MSC Industrial Direct Co Inc (MSM) 2014 Q4 法說會逐字稿

Good morning and welcome to the MSC Industrial Direct Q4 and full-year 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 and good morning everyone.

I'd like to welcome you to our FY14 fourth-quarter and full-year conference call.

An online archive of this broadcast will be available one hour after the conclusion of the call and 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 regards 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 investment and strategic plan, including the CCSG acquisition and 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 and the MD&A sections of our latest annual report on form 10K filed with the SEC, as well as in our other SEC filings.

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

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

In addition, during 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 the adjusted financial measures for the most directory comparable GAAP measures.

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 is Jeff Kaczka our CFO.

As we are now entering our FY15, I'll use the call to step back, assess the Company's progress over the past year, and update our path forward.

I'll start with the headlines.

We are seeing the benefit of our market share gains through accelerating growth rate from momentum as the manufacturing economy improves.

We are building a new growth platform in CCSG with a very strong value proposition and a huge growth runway at high incremental margins.

We are executing on our growth and infrastructure initiatives as planned.

We are moving our portfolio of business to value-add sticky channels with high retention rates.

While we're temporarily impacted by the current pricing environment, and that is affecting our anticipated near-term operating margin performance, I remain confident in our earnings power as we leverage our investments and move through the abnormally soft pricing environment.

Last year at this time, we provided an annual framework to gauge progress during our FY14 and then a three-year perspective on the Company's performance.

I'll summarize our view as follows.

The Company's been in a period of investment required to position it for success.

Much like we've done at other points in our history, we've stepped up infrastructure and growth investments to position us for the next chapter of the story.

Additionally, we've been absorbing CCSG, the largest acquisition in Company history and one that offers a new strategic avenue for growth in the years to come.

Those investments have temporarily suppressed operating margins but will produce long-term returns in the form of sustainable market share gains that translate into top line growth and earnings leverage once we move past this current investment phase.

Looking at the year end review, we anticipated FY14 adjusted out margins in the range of 14% to 15% depending upon on the growth environment.

Assuming certain macro conditions, we also expected 2014 to be the bottom with respect to operating margin.

We anticipated modest operating margin improvement in FY15 and then a return to more typical incremental margins and hands operating margin expansion in FY16 and beyond.

Our two critical assumptions were one, a moderate demand environment and two, a moderate pricing environment.

As I look back on the past year, I'm pleased with our performance as we executed to our plan.

First, we continued our market share gains.

Our organic growth rates improved sequentially as market conditions improved and we maintained our significant share gain Delta above industry growth rates.

Second, we accomplish our primary goals with respect to the integration of CCSG, including earnings per share accretion.

Third, we executed toward our investment plans both on the growth and the infrastructure fronts.

Fourth, we achieved a financial targets that we laid out at the start of the year.

I am now turn things over to Jeff to discuss the financial results in greater detail and provide our fiscal first-quarter 2015 guidance.

I'll then return to provider our Outlook for FY15 in its entirety and for the longer term.

Thanks Erik and good morning everyone.

We continue the trend of improving average daily sales growth with an increase of nearly 8% in the fourth quarter and that momentum continued into our FY15 first quarter.

In addition, we achieved the top end of our adjusted earnings per share guidance of a $1.02 for the fourth-quarter despite gross margin coming in below our guidance.

As I get into the details of our fourth-quarter results, please note that this was the first quarter were for comparisons to prior year included a full quarter of CCSG activity.

Accordingly, our sales growth for the quarter is completely organic.

I'll remind you that while nonrecurring integration costs related to the CCSG business were quite small in the quarter, I will continue to speak in terms of our reported and adjusted results.

For our sales for the quarter came in at $726.6 million, reflecting an average daily sales growth of 7.8%.

The base MSC business grew at rates well above that, while CCSG crew in the low single digits.

Growth in the base business was fueled by national accounts and government, each of which grew at healthy double-digit rates.

Growth from vending accounts also continued to be a big driver contributing roughly 4 points of growth.

Turning to gross margin, we posted 45.6% for the quarter, just below the low end of our guidance of 45.7%.

The pressure on gross margin can be attributed to two factors, the mix of business coming from large accounts and vending, and the soft pricing environment.

Our reported EPS for the quarter was $1.01 and $1.02 on an adjusted basis, which excludes the nonrecurring CCSG integration costs.

Achieving the high end of our adjusted EPS guidance of $1.02 despite the pressure from gross margins, reflects our continued careful attention to operating expenses as well as favorability in our tax rate.

Our tax provision for the fourth quarter came in at 36.7% versus our guidance of 37.7%, mainly due to increased charitable contributions and the release of state tax reserves.

Turning to our balance sheet our DSOs were 47 days, slightly higher than last year's fourth quarter, and reflecting the higher growth in national accounts.

Inventory turns improved to 3.55 from last year's 3.39.

As expected we continued stocking the Columbus distribution center in preparation for the grand opening at the end of September and inventory levels ended the year at $450 million.

Given our current sales growth expectations and some further stocking in Columbus, I would anticipate inventory increasing by another $35 million or so in our fiscal first quarter.

With regards to the operating cash flow, we generated $46 million in the fourth quarter.

That of course was after the buildup of inventory related to the Columbus facility as well as growth in receivables related to national accounts.

We paid approximately $21 million in dividends and incurred capital expenditures and infrastructure investments of approximately $15 million, bringing our total CapEx for the year to $96 million.

As of year-end, our total debt stood at $337 million, primarily reflecting our outstanding term loan of $238 million and a $70 million balance on our revolving credit facility.

I should note that since our year-end, we've repaid $50 million of the outstanding revolver.

We finished the fiscal year with $47 million in cash and cash equivalents.

During the fourth-quarter, we also repurchased 857,000 shares at an average price of $87.60 per share.

Now let me turn to our guidance for the first fiscal quarter of 2015.

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

We expect total revenues to be between $727 million and $739 million, up 8% from prior year at the midpoint.

Excluding the impact of the refined accrual for direct ships, which elevated last year's reported sales, this translates to 8.6% transactional sales growth for total MSC.

Although the growth rate for CCSG remains in the low single digits, we are particularly pleased that the base MSC business excluding the drop-ship accrual impact, is approaching double digits.

We expect gross margins to be in the range of 45.3% plus or minus 20 basis points which is down about 110 basis points from the year ago quarter.

Once again, this is driven by two factors, the weak pricing environment, and mix.

In regards to pricing, our annual catalog price increase was only about 1.5 points.

This compares to normal increase of 3% to 4%.

So this year's increase was about 200 basis points below the norm.

In regards to mix, national accounts, government, and vending are all growing at a rapid pace.

We are pleased with this but these are the lower gross margin areas of the business.

Over time, we would expect core and CCSG growth rates to pick up and have a positive impact on gross margin.

For the first quarter, we expect adjusted operating expenses to increase at the midpoint of guidance by $3 million versus the fourth-quarter.

Despite the additional cost, for the Columbus distribution center, for variable costs on higher volume, and for growth investments, offset by productivity.

So the midpoint of our guidance implies an adjusted operating margin of approximately 13.5% in the first quarter, which is consistent with the operating margin framework that Erik will describe shortly.

Our tax rate is expected to be 38.3% and this all results and adjusted EPS guidance of $0.95 to $0.99.

This earnings guidance includes CCSG operating results and excludes integration cost, which are expected to be about $0.01 in the quarter.

Now that we are well into the integration, we will no longer separate CCSG from the rest of the business.

Therefore, moving forward, we will not report accretion levels for CCSG.

We will of course continue providing directional color on performance.

In summary, I'm pleased with the growing momentum on the top line and that we hit the high end of our earnings guidance for the fourth quarter.

I am also pleased that we achieved the FY14 framework on operating margin while making significant investments that will strengthen us for the future.

Finally, despite the soft pricing environment, I remain encouraged by the sales growth momentum that is continued into the first quarter.

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

Thanks Jeff.

As we did last year, we will now look out beyond our first quarter and I'll provide a framework for thinking about our operating margin performance for FY15.

This should help you understand how our business will perform under various scenarios.

We've summarized that on slide 5 in the presentation.

The four operating margin scenarios that you see are based on two factors, the demand environment and the pricing environment, and both have a meaningful impact on our business.

On demand, we see a moderate and a high demand environment as the likely scenarios.

A moderate environment should correlate with high single-digit sales growth rates up to about 10%.

This is how we characterize the current environment based on macro indicators, customer sentiment, and supplier Outlook.

A high-growth environment on the other hand should correlate with strong double digit growth rates.

While the low growth environment is possible, at this point we don't see it on the horizon.

Under either scenario, what's most important is that we continue to maintain and accelerate our share gains.

I remain pleased along that dimension, as I look back at FY14 and our performance in this first quarter.

We are currently growing at high single digits when the distribution industry is growing some where in the 3% to 4% range.

The resulting share gain Delta of 4% to 5% annually, is one that we expect to maintain and ultimately grow as our investment programs pay off and you can see this playing out on slide 6. With respect to the pricing environment, we also contemplate two scenarios, a low or soft price environment and a moderate one.

As of now, we are in a soft pricing environment.

We make this judgment based primarily on the rate and pace of manufacturer list price increases.

We then supplement that view with customer sentiment and a review of macro pricing indicators, such as commodities movement and measures like the intermediate goods ppi, a gauge of pricing for a wide range of finished and unfinished goods across the economy.

As you can see on slide 7, intermediate goods pricing has been soft for over two years and that's directly influencing the ability to raise prices.

One encouraging point is that, if you look over the past 30 years, the periods of soft pricing have generally only lasted about a couple of years.

Not surprisingly, in the soft pricing environment, as the one we are currently in, it's difficult for us to expand, or in the case of our fiscal first quarter, even maintain gross margins and that of course impacts our operating margin percentage.

In a soft pricing environment with moderate sales growth, we see modest contraction in operating margin percentages represented by the lower left quadrant on slide 5. Of note, this also of course takes into account the increasing infrastructure cost of Columbus.

As we move to a higher growth case, operating margins would be more or less flat with prior year, represented by the lower right quadrant.

The reasons for the suppressed operating margins under these scenarios is the impact that soft pricing has on our gross margin.

Without inflation, the offsetting loss of the price tailwind is more profound than the purchase cost benefit that we realize; and therefore, has a significant impact on our results.

Another headwind that we are experiencing and that Jeff mentioned is our mix of business.

National accounts, governments and vending are all gaining momentum with strong growth rates well into the double digits.

These, however, have gross margins that are considerably below Company average.

The growth in the segments is a clear sign of share gains and the early stages of industry consolidation beginning to play out.

At the same time, our higher gross margin areas including the core and CCSG, are lagging the Company average for now.

You can see this gross margin dynamic and its impact on earnings in our fiscal first quarter.

Jeff already covered the gross margin impact earlier, but I'd note that in a normalized pricing environment, we would expect double-digit EPS growth.

One question that we've received is whether the current soft pricing environment is due to a structural change in the industry, such as competitive movements to new entry enhances the new normal.

Our answer is a clear no.

The current environment is due to the lack of commodities inflation and that's resulted in a protracted period of extremely modest manufacturer price increases.

As we look to the future, there are some encouraging signs on the horizon, including some active commodities movement and significant announced price increases by the big freight carriers for calendar 2015.

We think that does bode well for a change in the pricing environment, next calendar year.

To be clear, competitive activity in our industry remains fierce.

However, that dynamic is no different from what we would've said 5 years ago or 10 years ago and the primary pressure continues to come from local distributors who are feeling the effects of industry consolidation.

We are, of course, mindful of new entrants into the MRO space and into our core metalworking business.

We pay close attention and are laser focused on sustaining our leadership position.

This is why we will not back off of important growth investments or our actions to enhance our value proposition.

We've been on an ongoing journey to position the Company strategically by moving our portfolio to higher value-add and higher retention business.

You've seen this play out through many of our initiatives including metalworking, class C, vending, inventory management, e-commerce and more.

I feel very good about how MSC is positioned to succeed in the next decade as the consolidation story accelerates.

Now returning to our FY15 framework, while themes like gross margin declines in a soft pricing environment, should not be surprising, what might be is that we don't expect to see either gross or operating margin expansion under the moderate-moderate scenario.

This is a change from what we described at this time last year, so I want to hit it head on.

Last year, we said that we expected to see slight or modest operating margin expansion in a moderate demand moderate pricing environment.

Here we are now projecting a very modest decline in this type of environment.

That change is because we are already beginning the year in a soft pricing environment and that makes it more difficult to make up over the balance of the year.

Again, we are quite hopeful that the encouraging prospects for calendar 2015 lead to an improved pricing environment and that would of course mean a significant mid-year price increase.

Even in that case though, given that the first [ push ] portion of our year is really a moderate low scenario, the average of the two results in the picture that I've described.

The case for FY15 operating margin expansion happens in two ways, one is the demand environment moves to high and we think the chances of this happening are quite possible.

While we continue to characterize current conditions as moderate, we are encouraged by a few data points with respect to 2015 with the back half of our fiscal year.

Certainly customer sentiment is gradually improving and macro indicators remain solid.

Additionally, the initial forecast for 2015 tooling consumption looks strong and that bodes well for our core customers.

The second case for operating margin expansion occurs if the pricing environment becomes not just moderate but robust.

While we don't see this as likely as we do on the demand side, it certainly is plausible.

The framework I just laid out describes our business in terms of operating margin percentages.

Let me also touch on earnings per share growth.

Implied in this framework is that EPS grows for the year in each of the four quadrants with the exception of the bottom range of the lower left, the low price moderate demand scenario.

EPS growth would exceed revenue growth at any point in the matrix where we project operating margins to expand.

For example, should the high demand moderate price scenario come to fruition, it would mean top line growth rates well into double digits and EPS growth at slightly higher rates generating operating leverage.

Before I move on from FY15, let me touch on two topics.

Investment spending and CCSG.

We are proceeding according to plan with respect to investment spending.

We completed our big infrastructure initiatives in FY14 on time and on budget.

Davidson is now fully in our run rate, while the data center move is also complete and many of the expenses have subsided.

Columbus is now open, so expenses will step up and the fiscal first quarter in both depreciation and hiring, becoming permanently embedded in our PNL and starting to get leveraged as we move through the year and generate our expected top line growth.

I attended the grand opening last month and I'm thrilled with the building and more importantly with the team.

So overall, spending on infrastructure was as planned and is increasing slightly now as expected.

Our organic growth in investments also remain on track.

Those include vending, e-commerce, product expansion, and sales force expansion.

We anticipate all continuing as expected in FY15.

At this point, that is including CCSG, we expect to grow sales force headcount by roughly 8% to 10%.

That's based on the early performance of our new class of sales Associates and on the compelling share opportunity that we see.

Should we see a continuing gross margin drag based on an ongoing soft pricing environment, we would consider tempering our rate of investment as appropriate.

Investment spending notwithstanding, our performance on OpEx is in line with planned and what we had anticipated.

I'll now turn to CCSG.

FY14 met our expectations.

We achieved $0.19 in EPS accretion towards the high end of our range.

We executed a large portion of the integration plan and in doing so did much of the heavy lifting to lay the foundation for a strong growth platform.

On the back end, we closed several facilities and capitalized on purchase cost and other contracts savings.

On the front end, we retooled the sales force to become more aggressive, performance driven and MSC like turning over nearly 30% of the sales organization.

Despite this planned turnover, we turned a mid-single-digit decliner into a low single-digit grower towards the back end of FY14.

Looking ahead to FY15, we had two financial goals.

$0.30 to $0.40 of EPS accretion, and $15 million to $20 million of cost synergies, as a run rate by the end of this fiscal year.

Our approach with acquisition is to come in with clear plan and then use our experience with the business to learn and thoughtfully incorporate best practice.

For example, we have decided to leave two of CCSG's distribution operations open at part of our network given the unique value to our business as part of the class-C platform.

This is despite the fact that this will likely put us at the lower end of the cost synergy range.

With respect to EPS accretion, our current forecast also puts us at the lower end of the stated range, primarily due to the relatively slow ramp in sales growth.

While not satisfied with the low single digit growth rates the business has seen today, we've seen improvement from the trending in that business and our vision is that this will grow at MSC rates or higher overtime.

There's a couple of factors at play with respect growth.

First, there are macro factors influencing the business, namely the relative weakness of the Canadian market along with currency impact and the softness of the US natural resources sector, which is an important end market for CCSG.

Second, the three growth levers of customer service improvements, sales force which will in an expansion, and cross-selling are as expected taking time to ramp.

They've begun providing benefits that will increase moving forward and I'll briefly touch on each.

First, we continue making solid progress on service improvements which are tracking to plan.

Second, sales force expansion; we spent our first year setting the foundation by bringing MSC sales management practices and expectations to bear.

We had significant planned turnover in order to reposition the sales organization as one that is aggressive and cost efficient so we see more upside and incremental margins as we grow.

Despite the sales force turnover, we were able to slightly improve the growth trend in the business and that's a testament to the stickiness of the CCSG value proposition.

We are now at the point where most of that foundation building has been done and we are starting to expand the sales force.

Third, is cross-selling; our primary cross-selling initiative is the introduction of the MSC offering through catalog, Web, and promotions into the CCSG customer base.

This initiative only began in July and we expect it to take time to become fully embraced but early signs are encouraging.

Looking beyond FY15, the elements are in place for the CCSG growth story.

We have a solid foundation with a compelling value proposition, a rationalized operation, a re-engineered and lower-cost sales force, and stronger levels of customer service and execution.

Let me now turn back to the entire Company and look out longer-term.

We expect to increasingly leverage our investment spending as we grow.

Therefore, we are confident that our existing business will produce historical rates of incremental margins and enhance our operating margin expansion.

There's a few assumptions implicit in that statement.

First, the pricing environment returns to a more normalized level.

We don't need a robust environment but just one that is moderate.

Second, our mix headwind mitigates.

The headwind of large accounts and vending will certainly remain but we don't anticipate it being as severe as it currently is.

We expect a high-margin CCSG business and our core to see accelerating growth rates in the quarters to come.

Together, these factors would deal with a more stable and an even expanding gross margins picture and we would then expect leverage on operating expenses to produce healthy up margin expansion.

Nothing has changed with respect to our execution of investment programs, our spending in the business, and hence the kind of leverage that we see once we move past the temporary headwinds from the investments that we've been making.

We still expect the business to return to high-teens operating margins over time as the pricing and mix influences become more normalized.

There's one added dimension to our plan this year and that's capital allocation.

We plan to continue a conservative posture but believe that there's room to keep the company secure and opportunistic while building more progressive in our capital allocations.

We will continue to take a balanced approach and how we return cash to shareholders and that includes consistent ordinary dividend increases, occasional special dividends, and opportunistic share repurchase as you can see on slide 8. We are however increasing our use of these tools.

We'll continue to use share repurchase opportunistically, like we did in FY14, when we repurchased over 2 million shares.

We plan to continue growing our dividends as we've done over the last several years and we're paying a $3 per share special dividend as another means of returning cash to shareholders as we've done from time to time in the past.

These moves, while significant, still allow plenty of room for share repurchase and strategic M&A.

They will still result in a conservative leverage ratio as measured by net debt to EBITDA, and we are quite comfortable in the current range and for the right opportunities, we certainly increase that ratio but will continue to maintain a conservative balance sheet.

In summary, I'd like to thank our team for their hard work and dedication this past year and for the year to come, and I'll now open the lines for questions.

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

(Operator Instructions)

At this time, we will pause momentarily to assemble our roster.

Sam Darkatsh, Raymond James.

Hi this is Josh filling in for Sam.

Thanks for taking my questions, guys

Hi, good morning, Josh.

Could you talk a little bit more about what some of the primary puts and takes might have been in the margin in the fourth quarter versus what you may have been playing internally six months ago?

Yes, Josh sure, it's Erik.

And I assume, in margin you are referring to gross margin?

Both gross and operating margin.

I think so.

If I step back for a second, and look at the big picture and then I'll drill in on your question.

We feel very good how we are executing and I think if you would have asked us how does the fourth-quarter and even the first quarter play out relative to expectation, I think what we are seeing on the revenue side is what we would've expected to see, that as the environment improves our share gains maintain and expand and we see that and sequential top line improvement we did.

On the OpEx line, really just as planned.

Good expense control, we did see sequentially increases based on the step up as an investment just as planned.

I think certainly the one surprise would be on the gross margin line and as we talked about it, have talked about historically a gross margin equation is really a set of puts and takes as you referred to it or will sometimes call a tailwind and headwinds and as Jeff described, what you're seeing is two unusually large headwinds right now that over time we expect to abate.

One being the soft pricing environment, and two being a more pronounced mix effect then we would typically see based on strong gross growth and share gains in certain of the segments that we have described and growth in the core CCSG higher market segments that led Company average.

Thanks.

And then you've talked about the mix headwinds from large customers updating over time.

Would that be because of an acceleration in the smaller customers or could you detail that a little more?

Sure.

Good question.

And the short answer is yes.

We certainly like what we're seeing in the large customer segments of government national accounts and in our vending channel.

So, we absolutely like the momentum there.

What we are seeing and what we would anticipate out on the horizon is that just as you said those two channels CCSG and our core would pickup as well.

I'll touch on each briefly.

With respect to CCSG, you heard in the prepared remarks, we have a whole lot of focus and heavy lifting that has gone out over the past year.

We feel like we're ready to leverage that platform and it offers us a tremendous growth runway.

With respect to our core, I think what were seeing in the core tracks very much with what we're seeing and hearing in customer sentiment and in the macro indices, which is that the core smaller customers are lagging larger customers.

It's not a phenomenon that's new to us if you look back over prior cycles we've talked about this that both up and down the larger accounts tend to lead the way in the smaller accounts follow.

Our sense is that is what is happening here and that's senses concerned confirmed when we look out at some of the forecast for 2015 that contemplate, I mentioned strong two in consumption most of those forecast is suggesting that would be both in larger and smaller shops, so short answer is we expect the two higher-margin segments to improve in growth.

One more if I might, it looks like the implied range for November daily sales growth is pretty wide.

Is there a reason for the wide range?

I don't know that is wide.

But one thing we would call out Josh is that remember Jeff referred to last year's direct ship accrual that was right for the month of a couple hundred basis points, that was strictly in November.

That is impacting, you know, on a transactional basis, I think the headline is we really like what we're seeing particular right now in the base business.

Solid sequential growth improvements and when we look at October and November as Jeff had mentioned, it's starting to hit the double digits.

Thanks guys good luck with the next year.

Thank you.

Ryan Merkel, William Blair.

Thanks good morning, everyone.

Hi Ryan.

I think first, on gross margin you're guiding it down about 80 basis points I think for FY15.

Can you just break that out?

How much of that is mix and how much of it is a softer price backdrop?

Ryan, so, the one thing I say is the gross margin obviously in the framework that we played out in the four quadrants, if you will, different assumptions about gross margin given the correlation between gross margin and pricing.

But certainly near-term, we talked about what you're seeing right now in the prepared remarks roughly even split between the mix and the soft pricing influence and so if you look Q1 in particular, roughly in between both

Okay.

Then I want to ask a question about FY16 just so I can kind of understand what you're saying here.

If we are not high-growth environment, in FY16 and you get 1% price again, could incremental margins approach 20% because the investment spend is falling off?

And then second part of that question is if we're in a 3% price environment some more normal are you over 20% incremental margins in 2016?

Okay, so Ryan let me try to explain the dynamics of what's happening here.

Right now, what you're seeing is three things impacting the current performance of the business as it relates to operating margin percentage.

Those three things are number one, a temporary headwind as we expected as anticipated from the investment step-up.

We had said that this was the last year of the lingering effects, so that's one.

Two is an abnormally soft pricing environment and then three is an unusually large mix effect.

Take the first effect, we expect as we, nothing has changed with respect to how were executing and our investment programs and expense management.

As we move through FY15, we anticipate the OpEx headwind the investment headwind to mitigate.

The other two factors, the mix factor in the price factor, we would, as we look out over time, we think there pronounced now, we would also expect them to abate.

Certainly, when you take those three factors together, what we are trying to get across, is when we look out past the current environment, we see all three of those factors moderating.

That produces more historical levels of incremental margins, which we would call in the 20%'s.

Okay perfect.

Then just last one for me, you mentioned that the competitive environment today is really no different than five years ago.

I just want to ask on Amazon supply, are you seeing them at all in the market?

Has anything changed there, are customers asking you about Amazon?

Just a little update there.

Yes, Ryan, good question let me just clarify.

Certainly, the competitive environment is more intense now than it was a couple of years ago, I want to be clear.

My point is that's the same answer that you would've received two years ago that as this industry unfolds, solely competitive intensity picks up, I think you're right though, the big headline is, no real change in the dynamic, meaning where the pressure is coming from.

To answer specifically on Amazon supply, very minimal Ryan.

I think, if you triangulated outside of MSC and just looked at reports on their traction, certainly not to suggest we don't take it seriously for the future, but if your question is any impact today, really minimal.

Perfect thank you.

Matt Duncan, Stephens Inc.

Good morning guys.

Hi Matt.

Going back to gross margin for a second Jeff, is there any impact on gross margin from the opening of the Columbus DC here in the first quarter of it there may be lessons over the balance of the year?

No impact from the Columbus opening.

On gross margin.

Okay, so there's no doubling of inventory or double headcount right now that you would have headcount

There is an increase in inventory associated with that but that has no impact on the gross margin.

Okay all right so then

Some on OpEx though, so there is an impact at the operating margin level.

Okay.

Then Erik, last year you had said that he would get back to high-teens op margin at $3.5 billion in sales.

I want to make sure that we make sort of understand.

Is that still a doable thing or is it really going to be a function of how sales gets to $3.5 billion, going back your conversation around price?

Can you get to that high teens to $3.5 billion without moderate price or do we have to have it?

Matt, very good question, so here's what I would say.

To a large measure, the high-teens at $3.5 billion is going to be a function of what plays out this year.

Okay, so if you told me right now that where we land for FY15 is that upper right quadrant, what I would say is we're basically right on track with what we had anticipated last year and it's well within reach.

If that weren't the case, in the extreme case is where we landed were in the lower left quadrant, what I would tell you is certainly it's still an achievable goal; however, we would need one or two years of robust pricing to offset the couple of years of soft pricing because that robust pricing would lead to significant gross margin expansion and enhance significant incrementals.

The answer, it's largely a function of where we land this year.

That got it.

On the special dividend, can you talk about the rationale as to why now?

Well Matt, as Erik had described, we see the opportunity to be a little more progressive in our approach to capital allocation.

The business consistently generates cash beyond what the business requires and we took the approach of being a little more progressive yet maintaining our conservative nature and our flexibility and we believe this would increase the returns to shareholders.

We also believe we'll continue to take a balanced approach there and you've seen we're investing organically in the business.

We did a large acquisition not too long ago.

We did share repurchase a significant amount of share repurchase this year and we're balancing that with a special dividend.

Okay.

Last thing from me, does this special dividend say anything about your appetite for larger acquisitions or is it too mutually exclusive?

I would say, Matt this is Erik.

I would not connect the two.

I think, yes strategic M&A remains a part of our plan and I think what you should read into the special is two things.

Number one, is confidence in our plan in the future and in the cash generation of the business.

We feel very good about our prospects.

Number two, as Jeff described, we together step back, look at our balance sheet and looked and saw an opportunity.

We have done a very good job historically in this business of operating well and we feel like this is another tool in the arsenal to increase total shareholder return while still keeping the Company conservatively managed.

Perfect thanks Eric, appreciate it guys.

Thank you.

David Manthey, Robert W Baird.

Thank you.

Good morning, guys.

First off with the change in gross margin, if it's flat or going in reverse, the contribution margin clearly gets tougher and becomes less meaningful as a performance metric.

As you're thinking about managing the business, the cost side, are you looking more now at the read-through or pull-through margin changing even over changing and gross profit dollars and if so, or even if not, could you tell us how we should think about that metric, where do you think that would land in going forward?

David, I think for us, as we look at spending, I think if you look if you look at was happening here.

We are operating two plans with respect to our expenses and certainly we are mindful of the fact that gross margins are pressured in a soft pricing environment, we noted that.

If that extended, certainly we would evaluate tempering some of our investments but we do look at, with respect to investment spending for instance, decoupling it from gross margin per se and looking at the investment on its merits and the spend on its merits.

Certainly, we haven't lost sight of one of the metrics for a long time that we've reference, which is incremental margins in the business so that something we look at.

And as we said, as we get to a more steadied state, we still see incrementals in the 20%'s.

We still see this as a high-teens of margin business over time.

Our perspective is we are going to manage expenses carefully, make investment decisions prudently really regardless of environment.

Okay and then with the growth in large customers and government and vending, could you remind us in terms of EBIT contributions of that mix relative to gross margins in terms of lower cost to serve, is the Delta on the EBIT line much, much closer or could you just talk about what that is?

Yes, the answer is David, it's a lot closer.

It's a more significant headwind on gross margin, much closer on the EBIT margin.

One I'll call out, we have referred to our vending improvement plan for a while, while vending does continue to be somewhat of a gross margin headwind, I will say that we've seen a nice improvements there.

We don't see it right now as an improvement on the operating margin line.

Excuse me as a headwind on the operating margin line

Okay.

Then finally, in past calls you talked about some of the industries and areas where you're seeing better strength or your weakness etc.

And I think last time you talk more about heavy equipment and primary metals and metal working.

Are those still doing well for you or any other areas you want to talk about?

Yes, Dave, I would say in general what we are describing as a gradual, so we certainly wouldn't say we see rapid acceleration in the economy but we've continued to see progressive improvements across most segments and I think you're seeing that reflected in our growth rate.

I think the one thing that I call out is right now, the divide between the larger businesses and the smaller businesses and that is impacting and specifically the fact that we are seeing larger businesses growing faster, their business, growing and more robust then smaller businesses and the way that is playing out and our dynamic is as we describe the larger segments growing faster than the core.

It is something, as we look ahead, there's a few theories on why that's the case.

It's something we have seen historically in our business before this national account tends to be a leading indicator and we are encouraged that most of the 2015 forecasts that are suggesting that smaller businesses are going to enjoy slow growth as well as the larger businesses.

We think that bodes well for mitigating some of the mix headwind.

Got it, thanks Erik.

Thank you.

John Baliotti, Janney Capital Markets this would have

Thanks, good morning.

Erik, I think, you know the comment you made about large customers growing faster and that tends to lead the rest of the group, that I think has gone on for a couple quarters but I think what's interesting is that your active customer size has steadily improved its growth, year-over-year growth rates, since the beginning of the fiscal year; and had, what appears to be its best growth in this final quarter.

I was just wondering could you talk about that a little bit?

Yes sure John, one thing I'd note is, this quarter, we added into the op stats, you'll see a footnote there that we added in for the first time given that we've lapped CCSG.

You'll see a big jump up.

That is the unique CCSG customers coming into the fold.

Ex that though, look, you're right.

What you'd see this quarter is still sequential improvement in the customer count.

I attribute that probably less to macro and more to some things that were doing in the business on the retention side on the marketing side.

As you know, we've not put too much on fewer customer count and to be honest, we still don't.

So, certainly all those being equal, yes, nice to see you lift, I wouldn't make too much of it though.

I guess if you lead up a fourth quarter, even look at the other three quarters and look at your total associate growth, it seems like there's opportunity for leverage there.

I know we talked a lot of about gross margins on this call but you know the other side of that, your operating expenses.

It seems like -- I know they are going to go up initially but it seems like aside from the headcount growth you're talking about for the year, it seems like what we saw a couple quarters this year that there's implied, you're going to get some leverage off of those, that headcount?

I think John I think it's a fair point and it's certainly one of the messages we want to get across.

We see a lot of leverage inherent in the business because we have over the last couple of years put down a significant infrastructure build that's been the OpEx headwind, we see it on the MSC side, so I think you're right.

We also see it on the CCSG side.

Where we've done a lot of heavy lifting to get the business ready to grow, so we see leverage on both sides, which is why, once we get through the noise, we do see significant operating margin expansion in this business to get back to high-teens over time.

Great okay thanks Eric

Thank you John

Flavio Campos, Credit Suisse.

Hi good morning everybody, thank you for taking my question.

I just wanted to focus for second on the non-manufacturers of the business that's been accelerating quite significantly over the past couple of quarters.

Can you give us some color what's driving that and if there's any, what's the margin profile there that's helping or hurting gross margins and what's the Outlook on that side of the business?

Flavio, good observation and what you're referring to in the non- manufacturing growth rates really tracks back to the success that we are having in the large accounts segments, so government is going to fall in non-manufacturing, as we've described really a strong period of growth, you know to some degree, we would attribute that to a more stable budget environment on both the federal and the state side but to be honest, we also see a lot of share gains there.

We think that while things were soft in the government sector, we took the time to really focus and achieve some nice share gain wins that we're seeing now as spend takes up.

I'd also say on the national accounts front, there's a slightly larger exposure to non-manufacturing.

What you're seeing is the benefit of the large accounts growth, which is as we've described and the margin side, slightly lower on the gross margin side and part of the headwind.

Moving forward as we've discussed should things play out as many of the forecast indicate in calendar 2015.

What we would anticipate as we move through the back half of the year is not that the non-manufacturing growth rate comes down but rather the mix impact mitigates because the manufacturing growth rate picks up based on the core of the smaller shops as we've described.

Perfect, that's very helpful.

A quick follow-up on a different front, e-commerce, what about e-commerce [ expanding ] how's that doing online and VMI and as I understand those are a higher-margin businesses?

Yes, so e-commerce right, Flavio, as you know, e-commerce is a accumulation of a few pieces of electronic business and that continues to grow.

We didn't call it out, we can certainly, we'll make sure on the follow-up call we will give you the percentages as we normally do.

It continues to do quite well.

You are right, the primary channel there is MSCDirect.com that continues to grow as a percentage of sales an important part of our value proposition and how we get, as we refer to at sticky with customers.

The one thing I would note while MSCDirect.com from a margin standpoint tends to be quite good, we have said vending, a portion of our vending program, is part of the e-commerce and those gross margins are lower.

The e-commerce bucket, sort of a mixed thing on gross margin, but in terms of the performance of the e-commerce channel, very strong, and as I've said part of our plan to get stickier.

Perfect, very helpful, thank you for taking my questions.

Sure.

Eli Lustgarten, Longbow.

Good morning, everyone.

Hi, Eli how are you?

Fine.

Just a couple of fine points we've covered a lot of material here.

One, can you talk about what your actual investment spending and CapEX spending will be with 2014 and 2015 and 2016, so we can get, have a way to calibrate that and I mean we're talking about approaching the peak of that market, so can we get some way to calibrate those numbers?

Sure.

I'll take that Eli.

In FY14, our CapEx was about $96 million, as I had mentioned, that was slightly below our expectations as we've looked at FY15, I'd expect it to kind of be in the range of $75 million to $85 million.

We do have some carryover associated with the Columbus facility in that number and then, of course continued investment in vending as well as IT and some other supply chain improvements.

You expect that to continue going down in 2016, is that correct?

The trend in it would depend on other investment opportunities would, the expectation would be that would moderate.

Going back, I know a lot of the focus was more normalized pricing, more normalized customer mix, but have you ever started to look at the probability that there is a new norm that is developing and it may not be at one extreme or the other extreme but somewhere in between?

For example, vending will continue to be one of the stronger growth markets of e-commerce will continue to probably be gross markets.

National Council continue to be very strong over the next couple of years, as we set expectations, and the probability of commodity prices and investments and resource will remain subdued at least within a couple years according to every point of every Mining Company that we talk to across the board.

I'm just wondering, is there a contingency plan or did have you factored the case of some combination thereof of things not going back to the level you know that we'd like it to?

Eli very good question.

What I'd remind you is right now, what you're seeing right now, you've got three things going on and so one is this temporary spike in investment spending.

That's going to abate.

Two, the soft pricing, which as we mentioned and the third is the mix.

In terms of the new normal, the first one is going to mitigate, as we move through the year, so that we know and is in our control.

Of the other two, certainly it's plausible and it's on the pricing front it's plausible that commodities inflation would stay soft for a while.

It's why we laid out the four quadrants.

It's certainly to see another couple of years with it, would bump this historical trend, which is why we wanted to lay out the PPL long runway of data on PPI statistics but certainly it's not out of the question.

That said, the third element, the mix headwind, we would expect to mitigate and we don't see it as a new normal, we see it more as timing.

As we look out, even as one word to hypothesize that pricing remains soft, we still do see leverage in the business and think that what you're seeing right now is in abnormal picture due to timing.

This concludes our question-and-answer session.

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

Thank you, everyone, for joining us today.

As always, I'll be available the remainder of the day and throughout the week for your further questions.

Our next earnings date is set for January 7, 2015 same time and we will look forward to speaking with you over the coming months.

Thanks, again.

The conference has now concluded.

Thank you for attending today's presentation.

You may now disconnect.