MSC Industrial Direct Co Inc (MSM) 2015 Q4 法說會逐字稿

Good morning and welcome to MSC Industrial Supply 2015 fourth-quarter and full-year conference call.

(Operator Instructions)

Please note that this event is being recorded.

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

Thank you.

Good morning, everyone.

I would like you to welcome you to our FY15 fourth-quarter and full-year 2015 conference call.

I'd also like to apologize for the brief delay this morning.

We did have quite a few callers, and we wanted to wait until everybody was on the line.

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 specifics, both of which can be found on the Investor Relations section of our website.

Let me reference our Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995.

Our comments on this call, as well as the supplemental information we are providing on the website, contain forward-looking statements within the meaning of the 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.

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

Information about these risks is noted in our earnings press release and the risk factors and the MD&A section on the latest annual report Form 10-K 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 may 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 to the most directly 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.

Rustom Jilla, our Executive Vice President and CFO, is also in the room; and this will be his first earnings call with us.

Rustom joined MSC on July 20th and, as expected, he's been a great addition to our team, bringing a new perspective and energy at this important time in our journey.

I'll begin by covering the deteriorating and quite difficult demand environment.

I'll then turn to recent business developments which, within the context of the environment, were highlighted by four important results.

One, solid share gain performance.

Two, continued stabilization of gross margins.

Three, very strong expense control.

And, four, as a consequence of the first three, earnings per share slightly above the midpoint of our fourth-quarter guidance.

Rustom will provide additional detail on our financial results.

He'll share our first-quarter 2016 guidance and then discuss our FY16 operating margin framework.

I'll conclude with some additional comments on our expectations for the year and reinforce the opportunity we see going forward, particularly in the increasingly challenging environment.

We'll then open up the call for questions.

So let me begin with market conditions and our performance against the challenging backdrop.

We remain in a difficult environment, where conditions worsened as the quarter progressed.

The root causes for the slowdown remain the same.

The prolonged impact of the rapid drop in oil prices, the strong US dollar and its impact on export demand, and foreign exchange headwinds, all of which are negatively impacting broader manufacturing activity.

Looking at macro indicators, they reflect a sharp slowdown in manufacturing, with US factory activity hitting more than a two-year low in August.

The resulting volatility in the stock markets has not helped confidence either.

Looking at the ISM, it's now at its lowest level in two years, having declined for the past three months.

As for the MBI, the September reading was 44.1, which makes it the sixth month of continued deterioration and readings below 50.

These indicators confirm a considerable slowdown in metalworking activity as the quarter progressed.

They're also very much in line with what we heard from customers and other industry participants.

With the exception of pockets, like aerospace and automotive, customers have seen significant slowdowns in their volumes, their backlogs and their quoting activity.

In addition, visibility remains extremely low.

We're now beginning to hear of layoffs for the first time in quite awhile.

We also believe that some of the slowdown can be attributed to destocking of customer inventory levels, although this is very difficult to quantify.

With respect to the pricing environment, conditions remain extremely soft, due primarily to the lack of commodities inflation.

Supplier or manufacturer pricing activity, which is the primary driver of distributor pricing movement, remains well below historical levels.

As such and as expected, our annual catalog increase was modest, at about 1%.

Within the context of this difficult environment, our Business performed well.

As our share gains continued, we maintained progress on gross margin stabilization.

And the organization heightened its focus on operating expense reductions.

Organic net sales were essentially flat for the fourth quarter on a year-over-year basis, slightly below the low end of our expectations.

The monthly trend deteriorated through the quarter, with low-single-digit growth in June decelerating to a low-single-digit decline by August.

In general, the growth rates for each of our customer classes is moderated.

Our Government business grew at a low-double-digit pace, while national accounts growth came down to low single digits.

Our core customers lag the Company average and were slightly negative for the quarter, reflective of the particularly soft metalworking market.

TCSG also lagged the Company average and declined mid-single digits, impacted by market conditions and foreign exchange.

The combination of these factors means that customer mix remained a gross margin headwind.

Despite the overall slowing growth rate in the quarter, our share gain performance was solid.

Both vending and eCommerce remain strong, as our customers continue to leverage our technology platforms.

eCommerce reached 56.7% of sales for the fourth quarter, up from 55.9% last quarter and 53.7% a year ago.

Sales to vending customers added roughly 2 points to our growth rate.

We also added approximately 150,000 SKUs, net of removals, to our Web offering for the last fiscal year.

And now have about 1 million SKUs available online.

Continued growth in these areas bodes well for future share gains.

With respect to sales force expansion, as we indicated we would do last quarter, we continued moderating headcount growth.

Our full-year expansion came to about 2.5%.

Sales force expansion remains one of our important growth levers.

And in the current environment, we anticipate increasing sales headcount in the low-single-digit range for the upcoming year.

As I mentioned earlier, we maintained our progress on gross margin stabilization.

On our last call, we shared that we expected a sequential decline in the fourth quarter, due primarily to the anticipated step-down in supplier rebates.

While this step-down did have the expected impact, our fourth-quarter gross margin was slightly above the high end of our guidance range.

The overall stabilization continues to be largely a function of the purchasing and selling countermeasures that we've taken.

I also want to note the strong expense control in the quarter.

The organization once again responded to our call to action, bringing operating expenses down to levels flat with last year and considerably lower than guidance.

And this was despite continued spending on ongoing growth initiatives.

I'll now turn things over to Rustom.

Thank you, Erik.

Good morning, everyone.

Let me start by saying I'm delighted to be part of the MSC team.

It's a Company with an ethical, collaborative, caring and very customer-focused culture.

This is a great foundation to build upon as industrial distribution and the manufacturing sector that we serve, are both changing rapidly, and we need to adapt to successfully meet the challenges and fully benefit from the opportunities ahead.

Now let's turn to our fourth quarter in greater detail.

Erik covered sales quite thoroughly.

So I'll simply recap that our sales growth for the quarter on an average daily sales basis was flat, compared to same period last year, and below the low end of our guidance range as the demand environment deteriorated rapidly between June and August.

With regard to gross margin, we posted 45% for the quarter, just about the high end of our guidance and about 60 basis points lower than the fourth quarter last year.

The year-over-year reduction reflects headwinds from customer mix and the soft pricing environment, partially offset by the continued benefit of gross margin countermeasures, such as discount optimization, various freight initiatives, and supplier cost reductions.

These cost reductions will have an increasing impact as we move into FY16.

Our adjusted EPS for the quarter was $0.96, just about the midpoint of our guidance range of $0.93 to $0.97.

Note that there were minimal non-recurring costs this quarter, so adjusted and reported EPS were both $0.96.

As seen in recent quarters, despite sales coming in below the low end of our guidance, our focus on gross margin stabilization and control of our operating expenses enabled us to post EPS within our guidance range.

In fact, our adjusted operating expenses came in roughly $3.8 million lower than our guidance and up approximately $1.2 million from FY14.

This was despite continued investments.

We increased the intensity and focus of various costdown measures that began last year in response to change in macro conditions.

Our focus on reducing discretionary spend, lowering headcount, optimizing freight programs and implementing other productivity initiatives continues to pay off.

As the percentage of sales adjusted operating expenses were just 10 basis points higher than last year's fourth quarter despite [tracked] sales and increased investment spending.

Now, this tight control has intensified as we have entered FY16.

Finally, our tax provision came in at 36.9%, slightly better than our guidance of 37.4%.

Now turning to the balance sheet, our DSOs were 15 days, up from last year's fourth quarter, reflecting continued growth in our national accounts but down 1 day sequentially.

Inventory returns were down to 3.19 from the prior quarter level of 3.29.

However, inventories actually declined by roughly $4 million over the quarter.

So the lower terms are a function of the 13-point average return calculation and reflect the previous inventory buildup related to expected future sales growth, stocking of the Columbus CFC and improving service levels.

Our high cash conversion ratio turned 147% of our fourth quarter net income into cash flow from operations.

This compared to 73% for the same quarter last year.

For the full year 2015, our conversion ratios stood at 108% versus 115% for 2014.

In terms of other use of cash, we paid out approximately $24.7 million in dividends in the fourth quarter.

Total capital expenditures were $13.2 million for the quarter, bringing our total for the year to $51.4 million.

Capital expenditure was slightly lower than expected in 2015, as some projects were pushed into next year.

And 2016 capital expenditure is envisaged to be in the $60 million to $70 million range.

We remain committed to consistent and steady increases in our dividend, and announced last week that the Board of Directors has declared a $0.43 quarterly dividend, up 7.5%.

At the end of Q4, we had roughly $428 million in debt, mostly comprised of $212 million on our term loan and $188 million balance on our revolving credit facility.

We closed the quarter with $38 million in cash and cash equivalents, which resulted in a leverage ratio of 0.87 times.

Our cash flow generation remains strong, and we repaid another $55 million on the revolver in September, such that our leverage ratio at the end of September stood at 0.74 times.

Now to our guidance for the first fiscal quarter of 2016.

And please note that our visibility is limited in the current environment.

We envisage first quarter revenues to decline on an average daily sales basis by 2% to 4% versus the prior year.

Through last Friday, our quarter-to-date sales decline was approximately 2%.

But we have seen the rate of decline accelerate in October and are projecting a mid-single-digit decline in November.

We expect a gross margin of 44.9%, plus or minus 20 basis points, basically flat sequentially and down slightly versus the same quarter a year ago.

While this reflects the headwinds from the soft pricing environment and customer mix, not to mention lower supplier rebates, it also reflects the sustained impact of our gross margin initiatives.

As I noted earlier, the initiatives on discount optimization, supplier cost reductions and freight are giving a sustained benefit.

In addition, as the market environment has grown increasingly challenging, we expect more from our suppliers in terms of cost reductions over the coming quarters.

We also expect adjusted operating expenses in absolute terms to be about $3 million lower sequentially, despite the roughly $2 million increase in medical claims experience.

Absent the increased medical claims, which generally fluctuate by quarter, expenses are expected to be down $5 million sequentially.

Roughly $2 million of this is expected to be the result of a reduction in variable expenses, associated lower volumes.

So the remaining $3 million is expected to be attributable to cost reduction actions net of growth investments.

Our growth investment priorities for 2016 include continued modest sales force expansion, skew expansion, vending growth, digital marketing, and eCommerce, along with a couple of new technology-based sales force effectiveness initiatives.

And as such, we expect an operating margin of about 12.6% at the midpoint of guidance, which is firmly in the lower-left quadrant of our FY16 operating margin framework, which I will discuss in just a minute.

Finally, our EPS guidance for the first quarter is a range of $0.85 to $0.89.

And this assumes a tax rate of 38.4%.

Now turning to our FY16 operating margin framework.

Based on the feedback we received the past couple of years, we continue to look beyond that first quarter.

And so we've provided you with a framework on how we expect our operating margin to perform under various scenarios.

We have summarized it on slide 5 in the presentation.

Similar to last year, the operating margin scenarios are based on two factors, MSC's growth level and the pricing environments.

However, given the current macro environment, our 2016 framework will encompass more challenging scenarios than before.

For MSC growth, our framework now envisions slightly negative and low as likely scenarios.

The slightly negative scenario would correlate with sales declines in the low single digits.

The low growth scenario would envision sales growth in the low single digits.

As I mentioned for our first-quarter guidance, the slightly negative growth scenario is where we are today.

Note that both these levels would be consistent with significant market share gains for MSC in 2016.

Then, with respect to pricing, we also contemplate two scenarios as the environment is generally weakened compared to the start of FY15.

The first scenario is what we call flat and assumes exactly that.

Roughly zero realized pricing.

A low price environment is the second scenario, which assumes roughly 1% of realized pricing.

In a flat price environment with slightly negative sales growth, we see operating margins declining for FY15's adjusted operating margin of 13.2%.

You can see this represented by the lower-left quadrant in slide 5. And unfortunately, this is where we are today.

As we move to a low growth case along with a low pricing environment, which is similar to our FY15, operating margins would improve nicely year over year.

This is represented by the upper-right quadrant.

Let me make a very important point here.

Not only are we improving leverage over FY15 under any scenario, but even at zero sales growth, we expect to maintain our operating margin level.

This demonstrates our rigorous cost control in these challenging times.

As noted before, we are continuing to spend on growth initiatives; but they are being funded by cost savings.

These cost savings include temporary cost-reduction measures, like clamping down further on discretionary spend and also more permanent productivity initiatives.

The productivity efforts range from line items like freight to broader company-wide efforts to reduce waste and inefficiency.

Our team has rallied very well to identify areas of spend, including some roles and job functions that are no longer needed.

Since a good portion of this cost cutting is permanent, this allows us to better leverage sales growth.

In fact, under any positive sales growth scenario, earnings will expand faster than sales.

Finally, I'll note that our cash flow conversion is expected to be over 100%.

And I'll now turn it back to Erik.

Thank you, Rustom.

As I look beyond FY16, I remain excited about this Business.

Historically, economic slowdowns are the times when MSC makes its greatest strides.

And we expect to do the same this time.

While the 70% of the market that's made up of local and regional distributors is on its heels, we are on our toes.

While others are cutting inventories and receivables to preserve cash, our strong free cash flow generation allows us to invest and to provide customers with industry-leading service.

While others are retrenching and only focusing on a handful of accounts, we're attracting new accounts and increasing our share of wallet with existing ones.

While others are hanging on to what they have, we're aggressively pursuing improved purchase costs and supplier deals, and pursuing new supplier relationships that will add to the strength of our product portfolio.

If you look at our track record over long periods of time, you'll find that MSC outperforms the market when the economy recovers.

We historically deliver disproportionate revenue growth and disproportionate earnings leverage.

For example, if you look at the three- to four-year period following the end of previous cycles, we grew on average at strong double digit compound annual growth rate.

And we expanded our operating margins.

And today, with our recent infrastructure projects complete, we have significant earnings leverage potential.

I would like to thank the entire team of MSC associates for their commitment and their strong execution and customer focus during FY15.

And I look forward to more of the same in the year to come.

We'll now open up the line for questions.

Thank you.

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

(Operator Instructions).

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

Our first question comes from Matt Duncan of Stephens, Inc.

Please go ahead.

Good morning, guys.

Hi, Matt.

Hi, Matt.

Rustom, welcome.

Thanks, Matt.

The first question I have, Erik, on sort of your end markets, where are you seeing weakness sort of get worse than it has been?

Where are things sequentially getting worse?

Matt, I would say the answer is more about where it's not getting -- it would be easier if it was not getting worse than where it is.

I think we're seeing pretty much with the exception of a couple of pockets that I mentioned, it's pretty broad-based.

It's particularly acute within our core metalworking related markets.

Heavy equipment and machinery.

Primary metals guys.

Machine shops.

And I would say it's also more acute in the mid-size and small customers than it is at the largest customers.

But it's pretty broad based everywhere, and it's more acute in pockets.

Okay.

So I guess, keeping that in mind then what I'm trying to understand the framework you guys have laid out for FY16 operating margins.

Sort of the low end scenario is slightly negative sales growth.

It sounds like that's where we are in October, maybe November is more like a mid single digit decline.

So how do we get back to sort of slightly negative from here?

Just walk us through what you guys think the shape of the year is going to look like here.

Matt, so I'll take this.

I think the reality is -- let me be clear.

Rustom made the point our visibility is really low.

So it's tough for us to look out beyond the month, let alone a year.

What I'll tell you is that we would characterize our fiscal quarter guidance which was revenues between minus two and minus four.

To us that would fit into this slightly negative bucket.

And that's about where we see things today.

Should they get considerably worse, obviously it would be outside of this framework.

But right now with our limited visibility we have in front of us, we would put ourselves squarely in the lower left.

Totally understood.

Okay.

Last thing on the cost side, can you maybe give us a little more detail on, Rustom, what sort of things are you guys getting more aggressive on taking out on the cost side?

And can you quantify in dollar terms what the annual savings are from the more permanent actions that you're taking?

So, yes, we can.

I would quantify that in dollar terms what we're doing there, but I can certainly talk about what we're doing.

We have various freight initiatives, supply cost reductions, a whole bunch of discretionary costs.

Things like professional fees, IT data cost savings, using virtual meetings, which actually not only sort of cut back on our travel and [I and E costs] but sort of enhance productivity.

And some small headcount reductions, just to name a few.

Probably want to make the point and you can see that looking at our headcount, right?

You see that in the quarter we added roughly, I'm rounding, roughly 30 heads in sales.

Right?

But on net sales headcount overall is down 50.

So you can do the -- you can do the math on what we're doing there.

Now, important to point out the team has been focusing on cost since earlier in the year.

Since earlier in 2015.

But the last two to three months we really ratcheted up our intensity and the whole object is to be able to grow EPS (inaudible) to sales in any environment.

So a great team effort actually.

I think Erik made this point, as well.

People are rising to the occasion as a team.

Okay.

Very helpful.

Thanks, guys.

Thanks, Matt.

Our next question comes from Ryan Merkel of William Blair.

Please go ahead.

Hi, guys.

Good morning.

Good morning, Ryan.

So first question for me, pretty impressed with gross margins.

You stabilized that nicely.

I'm just wondering what does the full year framework assume for gross margins?

And then, second part of that question, what's the mix headwind you're expecting in FY16?

Yes, Ryan, thanks.

Look, I think you're pointing out something that I -- Rustom and I are pleased with seeing the sequential stabilization in the face of what's really a difficult pricing environment.

So let me get right to the point.

To your question what's implicit in this framework, at least particularly with where we are today, which is essentially getting nothing from price would be modest gross margin declines over prior years.

So FY15 ended at 45.2%.

Contemplated here would be with no price modest declines.

And modest to give you a feel would be 50 basis points or less would be modest.

The formula in terms of what you laid out, you touched on customer mix.

Let me sort of pull back and tell you what I think the story -- what's happening in gross margin.

A couple of headwinds right now.

One is customer mix.

Two supplier rebates, which we flagged on the -- probably not surprisingly what we flagged on the last call as revenue growth decelerates.

And the third would be competitive pricing environment.

Very typical as the demand environment gets worse, we see a lot of pressure from the small to 70% of the market, that small distributor.

So not surprisingly either that the pricing environment and the competitive environment gets tougher on the pricing front.

To your point with respect to customer mix, really the -- what we touched on is in this environment, the small account and the mid sized accounts are fairing particularly poorly relative to large accounts.

So to the extent the gap widens between how the larger accounts fair and the small guys fair, you can imagine on a gross margin basis that's going to be the other headwind.

The way we're offsetting that headwind is pretty much what we've been talking to in the last couple of calls as counter measures on the sales side; i.e.

discounting optimization and disciplines.

And then on the buy side i.e.

aggressive focus on supplier cost reductions.

And I think you could expect to see, we expect to see that ratchet up as the year goes on.

Perfect.

That's helpful.

And then another question, the high end of the framework has in my opinion, pretty nice operating leverage, even with low growth and low inflation.

Maybe just talk about this a little bit.

I assume it reflects the end of invested spending and then possibly starting to see some returns on that investment?

Yes, Ryan, it does.

And it does -- it does reflect that.

But it also reflects the fact that we're taking out -- that we're taking out costs.

So, I mean, we're really taking out costs.

So the idea is that at any level of sales, we'd be able to have operating margins and sales growth.

Any level of sales growth we'd have operating margins and EPS begin to expand.

And that's really what that shows you.

Ryan, just to call out, Rustom had made the point that this is really a function -- I think he's absolutely right.

This is the function of the aggressive costdown actions that have been taken and really under Rustom's watch have been accelerated over the past couple of months.

Because if you think about it, even though it's the upper right quadrant of our scenario this year, the environmental conditions are actually reflective of what we had as our lower left quadrant in 2015 because the environment worsened.

If you think about it, in a low price, low demand environment, top-line growing low single digits, we're still expecting top margin leverage and that's a function of the headwinds of the infrastructure investments falling off which we had talked about over the last year that those would fall off.

They have.

And then, really the aggressive cost actions that Rustom described.

Right.

Yes.

I mean, bottom line I think it's a positive change or positive inflection.

It's good to see.

Thanks for taking the questions.

Thanks, Ryan.

Thank you.

Our next question comes from Adam Uhlman of Cleveland Research.

Please go ahead.

Hi, guys.

Good morning.

Hey, Adam.

Hey, Adam.

I had a question on the revenue trends for the quarter and the supplemental data.

You guys do a great job of breaking it down by region and by customer category.

And I guess I was surprised to see the pace of the slowdown was really led on the West Coast where demand slowed the most.

And then where you spread out the growth by customer type, it was the non-manufacturing customers that -- they're still growing pretty decently but slowed a lot from last quarter.

So I'm wondering if you could just break that down a bit more.

Any other granularity on what you might have with what's happening on the West Coast and the non-manufacturing customer types.

Adam, so let me talk -- I would tell you that -- let me talk customer segment first.

Manufacturing, non-manufacturing.

What I would say there, is both have slowed.

But in terms of the absolute growth Delta, you're right, non-manufacturing slowed more.

A couple of things, one is I feel -- it shows as a minus 1.8.

I feel quite good about our share gain performance in the manufacturing sector because realize our manufacturing business is concentrated in highly metalworking centric manufacturing markets, which has really been hit hard.

I think that's a really good result.

I think that's one thing you're seeing.

The other thing I call out is no question as the quarter progressed, the Government, which really had been -- we've been talking for the past year the Government had been performing at very high rates.

Still low double digits is what we described.

But coming down through the quarter.

And I think what you're seeing there is the debt ceiling issue trickling its way into Government spending.

So those are the two things I call out with respect to the segment.

With respect to the -- sorry.

No.

I was just going to say, Adam, from a regional perspective, they all decline with the exception of northeast, which kind of held its strength there.

Unless there's something specific, I would say why don't you get with me after the call, and I can see if there's anything special going on in the west why it came down more than the other regions.

Okay.

Adam, the one thing -- the one thing I would add is regardless of the region as broken out here, the one thing when you get under the coverage that you see is any area and how we define west, I believe has some of those areas captured that have anything to do with oil and gas is down dramatically.

So we see wide swings, even though these are kind of smoothed out averages in specific markets.

Okay.

Got you.

Great.

Thanks very much.

You're welcome.

Our next question comes from Robert McCarthy of Stifel.

Please go ahead.

Good morning, everyone.

Hi, Rob.

Hi, Rob.

I guess just looking at some of your operational statistics, it looks like there was a slight sequential decline for total eCommerce which is not surprising giving the environment and you look at the run rate flattening out.

Maybe you could just give some context around that to kind of start.

Rob, I think the highlight the sequential decline in dollars is, you're right, more a function of the environment.

I think the bigger story on eCommerce and the way we gauge progress is as a percentage of sales.

Yes.

And as a percentage of sales basis, eCommerce is up sequentially year over year.

It's been one of our strong investment stories -- we flagged as an area of investment.

ECommerce encompasses a wide area of efforts, and we're really pleased with the performance of the website and MSC direct.

The way that's working a lot of the investments we've made into functionality have worked out quite well in integrating into our customers.

And so I think it's a really good story, and I think the absolute dollars is just a function of the environment.

Yes.

And then just drilling into international weather.

I think the Canadian exposure is in there, but I think maybe just give the context around the sequentials.

There's an obvious reason for that sequential decline and that deteroiation but maybe you could just give a narrative around that.

Yes.

I think you hit it.

You got it.

It's primarily foreign exchange and it's primarily Canada that's been the biggest influence there, which is a relatively nice size of the class C business.

So I think you hit the nail on the head.

Actually --

Go ahead.

On our macro -- on our overall business, the effects (inaudible) was roughly about 40 basis points in the quarter.

40 basis points.

Okay.

And then just the last question I would have is just qualitatively thinking to your matrix.

I mean, does the low end kind of take into account -- you spoke to obviously the investments you're going to be making and net of the cost initiatives and the investment continues and for share gain.

I understand that.

But, does the bottom end of the range contemplate kind of qualitatively what you all have talked about in the past, which is really just injecting the system with a lot of perhaps sales force or feed them street kind of take a share in a tough recessionary environment or is that something below what the matrix is right now, in terms of how you're thinking about things?

In other words, are you in a scenario right now where you see the prospect for even accelerated share gain in a distressed environment contemplated in this framework?

Yes, Rob, it's a great question and it's one of the things that we have talked about.

And, quite frankly, one of the most exciting things, if you can call exciting about a downturn, is the opportunity to acquire some great talent, to make some great investments that really juice the returns coming out of the recession.

And we said this time will be no different.

A couple of things, one to answer your question directly, the framework does contemplate that, yes.

Two, I would say we're not quite there yet in the current environment.

And really the when we'll know we're there yet is when we see industry talent that otherwise we couldn't get, become available.

We may be getting close, who knows, but we're not there yet.

And just to put this -- some framework around this, hypothetically, if we were highly successful with our efforts and we were able to add an incremental, call it 5%, to our sales force, something in that neighborhood, we would consider that to be a pretty good result.

That 5% is something like, in year 15 to 20-basis point margin impact.

So that kind of gives us some flavor, it doesn't dramatically change the picture and why I can tell you it's contemplated in the framework we laid out.

On the chief custom officer, or any of the other C-suite additions, is there any updates there?

No further updates.

I mean, the update that I will tell you is, for right now I sent an email out to an announcement to our organization internally that I have assumed the role given the current environment, given the incredible opportunity I see right now to accelerate share gains.

I have assumed and stepped into the Chief Customer Officer role.

I think it's a function of the opportunity I see in front of us and also the confidence I have in our leadership team right now as this new team is coming together and really gelling.

I appreciate your time.

Keep punching.

Thank you, Rob.

Thank you.

Our next question comes Ryan Mink of KeyBank.

Please go ahead.

Thanks.

Good morning, guys.

Hi there.

I guess first I wanted to follow up on the operating margin expectations going into next year.

And maybe if there's any way you could talk a little bit about or quantifying the actual headwind from some of the infrastructure investments you made and what that headwind was or maybe even directionally in 2015 how much of a headwind it actually was and how that's rolling off into FY16.

Well, most of the -- if I followed that, I mean, there's pretty much no additional infrastructure investments that are flowing through into 2016, right?

So whatever we had in terms of stepped up infrastructure spending is now in the base.

It's in the comparative period.

So we're getting nothing from that.

What we had or what the company has done is over several years has build up and enhance its capacity.

The focus much more right now in this period in time is to continue to make investments but to make investments that we are funding by taking out costs.

Right?

On a net basis, that's why you're looking at a sort of being fairly confident that we're seeing sequential cost reduction even in the quarter despite continuing to invest.

And that's why we see that quadrant in the top right as Erik nicely pointed out.

The 13.7% up margins coming with the top right are better than what that environment would have suggested last year.

Rustom, is there a way of quantifying what the headwinds were in 2015 in terms of the infrastructure investments on margins?

Ryan, this is John.

I think we said in the past that between the CFC, the Columbus CFC and the CFC down in Davidson that those are -- if you went back to a point in time where you didn't have them at all, that would have been adding something like 15 to 20 -- somewhere in the $15 million to $20 million range of incremental cost.

But, remember, this took place over a several-year period.

So if you're asking 2015 specifically over 2014, I'd have to go back and see what the timing was of those.

But it was more from the CFC last year because the CFC was done in 2014 or even 2013.

The end of 2013.

Does that help?

Okay.

Yes.

That's fine.

Okay.

Maybe I can follow-up with you off line.

And then my second question is I think last quarter you guys gave some nice color on CCSG with regard to some of the cross-selling initiatives that seem to be gaining traction.

It sounds like it was the overall sales for that business was down.

I think you said mid single-digits or so.

Maybe talk a little bit about the traction you are seeing or some of the results on the cross-selling with regard to CCSG.

Yes, Ryan.

So we gave a little color this time that down mid single digits.

What I would tell you on CCSG still highly confident in this business it is a critical part of the MSC story, and one we're investing in heavily.

Obviously, I'd like to see the growth rate better and perform better.

I think a big driver there has certainly been what's happening in the marketplace, just like MSC.

CCSG is being influenced by pretty much the same headwinds with the added impact of foreign exchange because of the Canadian exposure that MSC has lesser.

Look, the three performance levers that we called out that continue to be areas of focus are, number one, improving basic customer service getting into MSC levels of service.

Two, cross-selling products.

And then, three, sales force retooling efforts.

And, what I would tell you, the color I'd offer there is on the service front, really pleased in the customer service experience and the metrics.

I think we're doing a real nice job there.

Cross-selling, as we described, came out of the gate slowly and has picked up pace.

And I expect it based on the work being done to continue picking up pace as we move through the year.

And the third one, sales force retooling is very much a work in process, and I'm encouraged by what I'm seeing there as well.

Okay.

Great.

And then if I may just really one last question, vending seems to be adding some nice offsets to the broader fundamental weakness we're seeing for you guys.

2% or something this quarter.

Is there something going on different with the way you guys are approaching the market with vending today than maybe where you were a couple years ago?

Maybe talk about the vending initiative you guys have and what you expect from that from a sales growth standpoint into next year.

Ryan, sure.

So I would say vending, first of all, take your last question first, we expect to be and you hear it's part of our investment program and we expect it to be a continuing growth contributor.

I would say our approach to vending has been more or less consistent since we started the initiative.

And for us, vending is really just a tool.

It's a tool aimed at helping improve our customer's operations, streamlining inventories, improving their production process, speeding up cycle times.

That's really our focus.

And vending is just a means to an end, if you will.

And I think that's part of the reason why our focus has been pretty consistent.

Our approach has been pretty consistent.

And why it's done well for us is it's been a means to an end.

So I -- that's how I describe it, and we expect it to be a continuing growth driver in the coming year.

Okay.

Good luck, guys.

Appreciate it.

Thank you, Ryan.

Thank you.

And, once again, if you do have a question, please press star and then one on your phone.

Our next question comes from John Inch of Deutsche Bank.

Please go ahead.

Thank you.

Good morning, everyone.

Hi, John.

Hi, John.

Hey, Erik, if the current environment -- it's obvious -- based on the short cycle nature of your business, right, there's not a ton of visibility.

So I guess my question is if the current environment is in the lower left quadrant, why isn't the lower left quadrant the midpoint of the framework?

I apologize if you answered that before.

Why would -- you see my point, right?

Because if you go back a year ago, the midpoint wasn't what you realized.

You realized the lower left.

So now we're starting out with the thing at the lower left.

Why doesn't -- why not just present a framework that slides, the cross hairs into the 12.6, I guess, is my first question.

John, what I would say is right now given the limited visibility, we wanted to start with a framework that contemplated where we are today, which is squarely in this -- that minus 2 to minus 4 guidance what we would consider to be in that lower left box.

We're mindful that as we move through the year, the comps -- even if average daily sales don't grow over time, the comps in the back half of the year -- right now we're facing comps of relatively high growth comps during the first half of the fiscal.

Those declined.

Could things get worse than they are today?

Sure.

They could.

But given the limited visibility and given we wouldn't even -- it would be tough to predict, we felt like this was the most appropriate way to outline the business.

And I think the other point we wanted to make was that in most scenarios contemplated, operating margins, given the cost reductions taken out, operating margins hold or under any growth scenario they grow.

Now, if things were to get worse, would the operating margins come down?

Sure.

But at the same time, we would really step up the cost takeout.

Yes.

That makes sense.

Can I ask you, Erik, so the price environment contemplation has flat at sort of the down side.

But if I remember correctly, I think you actually had negative price incurred in the first fiscal quarter of this past year.

So is there something that you're seeing in the environment that you believe can sustain a flat result?

Because, I realize it's not apples-to-apples.

But others are actually incurring negative price.

Is it -- maybe you could just address that point.

Yes.

John, so the reason we put the two price scenarios here, we -- if you go back, you're absolutely right.

If you looked at our last year at the pricing contribution, we had quarters where I think this past quarter the price contribution was slightly up.

We've had quarters where it was slightly down.

To us, we would consider all of that to be flat, meaning around zero.

Not exactly zero but roughly.

So we've seen it now for several quarters in a row where it's been pretty much a consistent pattern of hovering around zero.

We don't get too excited that it was plus this quarter and minus the quarter before.

So that was why from what we see today, that's been the pattern.

We don't see anything radical changing.

Again, could there be a case of significant deflation?

Maybe.

We don't see it today, which is why we didn't put it in the framework.

No.

That's fair.

That's fair.

Although you did call out pretty significant sequential macro deterioration from August through to October and the 70% of the market cutting price.

So in theory, right, that's not a dynamic that would have been in the past but your point is well taken.

At the end of the day why forecast a lot of stuff you haven't really realized in the past I think is more or less what you're saying.

That's right.

It's Rustom.

There's one more point to add there.

If that really becomes such a strongly deflationary, price reducing environment all around, that would also look for our inputs, right, for what we buy.

It's not going to be only on the price reductions on the selling end.

I agree.

There's an element of pass through, right, is kind of what you're saying.

Yes.

Can I ask one more point.

John has tried to explain this to me before and I think he's done a good job.

I'm a little thick.

If you have vending up 2 % and the results are flat and you've got Government up double digit and you've got -- you've got the national account still and positive, doesn't that suggest kind of the business's out spending Government and national accounts are down high single digit, or is that just not the way to think about it?

John, let me just step back.

So there's a few different cuts that we take to our business.

Yes.

And I think part of the issue there is it's a bit of apples and oranges.

So one cut would be by customer type, which we break out for you by national accounts, Government, and core.

Another cut would be by channel: vending, non-vending, eCommerce, non-eCommerce.

So the only chink in the armor or the logic there is we have vending that's going into Government accounts.

So it's not quite as clean as splitting those apart.

I think to your point, what I would say is if you take -- so when we break out vending growth, remember, what we're doing is describing the growth at customers that have vending machines.

Okay.

That's many, many thousands of customers.

Yep.

And what is true is those customers are adding two points to our growth rate.

The overall growth was flat.

So, yes, it would be fair to say that all non-vending customers were minus two.

Yes.

That would be correct.

And I think from our perspective, that's a function of what's happening, particularly for our core markets.

They have been bad all over.

But core metalworking markets particularly, acutely bad.

But that's the story.

And just last do you think vending can hold up the two?

Because I think it's pretty impressive -- I guess what I don't fully appreciate is why vending doesn't face some sort of, maybe not for MSC, but in general because lots of distributors are introducing these machines and programs.

Why doesn't it face a limiting return if you tap into all of the customers that could theoretically adopt these things?

Do you think the 2% could still hold, because it seems pretty impressive to me?

Yes.

Thank you, John.

We agree.

I would say it's somewhat a function of what happens in the overall environment.

So if you think back a couple of quarters ago, we were talking about vending at three or four points of contribution.

Nothing has really changed in our execution of vending.

It's really been a function of -- so if the demand environment were to come down further, is it possible that the minus two comes down -- the plus two comes down.

It's possible.

I think our execution, though, of the vending initiative has been strong.

The other thing I'd say in terms of runway, I think there's plenty of runway left.

Ryan asked the question earlier about vending.

One point I missed -- this is more of a macro landscape change than an internal change, which is that vending is becoming a lot more ubiquitous in the market.

What I mean by that is, a few years ago, we would be introducing the concept to our customers.

That's no longer the case.

Most customers are familiar with it.

They may have a program in place with another distributor and they're looking to upgrade.

So I think what that does is opens up the pool of runways.

It's pretty broad now.

I do think the program has a lot of legs.

Great.

Thanks much.

I appreciate it.

And our last question comes from David Manthey of Robert W. Baird.

Please go ahead.

Thank you.

Hi, David.

Good morning.

First off, did you say low single digit increase in price in the big book?

Did I catch that correctly?

Around 1%.

So I guess that would be very low single digit, but around one, David.

The lowest possible single digit.

Right.

Second, I think did you -- in your matrix you're looking at flat to higher pricing generally, so I guess you're assuming that you're going to net that out fairly successfully in 2016.

But I think you also mentioned that you're expecting more reductions in price from suppliers in coming quarters.

I want to make sure I heard that right and just how do I put those two pieces together?

So, David, yes, it's Rustom.

Yes, we would be -- we would be expecting and thinking of supplier cost reductions as we move forward.

We are initializing all continuing constructive dialogues with these suppliers.

And, look, basically suppliers that see our value add as a driver of growth in brand building and they're investing in us and obviously, getting strong focus for the resale.

Okay.

So your assumption is you'll be able to capture and maintain the pricing while we're getting on the cost side?

Yes, David, so remember from the framework if you take where we are now, so what's contemplated in the model here that's driving this framework is, as I called it, slight erosion in gross margin which we defined as 50 basis points or less.

So what we have going on, on the headwind side would be the customer mix that I described earlier.

It would be if the demand environment continues, step down rebate program and then the third one would be just the competitive pricing environment with local distributors.

Counter balancing that obviously, in flat pricing, pricing is not as much of a tail wind as it would be.

What Rustom is calling out we would have an additional tail wind that would be bigger than normal which would be cost reductions we're expecting from suppliers.

And, David, just to add to what Erik just said, as we look at this, right, first of all, tough environment.

Right?

So we're looking at on the sales line and trying to outperform the market.

In terms of margins, we're trying to maintain margins through a combination of pricing discipline, supplier, all of the gross margin initiatives and finally through cost reduction.

So we're trying to hit all three aspects of it.

That's very helpful.

Thank you.

Thank you, David.

And this concludes our question-and-answer session.

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

Thank you, everyone, for joining us today.

Our next earnings date is set for January 6th, 2016.

And we will look forward to talking to you in the coming months.

Thanks again.