.

Okay.

Thanks.

Basili Alukos, Morningstar.

Good morning, guys.

I just wanted to ask the question, you had mentioned since 1995 the large distributors had 15%.

Today, now the share is 30%.

You weren't taking that share by price.

It was done more based on services.

I'm wondering, going forward, as the larger players roughly offer the same services, does that service advantage still hold or does the future look like it's more then becoming kind of a price issue (multiple speakers)?

Yes, this is Erik.

I think what you heard from David and what he was getting across is that, if anything, the distinction to draw is between the local players that are still making up 70% of the market and the large nationals.

If anything, David described the technology and value-add solutions as two trends that are accelerating the pace of consolidation and, I would say, making it less about price than it has been.

So if anything, we see the pace of consolidation picking up.

Okay.

Great.

That does it.

Thanks.

At this time, I would like to turn the conference call back over to management for any closing remarks.

Okay.

Well, thank you all for your time and attention today, and we look forward to speaking to you again next quarter.

Thank you.

Ladies and gentlemen, today's conference is now concluded.

We do thank you for attending today's presentation.

You may now disconnect your telephone lines.