MSC Industrial Direct Co Inc (MSM) 2014 Q3 法說會逐字稿

Good morning, and welcome to the MSC Industrial Direct fiscal third quarter 2014 conference call.

(Operator Instructions)

Please note this event is being recorded.

I would now like to turn the conference over to John Chironna, Vice President of Investor Relations and Treasurer.

Please go ahead.

Thank you, Emily, and good morning everyone.

I'd like to welcome you to our FY14 third quarter conference call.

An online archive of this broadcast will be available one hour after the conclusion of the call, and one for one month on the investor relations homepage at www.investor.mscdirect.com.

During today's call, we will refer to various financial and management data in the presentation slides that accompany our comments, as well as our operational statistics, both of which can be found on the investor relations section of our website.

With regard to our Safe Harbor statement under the Private Securities Litigation Reform Act of 1995, please note that our comments on this call, as well as the supplemental information we are providing on the website, contain forward-looking statements within the meaning of the US securities laws.

Including guidance about expected future results, expectations regarding our ability to gain market share and expected benefits from our investments and strategic plans, including the BDNA acquisition, the expectations regarding future revenue, and margin growth.

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

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

These forward-looking statements are based on our current expectations, and the Company assumes no obligation to update these statements.

Investors are cautioned not to place undue reliance on these forward-looking statements.

In addition, during the course of this call, we will refer to certain adjusted financial results which are non-GAAP measures.

Please refer to the tables attached to the press release, and the GAAP versus non-GAAP reconciliations in our presentation, which contain the reconciliation of adjusted financial measures to the most directly comparable GAAP measures.

Finally, please note that we recently renamed BDNA to Class C Solutions Group, so future references will use that name, or CCSG.

Also, now that the acquisition has passed its anniversary date, this will be the last quarter where we will be breaking it out specifically.

We will, of course, continue to share information about performance and synergies, as well as comments on the CCSG in general from time to time.

I'll now turn the call over to our Chief Executive Officer, Erik Gershwind.

Thanks, John.

Good morning, and thank you for joining us today.

Also in the room with us this morning is Jeff Kaczka, our CFO.

I'll begin by saying that I'm pleased with our execution and our overall performance during the first three quarters of our FY14.

On today's call, I'll discuss the current environment, where we continue to see somewhat improved momentum, our Q3 performance, where we produced solid results, and progress on our infrastructure and growth initiatives, including CCSG, which continue to go quite well.

Jeff will discuss our financial results and provide our fiscal fourth-quarter guidance, and I'll then conclude with a summary.

And of course, we'll open the call up for Q&A at that point.

I'll start with the environment.

After leaving behind the weather-related disruptions and holiday season that we faced in our fiscal second quarter, overall market conditions improved during our March through May third quarter.

I mentioned on the last call that the ISM readings and the Metalworking Business Index had recently converged to similar levels.

That remained true during the past three months, with both in the mid-50s range.

Both of those macro indicators are generally consistent with what we're seeing and hearing from customers.

That feedback includes a firmer demand environment, more robust order flows, and some talk of order backlogs.

That said, despite these encouraging signs and significant improvement over prior year, we would still characterize the current environment as one of moderate growth.

Customers remain slightly more confident, but they also remain appropriately cautious with their spending and capital investments.

On a related note, while customers' order backlogs are generally solid for the next few months, we're not hearing much about visibility longer term, which would be more typical of a high-growth environment.

While the demand environment has improved considerably over prior year, we would not say the same of the pricing environment, which remains soft.

Our gauge here is the rated pace of manufacturer list increases, which remains sparse.

There are some indications of potential commodities inflation in products made with the nickel and other steel used in many of our cutting tools.

If that were to continue for a sustained period of time, it would likely result in a more robust pricing environment in quarters to come.

To summarize, the overall market environment remained positive and stable throughout the third quarter and into June.

I'll now turn to our recent results.

For the quarter, we posted organic growth of just over 7% on the base business, which was towards the lower end of our guidance range.

As we reported on our last call, March growth was strong.

We saw that trend continue through much of April, up until the Easter holidays, when we saw things soften relative to the prior two months.

That softness continued into May.

And as you see from our June average daily sales growth of 7.6%, things have picked up since then, in part aided by the timing of the July 4 holiday.

We do not make too much of the month-to-month variability.

When we look to the bigger picture, we see growth in excess of the market, and we see continued execution of our share gain initiatives against the backdrop of an improved but not robust demand environment.

As I mentioned on our last call, the government sector performed quite well in March, and that continued throughout our fiscal third quarter.

Our performance is in part based on a strong government spending environment, and in part based on share gains that have been achieved over the last couple of years.

Overall, government currently represents 8% of total Company sales.

Turning to our national accounts program, it has continued to grow above the Company average, as we continue to take share by winning new accounts and executing on our growth initiatives.

Our value proposition continues resonating with the procurement and supply chain functions at larger companies, who are looking to consolidate suppliers and gain visibility into their MRO spend.

As a result, we are seeing success in current account penetration, through better program implementation, and in our new account signings.

I'll now turn to an update on our infrastructure and growth initiatives, as well as our progress on CCSG.

Our co-headquarters initiative in Davidson, North Carolina has been complete for three quarters, and all expenses are fully in our run rate.

The project was completed on schedule and on target, and this will be the last quarter that I'll comment on it.

We're very happy with the talent pool that we've attracted, and we now have about 250 associates located in Davidson.

As a reminder, we'll begin receiving the incentives related to Davidson in our calendar 2015.

Construction of our fifth customer fulfillment center in Columbus, Ohio is substantially complete.

We are staffing up, and we are on schedule to begin shipping in the fall of this year.

As expected, the operating expense impact continues to grow, and will do so into FY15, as we stock the facility with inventory and staff it in preparation for opening.

Next, our project to relocate our primary data center is complete.

It was finished slightly ahead of schedule and on budget.

I'll now update you on our growth initiatives, which continue to help us take share.

Sales from customers with a vending machine added roughly 4 points to our revenue growth in the third quarter.

Vending signings remained strong, which is a testament to the program's value, and to the growing momentum of supply chain technology in the indirect procurement space.

Excluding CCSG, e-commerce reached 48.9% of sales for the third quarter, as compared to 44.1% a year ago, and 47.6% last quarter.

This reflects our customers' increasing interest in our inventory management solutions, such as vending and VMI, as well as the increase in traction of MSCDirect.com.

We're quite pleased with the recent and ongoing improvements to our website, and are getting strong confirmation from our customers.

MSCDirect.com remains an important part of our value proposition.

And because of its sophisticated procurement functionality, it's a key element of the stickiness that we create with our customers.

Regarding sales force expansion, our target was to add between 5% to 7% to our field sales headcount for FY14.

During this past third quarter, we added a net of 25 sales associates, bringing total net additions to 65 for the first nine months.

We're encouraged by the early performance of our new hires.

And based on current trajectory, we plan to finish the year slightly above the high end of our targeted range for sales force additions.

Finally, we added another 35,000 SKUs to our web offering in the third quarter, and now have approximately 795,000 available on MSCDirect.com.

That brings our total SKU additions to 120,000 for our year to date, and we remain on track to add a total of roughly 150,000 for the fiscal year.

As those newly added SKUs mature over time, so will their contribution to growth.

I'll now turn to CCSG.

While recent top line performance has been nothing to write home about yet, as I look to the future, the outlook for CCSG is even more promising than it was a year ago.

This past quarter, we saw the US business return to slight growth, while currency and market weakness in Canada remained challenging and yielded contraction, netting out in total to a slight decline.

As it relates to the integration plan, synergy realization, and the achievement of our EPS accretion targets, though, we're right on track.

To date, we have closed three distribution centers, and are on plan to close the Cleveland headquarters this summer.

We began moving the first wave of associates to our Davidson location at the end of June, and it's been a very exciting time in Davidson, as our new colleagues our joining us there.

We also remain on track to achieve our targeted cost synergy run rate of $15 million to $20 million by the end of FY15.

With respect to financial performance, we're trending towards the high end of our $0.15 to $0.20 accretion range for the year.

Overall, as I said, I'm very encouraged by the actions that are being taken to improve this business and position it for growth in future quarters.

And there's three growth levers that we're focused on.

First is improved customer service, or what we call core execution.

That plan is well underway, and can be seen in improving metrics like call answer rates, fill rates, and general customer coverage.

Second, we are refining the sales force model and as a result, we are beginning to expand the CCSG sales force.

As a reminder, to date, the field sales metrics that we report on our website include only the base MSC business.

We are, at the same time, beginning to expand CCSG sales headcount, which will serve as a growth tailwind as those new hires mature.

Each of these first two growth levers, of course, take some time to translate into improved results.

The third growth lever we are focused on is realizing cross-selling, or revenue synergies.

As I mentioned last quarter, we began pilot projects to equip our CCSG sales associates with our Big Book catalog, access to our website, and resources to assist them in selling the MSC products and solutions.

We are encouraged by the initial pilot results, and during our fourth quarter, we'll be expanding that pilot more broadly.

We expect to see continued good results.

And assuming that we do during our fourth quarter, this should serve as a sizable growth program for FY15.

As John alluded to earlier, we also launched a new brand by renaming BDNA to Class C Solutions, a business of MSC.

We took one step in bringing the company under the MSC family, while still retaining its own separate identity.

To summarize CCSG, we achieved our 2014 financial and operating targets, without the benefit of any top line growth to speak of.

At the same time, we're making significant improvements that will result in future revenue growth.

And given the high incremental margins inherent in the model, we are very encouraged about the prospects for future growth in both revenues and earnings.

Overall, it's an exciting time right now within CCSG.

I'll now turn things over to Jeff to discuss the financial results in greater detail and provide our fiscal fourth-quarter guidance.

Thanks, Erik, and good morning, everyone.

Our monthly sales growth rate moved around a bit during the fiscal third quarter, due to the Easter holiday impact.

But overall, our average daily sales growth, excluding CCSG, came in at the low end of our guidance, or about 7%.

At the same time, we managed to achieve EPS toward the higher end of our guidance by posting an adjusted EPS of $1.06.

Furthermore, as Erik mentioned, I'm happy to say our infrastructure and growth initiatives continue to progress in line with our plans.

Let me start by getting into the details of our third-quarter results.

While the remaining nonrecurring costs related to our co-located headquarters are not material, we do still have nonrecurring integration costs related to the CCSG business.

So I'll continue to speak of our results in terms of recorded and adjusted results.

Our recorded sales growth on an average daily sales basis was just above 13% compared to the same period last year.

This includes a full quarter of CCSG sales, whereas the prior-year quarter only included sales from the acquisition date of April 22.

Excluding CCSG, our base business organic sales growth on an average daily sales basis was roughly 7%.

The growth rate benefited from the significant improvement in our government business, as well as from customers within our vending program, which contributed roughly 4 points of growth.

With regards to gross margin, we posted 46.3% for the quarter, above the midpoint of our guidance of 46%.

We were very pleased with this, but I would mention that the gross margin benefited partially from a couple of items that are unlikely to repeat.

Our reported EPS for the quarter was $1.03, or $1.06 on an adjusted basis, which excludes nonrecurring costs for the CCSG integration.

The adjusted EPS of $1.06, which was towards the higher end of our EPS guidance range of $1.03 to $1.07, reflects the impact of slightly higher gross margin, as well as the effective management of our operating expenses.

Finally, the tax provision came in at 37.9%, slightly below our 38% guidance.

Turning to the balance sheet, our DSOs were 48 days, slightly higher than last year's Q3.

And we are pleased that our inventory turns continued to improve to 3.54, from last year's level of 3.32.

As expected, we did add roughly $35 million in inventory during the quarter to support growth and to stock the new Columbus distribution center.

We would expect the build to continue during our fiscal fourth quarter, but at a slightly lower level.

From a cash flow perspective, we continue to generate significant levels of cash, as evidenced by our positive operating cash flow of $75 million in the quarter.

In addition, we paid out over $20 million in dividends, and incurred total capital expenditures and infrastructure investments of $23 million.

CapEx was in line with our plan, and our expectations for total year CapEx of slightly over $100 million remains on target.

As of the end of the third quarter, we had $275 million in debt, mostly comprised of $241 million outstanding on our term loan, and a $5 million balance on our revolving credit facility.

We closed the quarter with $45 million in cash and cash equivalents, and our current cash balance now stands at $47 million.

Now let me turn to our guidance for the fiscal fourth quarter of 2014.

And consistent with previous quarters, our guidance will continue to exclude the nonrecurring CCSG integration costs.

We expect total revenues to be between $718 million and $730 million, up 7.5% from the prior-year quarter at the midpoint.

This includes CCSG sales, which are expected to have a lower growth rate than base MSC.

We expect gross margins to be in the range of 45.9%, plus or minus 20 basis points, which is down from our fiscal third quarter and reflects the typical seasonal trends we see when going from our fiscal third quarter to the fourth quarter, as well as continued growth in our national accounts business.

Relative to the Company average, national accounts tend to be a headwind to our gross margins.

I would point out that the sequential decline in gross margin is lower than historic norms, thanks in large part to our strategic programs, particularly in the current soft pricing environment.

We expect adjusted operating expenses will increase at the midpoint of guidance by roughly $5 million versus the fiscal third quarter.

Now roughly half of the increase is from CCSG, including growth investments related to sales force expansion and our catalog rollout.

The other half of the increase pertains to the base business and includes investments in sales force expansion, the Columbus distribution center initiative, and staffing ramp-up ahead of normal fiscal first-quarter seasonal volume growth.

So the midpoint of our guidance implies an adjusted operating margin of approximately 14% in the fiscal fourth quarter, which keeps us well within our FY14 annual framework of 14% to 15%.

This adjusted operating margin reflects the typical seasonal trends in gross margin, and the continued ramp in investment spending for initiatives like the Columbus distribution center and sales force expansion.

The distribution center will not begin shipping until early FY15, so the related operating expenses are still ramping higher.

With regards to the sales force additions, we don't expect to see a material impact on the top line from hires made during the first half of this year until FY15.

And of course, we're continuing to hire new sales associates every quarter.

Our tax rate is expected to be 37.7%, and all this results in adjusted EPS guidance of $0.98 to $1.02.

This earnings guidance includes CCSG operating results, and excludes approximately $0.02 in integration costs.

Also, the CCSG business is expected to be accretive by about $0.04 in the fourth quarter, which would put total accretion of for FY14 at $0.19.

So in summary, we are now 10 months through our FY14, and well on track with respect to our infrastructure and growth initiatives, as well as our financial commitments when it comes to our FY14 framework.

Thanks, and I'll turn it back to Erik.

Thanks, Jeff.

Before we open up the call for questions, I'd like to take a step back and assess the Company's performance in a broader context.

We're headed towards the homestretch of our FY14, the second of two years of heavy infrastructure investment in the Company.

I remain very pleased with progress against our plan and our prospects for the future.

Our infrastructure projects have been well executed, delivered on time and on budget.

We kept focus all the while on market share gains to a challenging macro environment, and are beginning to see the payoff in the form of early top line momentum.

We completed, and are integrating, the largest acquisition in the history of the Company, one that holds great promise for the future.

We're moving the MSC portfolio of business towards sticky, high retention channels, including vending, e-commerce, VMI and more.

And finally, we're on track to deliver financial performance in line with the annual framework that we laid out at the start of the year.

By no means am I suggesting that our work is complete.

We are focused on executing the growth investments that we're making to deliver faster top line growth.

We're working hard to get the top line growing at CCSG as well, which will lead to even faster rates of earnings accretion.

And we are focused on growing Company earnings once again in the coming quarters, as we gain leverage on our investments.

On our next call, as we normally do, we'll share our outlook for FY15.

Finally, I'd like to thank our entire team for executing our plan over the past year, and for their continued commitment to our mission.

We'll now open the line for questions.

(Operator Instructions)

David Manthey, Robert W. Baird.

Thank you.

Good morning, guys.

Good morning.

First off, CCSG.

Could you remind us what percentage of that business is Canada?

And then, is there anything else that is inherent in the CCSG customer base or operations that would, just longer-term, make it a slower growth business than core MSC?

David, so CCSG -- first question, Canada -- figure roughly 15% of total.

We saw -- as you can imagine, we saw significant decline in that portion of the business to net out to a slight decline in the quarter, given that the bulk of the business is US and did show some slight growth.

So your other question, I think the answer is no.

We feel -- I feel really good about -- as we look at the CCSG business, I think nothing particular to call out on its macro exposure, other than the fact that it is more diversified than MSC's base business, a little less manufacturing.

I think the really relevant point, what we see, is a very compelling model that allows us to get these deep relationships with customers, and ultimately start to spread our tentacles in those accounts.

And that's really what's been in the works now, and what we anticipate in the coming quarters to get the growth moving.

Okay.

And then Jeff, when you were talking about the gross margin in the current quarter, I believe you made a comment about some non-repeating items, but you didn't outline them.

Could you give us an idea of what those were?

And approximate magnitude?

Yes.

Dave, it was just -- there were two items, primarily related to the timing of discounts and rebates.

And those two items combined just lifted us over the top end of our guidance range in terms of gross margin.

The top end was 46.2%, so a minor impact associated with those.

So we're talking 10 basis points or something?

Or so.

Yes.

Okay.

I think one other point -- and I think Jeff hit this in the prepared remarks is, I do think we are pleased with what we are seeing.

So while we got some benefit from nonrecurring, I think in general, given the soft pricing environment that we've seen, we are pleased with our execution and the gross margin discipline that we put in place.

Okay.

And just finally, on the manufacturing versus non, you mentioned government.

I guess that would be a driver there.

But is that also partially because of the inclusion of CCSG and the drag that that's having?

I would imagine they're primarily manufacturing rather than non?

No.

See, I would chalk it mostly up to government, and then some other odds and ends segments, Dave, in the base business, that have been showing growth.

But consider it primarily government driven, and not CCSG, in terms of the non-manufacturing.

Great.

Thanks very much.

John Inch, Deutsche Bank.

Thank you.

Good morning, everyone.

Hello, John.

Good morning, guys.

Jeff, just as a clarification, you made a commentary about the timing of the July 4 holiday.

Were you trying to imply that June sequentially did a little bit better versus May because of July 4?

I do not really understand what you were saying.

Yes.

That's right, John.

The -- for our fiscal month, it included the July 4 holiday, the June fiscal month.

And because the timing this year of July 4 was on Friday versus Thursday, we believe there was a slight improvement to the growth rate associated with that.

But all else equal, are we seeing, on a sequential basis -- we are seeing the 7% mark?

Is that -- with about 4 points from the vending machine, is that about the cadence that you're seeing?

The slight -- the improvement -- I'm sorry -- you said --

Your monthly sales growth is trending around 7%, all else equal, if you adjust for Easter and July 4 and all this stuff.

Is that really what you're seeing?

Yes.

What we're actually seeing a bit of an uptick, John, as we progress month by month through from the second quarter into what we saw in June.

Certainly an uptick, a slight uptick there, and I think that's reflected in our guidance for Q4.

Is CCSG also seeing that uptick?

Or what is happening to that business sequentially through June?

No.

So John, I think Jeff's right.

I would say, first of all, one thing I'd say is, there's been a lot of month to -- between the weather, the holidays -- there's been a lot of month-to-month variance in the growth rate.

And as we said, we don't make a whole lot of the month-to-month variability.

We are looking at the trending -- if you look, the base business, it's 7% all-in for Q3.

As Jeff points out, you can take our implied guidance of 7.5%, inclusive of CCSG, which is lower, meaning the base business is higher.

So I think there is some momentum that we're encouraged by, not satisfied, but encouraged, is what I'd say.

CCSG is not -- CCSG, as you look back over the last few quarters, has been hovering around flat and up a little bit, down a little bit.

In June, it was down slightly; in Q3, it was down slightly.

But I would say directionally hovering around flat.

And for the reasons I described, we are very encouraged about what we see turning into growth in quarters to come.

Yes.

That make sense.

Erik, based on your guide -- or Jeff, if you were to look at your growth initiative spending -- so that would be however you want to characterize it.

The cost of warehousing these new SKUs, the sales force additions.

What would be the FY14 magnitude of that spending?

And based on everything you know today -- I'm not asking for guidance, but is the spending up, flat, or down in FY15?

Because this perspective that you guys have been spending to capture market share for a long time, and is there a point at which you can pull off the levers to let some more of the earnings flow to the bottom line?

I'm just curious what your thought -- maybe you could frame that for us a little bit?

Sure, John.

So I'll -- two parts.

Let me take a look back.

We're right now at 2014, and then talk a little bit about 2015.

For 2014, what we had described was -- I want to go back to our framework, but it was around 50 -- 100 basis points of op margin impact in the base business.

About 50 basis points of impact was being driven by infrastructure investing, i.e.

Columbus, Davidson data center.

And around 50 basis points of op margin impacts from growth investment spending, the things that you rattled off.

Certainly -- so in 2014, yes, elevated spending.

As we look ahead to 2015, and we're going to come back and we are right in the midst of our normal planning process, where we put on all of the pieces together to refresh the 2015 view.

But if you go back to what we had said at the start of the year when we laid out a three-year perspective, we had anticipated 2014 being the trough in op margin.

What we call modest or slight uptick in op margin in 2015, and more aggressive op margin uptick in 2016.

And all of that was premised on what we've termed moderate growth environment and moderate pricing environment.

So we're putting all the inputs together on 2015.

What I would tell you is that certainly, we have some portion of the infrastructure investments that's going to be dropping off.

And by dropping off, what I mean is, largely in our run rate, not incremental.

So that is Davidson data centers behind us.

Columbus will be behind us as we move to the back half of 2015, for sure.

Growth investments will continue.

So to answer your question, we're putting it all into the mix now.

And we'll be back on the next call and give you a framework for 2015.

Okay.

So it sounds like, Erik, that the infrastructure get some anniversaring, and that the growth investments -- because you called out hiring and CCSG, et cetera.

It sounds like that's probably on a path to continue, so maybe the net is a slightly less of a run rate?

Is that fair?

I would say that CCSG will continue.

I would say we are lapping Davidson.

We are lapping data center.

Columbus, as we've described, will be a headwind into 2015 as we staff up.

We also have the depreciation that will kick in.

So give Columbus will remain a headwind.

So I would say somewhere between your answer there.

Okay.

One more quick one.

June, I believe, is government's fiscal year end, and I think there was a bit of a budget flush for government last year.

There was concern that government, certainly at the state level, had maybe spent a lot on snow removal and other things.

Did you see government -- it sounds like government was pretty good for you in June.

Did you see any less of a budget spend?

I realize it's only 8% of your mix, and that would be split federal versus state.

But did you guys see any kind of an impact, do you think, from weather, that maybe caused government to spend a little bit less in June versus last year?

John, really good question.

So actually, you're hitting the right theme here.

Because the year end of government really does drive a lot of activity.

It's actually end of September for federal.

And so you are correct that last year was a pretty soft year for government, but we did see, at the end of their fiscal year, a pretty aggressive ramp-up in average daily sales.

We've been talking about, with government, we're pleased with performance.

I think the headline on government is generally more spending, a more certain environment, with budgets being set now.

So there is more spending.

The other headline would be, I think we are benefiting from some share gains that we achieved while things were soft.

So to answer your question, we are still seeing nice growth.

We anticipate growth in the fourth quarter.

Although I will tell you that baked into our guidance is a slightly lesser growth rate, accounting for the fact that we have big comps at the end of the year end spend from prior year.

Got it.

Thank you.

Thanks, John.

Ryan Merkel, William Blair.

Thanks.

Good morning, everyone.

Hello, Ryan.

I want to ask a question about 2015, too.

And I know you're going to talk about it more on the next call.

But I just want to ask, we shouldn't extrapolate the fourth-quarter margin guidance into 2015?

Am I correct with that statement?

Yes.

Ryan, that's a really good point.

So I'll touch on 2015 a little more than I did in John's question.

In general, what I would say to you, this is the time of year when we go through our planning right now.

So we'll have a much better feel on the next call.

And just to remind you, we said slight uptick in margin, based on moderate growth, moderate pricing as we look at it now.

Certainly, the moderate growth part of the equation is a check; the moderate pricing part of the equation is not a check.

It would be an X at this point, all subject to change.

So that is certainly a relevant factor, but only one of several factors that we've got to put into the mix, along with the demand environment and along with our own spending and other decisions and execution.

So all that's being factored in now.

I do think you're right to point out -- I wouldn't make too much of Q4 as it relates to 2015.

Because Q4 is seasonally, for us, if you look, a lower op margin quarter because of the seasonal downturn in gross margin, combined with the uptick in expenses that we normally do to prepare for Q1, which is a higher growth level.

So net net, yes, you're right, I wouldn't make too much of Q4.

Okay.

Perfect.

Wanted to clarify that.

And then based on what you're seeing in the business today, call it moderate growth, and then thinking about the growth investments ramping.

Do you think double-digit organic growth is achievable sometime in the next, call it three to six months?

Good question.

Look, on growth, here's what I'd say, Ryan.

I would say we are encouraged by what we're seeing, but not satisfied.

I think we can do better.

We can continue to do better, but we are encouraged by what we're seeing.

And I think that there's three things I'd point to that make me encouraged.

Number one is sequential momentum in the growth rate from quarter to quarter.

As we discussed, from Q2 and Q3 to Q4, which is coincident with the demand environment firming up -- not robust, but firming up.

Number two, most important to me is seeing a consistent gap in our growth rate relative to market, and we are seeing that.

And basically, any way we look at that, whether that's relative to macro indicators, some research that's been recently done, our growth rate relative to peers' supplier feedback.

So I'm satisfied on the share game side.

I like the fact that we're seeing momentum.

And then the third piece is relative to historical performance.

We look back -- this Company overall has a long track record, and you look over extended periods of time, our organic CAGR is somewhere in the 9% range, and over long cycles.

And if you look at our Q4 guide, we are guiding 7.5%, the base business a little bit above that.

We're in that ballpark, in spite of being in a soft pricing environment.

So all that said, I'm encouraged.

I think that we have things in the works, i.e.

sales force expansion, i.e.

CCSG, that if they were to execute, if the demand environment were to hold, that's where I'd like to be, is double-digit growth rate.

Okay.

Perfect.

And if I can slip in one more, can you just comment on the core MSC accounts?

Those small and medium-sized metalworking customers.

Are they coming back to life at all?

And maybe you could just talk about the growth rate year over year, if you have it?

Yes.

So I think the relative points of the base business, Ryan, the headlines would be, certainly national accounts and government out ahead of Company average in growth rate.

We view that as an encouraging sign, particularly on the national accounts front.

If you go back and look at the business over cycles, historically, national accounts have served as somewhat of a leading indicator, both on the way up and the way down.

So we view that as an encouraging sign on what could come, particularly if the metalworking environment stays as it is.

So I also think I'd point to, we are seeing a tick-up in our customer count, which in part -- I don't make too much of.

But certainly in part, is reflective of an improved environment.

So we are, again, encouraged, and I think should the environment hold and we execute, which I expect us to do, there's the potential for improved momentum.

Okay.

Great.

Thank you.

Thanks, Ryan.

John Baliotti, Janney Capital Markets.

Good morning.

Hello, John.

Erik, you mentioned in your opening comments that customers remain cautious about spending.

And I don't think that's too much of a surprise, given that all the different macro factors put in the pot together.

But it looks like, as you've talked about your core growth is sequentially improving, margin impact from these strategic investments is declining through this fiscal year.

So it seems like you're more in a Phase 2, leverage these investments out to the customer, along with the CCSG, versus, let's say, being in an internal implementation phase.

Is that how you feel about these at this point?

John, I think if you told the MSC story the past two years, the title of the story would be heavy infrastructure investment.

Certainly, combined with growth investment and market share, but heavy infrastructure investment.

I think as we look forward, yes.

I think it's fair to say that it's going to more be about leveraging and investment, continued investment in growth, and leveraging the infrastructure investments being made.

Because it seems like you're now -- with the stage that you're at in these programs, and as we see this -- the declining impact in the margin, that you are more at a point where this is -- you're rolling this out.

And you can take advantage of, let's say, customers being concerned about the efficiency of their spend.

John, I think that's at the heart of -- if you look at the MSC plan, at the heart of the priorities that we have set out for ourselves in the coming years, it's all driven by what's happening with customers.

And that dynamic is a bit of what I described in the opening remarks.

Customers are looking to get their arms around indirect spend.

They're looking for supplier partners that are going to help them do that.

More visibility, more technology, and a heavier focus on using digital channels.

And if you look at where MSC is placing its chips, and the things we're doing, it's all driven by the customer.

It's heavy investment into inventory management, into technology that's going to help our customers get their arms around their spend, and heavy investment into digital channels, as evidenced by the growth in e-commerce.

So yes, I think that's right.

And I think the point being, the whole plan is driven around where we see the customer headed.

Great.

Thanks.

Sounds good.

Take care.

Thanks, John.

Hamzah Mazari, Credit Suisse.

Good morning.

Thank you.

Just a question on the revenue -- potential for revenue synergies from Class C Solutions.

You spoke about piloting around the sales force in fiscal Q4.

Could you give us a sense of, timing wise, when you think revenue synergies could materialize from Class C Solutions?

Yes.

Good question.

What I would tell you, first of all, is that I think we will have a better feel on the next call.

I'd like to get a quarter under our belts with the rollout of the catalog and such.

I think, bigger picture, the message with CCSG is, while the top line growth has been nothing to write home around, hovering at flat, the actions being taken under the surface, and those three growth levers that I pointed to, I'm very encouraged by our execution.

And on two of those three levers, I know from experience, and we know from experience, that they translate into results.

It's tough to pinpoint exactly when.

On the cross-selling synergies, I do think there's a case to be made that could happen sooner.

I think it's a little early to tell.

But certainly, as we said, should we execute as we expect, we would anticipate it being a nice growth program for our FY15.

Got you.

And just a bigger picture question around national account business, this cycle, amongst the publicly traded distributors, the distributors are getting a lot more diversified.

One of your competitors starting to metalworking a few years ago.

Another competitor is getting more -- bigger on the production assembly line and manufacturing.

Are you beginning to see the national account business get more competitive this cycle versus prior cycles?

Hamzah, I would say in general, national accounts has certainly been a competitive arena for a while, and I think it remains as such.

And it's why Jeff pointed out that it is a gross margin headwind.

I think the exciting part to me is, it's a sector in which we can begin to see the early stages of the consolidation story start to play out.

And I think that's a piece of what's driving our national accounts growth rates so strongly, along with some of the other large nationals.

Because for these businesses, who are, again, really looking to get their arms around this neglected area of spend of indirect materials, they need the procurement and the supply chain functions that our customers need distributors that have national capabilities.

That have all of the technology and inventory management solutions to bring that -- let them get their arms around it.

And so that, to me, is the big story is, it's an arena where the consolidation story can really be evidenced.

Great.

And last question, I'll turn it over.

A few quarters ago, Jeff, I think you folks had mentioned how to think about incremental margins, depending on whatever one assumes on revenue growth.

Could you maybe remind us on how to think about op leverage in your business model?

I realize there are a lot of moving parts, with the acquisition integration and investment spend.

But how should we think about incremental margin, given the current environment?

A lot of factors affect the incremental margin, as you know, Hamzah.

And this year, the decision to make those investments in infrastructure and growth have kept that incremental margin down.

And we've given our annual framework in terms of the operating margin.

But as we lap and head into FY15, I think Erik had given you a sense of what would happen with the infrastructure expenses, and we would begin to leverage those.

The growth investments will continue as long as we're getting the type of results that we expect.

And then another factor is the pricing environment.

Got you.

So FY16 is more of a normalized op margin from you folks?

Is that fair?

I think that's very fair.

Okay.

Great.

Thank you.

FY15, you said.

Okay.

Thank you.

You're welcome.

Matt Duncan, Stevens.

Good morning, guys.

Hello, Matt.

Erik, you talked a little bit about the -- where you're seeing better growth versus other places.

It sounds like it's both government and national accounts.

Are there any other end markets within the manufacturing sector that are showing any more strength than others?

Yes.

Sure, Matt.

I think in general, it's probably no big surprises, and we've called them out over the past couple of quarters.

There are certainly pockets.

For us, I think the bigger story in the general manufacturing area, where we have heavy exposure areas like the heavy equipment, the metal fabrication markets, the primary metals, have been stable and okay and firming up, but not great.

And for us, the biggest chunk of our revenues in the core is in those sectors where it's been okay, but certainly not explosive growth.

That's how we characterize it.

And Erik, that's really what I'm getting at.

Are you sensing, from your conversations with that customer base, that there is potentially an improvement in the tone of growth coming there?

Or should we still expect the same kind of environment we've been in?

Yes.

So the tone we want to get across is definite improvement.

So there is certainly improvement, and particularly relative to prior year, where things were soft.

There is -- the fact that we're talking about order backlogs at all is a significant change from where we were a couple of quarters ago.

So definite improvement.

I think we're stopping short, though, of saying absolutely robust.

And some of the examples there are cautious outlook on capital spending and the lack of visibility beyond the next few months, which normally, we would associate with really strong demand environment.

I think what you're seeing now, and what we're seeing now in the Metalworking Business Index, is consistent with that, of a -- what we term moderate growth environment.

Okay.

And then last thing from me.

On the M&A landscape, what are you guys seeing out there right now?

And do you feel like you're far enough down the path with integrating the barn steel that you can get a little active on the M&A side?

Yes.

What I would said about M&A, Matt, is definitely, as a reminder, it is certainly part of our growth strategy.

We see it as -- and what we had talked about at the time, was M&A being a vehicle to achieve the growth plan.

One of the primary places that we would put it to use is product line adjacencies outside of metalworking.

You saw us do it once with the Class C products, with the Barnes acquisition that is now CCSG.

What I would tell you is that, as each quarter passes, and we like our execution, and we're getting CCSG under our belts, our confidence grows.

And I think seeing it -- a continued path to use M&A as a product adjacency move certainly makes sense.

We've outlined, in the past, a number of other product lines that we think make sense, where we have -- there's discussions.

We have our eye on things.

So in general, what I would say is as each quarter passes, we are growing more confident and using that as part of our plan.

And are you okay with the multiples that you're seeing out there right now from potential targets?

Where are valuation expectations?

Matt, what I would tell you one multiples is -- it's a layer's answer.

It so much depends on the business.

Because so much of it, the way we look at it is, what are the underwriting economics of what we can do to a business with synergies?

And that is just so target specific, it's tough to give you a general answer.

Okay.

Thanks.

Kwame Webb, Morningstar.

Good morning, gentlemen.

Thanks so much for taking my question.

Good morning.

I just wanted to start with CCSG.

So number one, you mentioned a lot about headcount additions.

I think historically, you guys have said 12 months is really where you expect to start to see productivity.

Is that the right way to think about that?

And then also, if you can comment on customer service issues that you're working through?

I was surprised to see that that was so high in your growth drivers list.

Kwame, I'll take both of them.

Your first one was around headcount additions.

Yes, so the message there is, we've used the first year of the business to really refine the sales force model.

In that business, a lot of leverage and a lot of learnings from our years and years with the MSC sales force, and we have some really good people who we've brought over from the MSC side that are bringing those learnings to life.

We are beginning now, in the early stages of accelerating and expanding that sales force.

To your point, yes.

We're not going to see the benefits of that until the following fiscal year.

That is a fair assessment.

The second point on customer service, I'll tell you, that, for us, really is cultural.

And at the heart, on the MSC side, while we don't talk about it a lot, it is at the heart of what we do.

And I guess it's because we've done it so consistently for so long that we don't need to talk about it.

On that business, we have, and this has been a steady process over the past year, made a lot of improvements to areas like inventory fill rates, like call answer rates.

And those are things that we know from experience translate into improved customer satisfaction.

That translates into retention, and that translates into growth.

It's just tough to pinpoint the timing.

Great.

And then just the last one from me was vending.

If you could maybe comment on how does that profitability look, versus the rest of your business?

And maybe to the extent that optically, it doesn't look as good as the rest of the business?

How should we think about vending strategically as supporting the rest of the business?

Yes, Kwame, this is Jeff.

And vending has been an important element of our growth strategy in adding to the value-added services that we've been providing our customers.

We have, as we spoke about before, a vending improvement program, designed to increase the operating margin of those vending accounts over time.

And we are progressing quite well.

We're seeing some improvement, in terms of the gross margin trends and the vending accounts, as well as the way we service, and the operating expense associated with that.

So we're progressing quite well.

And is that more just a SKU management issue?

Ar is it more of a pricing issue, in terms of improving those GM's?

It's a combination of many things within the vending improvement program, including, again, on the OpEx side.

But in terms of -- yes, it's a mix of product, some of the exclusive brand, and the overall value add we bring to the customer.

Great.

Thank you so much.

Eli Lustgarten, Longbow Securities.

Good morning, everyone.

Hello, Eli, how are you?

Fine.

I have two questions.

One, we talk a lot about soft pricing environment.

Can you elaborate, or give us some color on soft pricing, both on -- by product line?

Is it broad-base?

Is it cutting tools?

Is it one specific?

You almost characterize it by lack of price increases.

But is there a price concession that's going on, and get some idea?

And could you also do it by customer accounts?

Whether the national accounts are beating everybody up for concessions in this kind of environment?

Or (inaudible) just an idea of what soft pricing really means?

Yes, Eli.

The big message on soft pricing is it's directly related to -- this is not change in customer behavior changing competitive dynamics; this is commodities.

And the fact that it's broad-based, and the fact that commodities really haven't moved.

That is the trigger in our industry for manufacturers moving prices.

And the manufacturers' list price changes are what triggers distributor pricing moves.

That cycle just hasn't kicked in.

We did mention a couple of pockets where we potentially saw signs of life in lift in commodities prices.

It just -- it hasn't been sustained enough to the point where manufacturers are bringing increases to market.

That's the story, though.

So it's not any spillover into price concessions in the business?

No.

And certainly, as evidenced by we have, I think, done a nice job managing stable gross margins through the year.

No price deflation.

And then one other follow-up question to your growth programs and growth investments.

With a moderate growth environment, and pricing not matching anybody's expectations at the moment, can you talk about the level and timing of your growth investments?

Whether or not it's -- you have it appropriately timed in size?

Or should there be some stretch-out if things continue this way or [something]?

Or just get an idea of how you're matching your growth investments, compared to the environment's [instant folding], particularly when the environment has not [kept] up with people's hopes?

Yes.

I think it's a good question Eli.

And I imagine, particularly in relation, as you look ahead to 2015 and the op margin framework.

I think what I would say there is, our approach to -- if the soft pricing -- let's assume the moderate growth environment holds.

But the moderate pricing environment doesn't come to bear, and we are in a soft pricing environment, what happens with growth spending?

I think our answer is, as it relates to op margin versus growth investments as a trade-off there, we don't see that as an either/or.

We are striving to achieve both.

And we are in the midst of putting that all into the mix now, and as we get ready for 2015.

So in essence, you think you've probably continue on your plans -- thinks -- because the execution is so much better than (multiple speakers).

Yes.

I think what we would strive to do is invest in growth and achieve the op margin frameworks.

And of course, we've got to be mindful of the soft pricing environment, and put that all in the hopper, but that's what we're shooting for.

Alright.

Thank you very much.

Sam Darkatsh, Raymond James.

Good morning, Erik, Jeff.

How are you?

Hello, Sam.

Most of my questions have been asked and answered.

Two quick ones.

First off, I'm a little confused with the inventory commentary.

I know you mentioned a fair amount of safety stock with Columbus, and also the new SKUs.

Yet inventories, at least on the year-on-year basis, were only up about 3%, with organic growth up about 7%.

So where's the disconnect?

Are you paring back on inventories in the base business outside of the initiatives?

Or where's the disconnect?

Yes.

No.

Actually, I think it's strong execution, Sam.

We have a new forecasting system that was put in place, and we're levering that quite well across our distribution network.

Okay.

Excellent.

And then last question.

And I apologize for asking this question a different way that's been asked over and over and today, I think.

But you have the absence of the infrastructure spending, the 50 basis points that you referenced for FY15.

If you continue at this general volume growth rate next year, the high single-digit growth rate, at present time, would you leverage OpEx more so than the 50 basis points next year?

Or should that be just what we are expecting, because of the additional growth spending?

Sam, it's Erik.

So yes.

You're getting at 2015, and I'll tell you, we are right in the midst of doing the work.

So you have a few factors.

First of all, remember, even at the start of last year, what we said was the op margin uptick in 2015 would be modest, slight, whatever we called it.

And that was in recognition of the fact that, while execution of the infrastructure would largely be behind us, particularly as it relates to Columbus, there was a significant step-up in expenses.

So there will be op margin, if you will, eaten away by Columbus in FY15, and that's the case regardless.

And that was part of what was driving the modest uptick in 2015.

And we weren't into full -- what Jeff described as full incremental margin mode until 2016.

So certainly, that's a factor.

The other -- what you're doing is giving me a growth assumption and saying we continue in moderate growth environment.

I think we're going to need to get a better sense of what happens in the pricing environment, and line that up with some of our internal priorities and put that all together.

And that's what we'll give you next quarter.

It's just a little early to say.

Very good.

Thank you much.

And this concludes our question-and-answer session.

I'd like to turn the conference back over to John Chironna for any closing remarks.

Thanks again, everyone, for joining us today.

Our next earnings date is set for Tuesday, October 28, and we look forward to speaking with you over the coming months.

The conference is now concluded.

Thank you for attending today's presentation.

You may now disconnect.